UPSC
SAMPOORNA
EC
INDIAN
NOMY
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BOOK FEATURES
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Holistic discussion of topics, strictly as per UPSC Prelims and Mains exam syllabus
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One-stop solution for subject-wise coverage
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Diagrams, Flowcharts, and Timelines for quick understanding and revision
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Integrated Preparation of Prelims and Mains stages of this exam
CONTENTS
1. Basics of Economics......................................1
1.1
Difference Between Economy and
Economics.....................................................................1
1.2 Why Study Economics?...........................................1
1.3 Economics and Its Subdivision............................1
1.4 Concept of Positive Economics and
Normative Economics..............................................1
1.5
Macro, Micro and Meso-Economics...................2
1.6
Different Approaches To Studying
Economics.....................................................................3
1.7
Beijing Consensus or State Capitalism
or Chinese Model of Development.....................6
1.8 Washington Consensus...........................................7
1.9 Santiago Consensus..................................................8
1.10 Mercantilism................................................................8
1.11 Behavioural Economics...........................................8
1.12 Green Economics.......................................................8
1.13 Health Economics......................................................9
1.14
S ectors and Types of Economies. . ..............9
1.15 Domestic Economy and Its Sectors................. 11
1.16 Kuznets Curve ......................................................... 12
1.17 Environmental Kuznets Curve.......................... 12
2. Salient Features of the Indian Economy.....13
2.1
Salient Features of Indian Economy............... 13
2.2
Indian Economy During British Times ......... 14
2.3
Indian Economy Posts Reforms of 1991....... 16
3. National Income Accounting......................19
3.1 Concept of Income.................................................. 19
3.2
Concept of Factor and
Non-Factor Incomes.............................................. 19
3.3
Concept of Factors of Production.................... 19
3.4 Meaning of National Income.............................. 20
3.5 Circular Flow of Income....................................... 20
3.6 Household Savings................................................. 21
3.7 Meaning of Economic
(Domestic) Territory............................................. 22
3.8
Methods of Calculating National Income...... 22
3.9
Sectoral Composition of India’s GDP.............. 23
3.10 GDP Deflator............................................................. 24
3.11 Nominal GDP and Real GDP............................... 24
3.12 Concept of Green GDP........................................... 25
3.13 Net Domestic Product........................................... 26
3.14 Gross National Product (GNP).......................... 26
3.15 GDP Vs GNP............................................................... 27
3.16 Net National Product (NNP)/
National Income (NI)............................................ 27
3.17 Fixed Vs Chain Base Method.............................. 27
3.18
Concept of Factor Cost (FC)
and Market Price (MP)......................................... 28
3.19
Meaning of Current and Constant Price........ 28
3.20 Concept of Value Addition.................................. 28
3.21 Gross Value Added (GVA).................................... 28
3.22
Changes in National Income (NI)
Calculations Done in 2015.................................. 29
3.23 Revised GDP Series................................................ 29
3.24
Institutions for Measuring
National Income: CSO; NSSO; NSC................... 29
3.25
Personal Income (PI) and
Disposable Income (DI)....................................... 30
3.26 Capital Output Ratio (COR)................................ 31
3.27 Transfer Payments................................................. 31
3.28 Concept of Seasonality......................................... 31
3.29 Concept of Potential GDP.................................... 31
3.30 Per Capita Income (PCI)...................................... 32
3.31
formal and Informal Sectors of Economy..... 32
3.32
Issues Associated with National Income
Accounting in India................................................ 32
3.33
Solutions To Issues Pertaining To National
Accounting................................................................. 33
4. Economic Growth and Development.........34
4.1 Concept of Economic Growth............................ 34
4.2
Factors Affecting Economic Growth............... 34
4.3
Need for Measuring Economic Growth......... 35
4.4
Cyclical and Structural Growth......................... 35
4.5 Growth Vs Development...................................... 36
4.6
Indicators of Economic Growth........................ 36
4.7
Share of Different Sectors in The Economy......37
4.8 Economic Development....................................... 37
4.9
Indicators of Economic Development............ 38
4.10 Jobless Growth......................................................... 40
4.11
Concept of Developed, Developing and
Least Develop ed Countries................................ 41
4.12 Niti Aayog: India@75- Objective
To Enhance Economic Growth.......................... 42
4.13
Inequality and Socio-Economic
Indicators................................................................... 43
4.14
Relationship Between Inequality
and Poverty............................................................... 43
4.15
Circular Economy or Circularity ..................... 43
5. Economic Planning in India.......................45
5.1 Meaning of Planning.............................................. 45
5.2 Types of Planning................................................... 45
5.3 Multi-Level Planning ............................................ 45
5.4
Indian Economic Planning Before
and After Independence...................................... 46
5.5 Goals of 5-Year Plans............................................. 46
5.6 Need for The Planning.......................................... 47
5.7 Objectives of Planning.......................................... 47
5.8
Dilemma: Agriculture Versus
Industrialization .................................................... 47
5.9
Achievements and Success of Indian
Planning...................................................................... 48
5.10
Failures and Shortcomings
of Indian Planning.................................................. 48
5.11
Nehru-Mahalanobis Model of Growth........... 49
5.12 India’s 5-Year Plans................................................ 49
5.13 Niti Aayog................................................................... 52
6. Poverty and Inequality................................55
6.1
Definitions of Poverty By Various
Institutions and organizations ......................... 55
6.2
Constitutional Mandate Pertaining
To Poverty and Inequality................................... 55
6.3
Sustainable Development Goal (SDG)
and Poverty............................................................... 56
6.4 Types of Poverty.................................................... 56
6.5 Perspectives Towards Poverty.......................... 56
6.6 Concept of Poverty Line....................................... 56
6.7
Estimation of Poverty in India:
Committees on Poverty........................................ 56
6.8
Importance and Utility of
Poverty Estimation................................................ 58
vi
6.9
Challenges in Estimating Poverty.................... 59
6.10
Solution for Effective
Measurement of Poverty..................................... 59
6.11
Highlights of Fifth-Five-Year Plan
(1974-79): Garibi-Hatao...................................... 59
6.12
Concept of Poverty By Amartya Sen............... 59
6.13
Socio-Economic and Caste Census (SECC).... 60
6.14
Indexes/Reports Pertaining To
Poverty and Inequality......................................... 61
6.15 Causes of Poverty.................................................... 62
6.16
Multifaceted Impact of Poverty........................ 63
6.17
Concept of “Feminization of Poverty” ........... 65
6.18 Social Sector in India............................................. 66
6.19
Financial Inclusion and Poverty
Alleviation.................................................................. 66
6.20
Role of Self-Help Groups (SHG)
in Poverty Alleviation........................................... 67
6.21
Approaches for Poverty Alleviation................ 67
6.22 Policies and Programmes Towards
Poverty Alleviation in India................................ 68
6.23
Reasons for Non-Effectivity of
Poverty Alleviation Programmes..................... 69
6.24
Strategies for Poverty Reduction in
Rural Areas................................................................ 69
7. Employment, Unemployment
and Skill Development................................70
7.1 Employment............................................................. 70
7.2
Key Employment and
Unemployment Indicators.................................. 71
7.3 Unemployment........................................................ 72
7.4
Nature of Unemployment in India.................. 73
7.5
Gainful Employment and Its Need.................. 74
7.6 Informal Employment.......................................... 75
7.7 Fixed Term Employment (FTE)........................ 77
7.8 Self-Employment.................................................... 78
7.9 Skill Development.................................................. 79
7.10 Gig Workers............................................................... 81
7.11 Social Security Code 2020.................................. 82
8. Inclusive Growth.........................................84
8.1 Feature of Inclusive Growth............................... 84
8.2
Need for Inclusive Growth ................................ 84
8.3 Elements of Inclusive Growth .......................... 85
8.4
Inclusive Growth:
Constitutional Mandate ...................................... 85
8.5
Approaches To Inclusive Growth..................... 86
8.6 Sustainable Development Goals
and Inclusive Growth............................................ 86
8.7
Dimensions of Inclusive Growth...................... 87
8.8
India @75 By Niti Aayog
and Inclusive Growth............................................ 87
8.9 Policy Interventions To Achieve
Inclusive Growth .................................................... 88
8.10
Environment Vs Development Debate.......... 89
8.11
Challenges in Achieving Inclusive
Growth ....................................................................... 89
8.12
Measuring (Indices and Reports)
Inclusive Growth..................................................... 90
8.13 Way forward............................................................. 90
8.14
World Economic forum
and Inclusive Growth .......................................... 91
8.15 Conclusion................................................................. 91
9. Money and Currency System......................93
9.1 Meaning of Money.................................................. 93
9.2 Function of Money................................................. 93
9.3 Evolution of Money................................................ 93
9.4 Types of Money....................................................... 95
9.5 Creation of Money.................................................. 95
9.6 Demand of Money.................................................. 96
9.7 Money Supply – Monetary Aggregates.......... 98
9.8 Money Multiplier.................................................... 99
9.9
The Velocity of Money Circulation............... 100
9.10 Credit Creation in India..................................... 100
9.11 Variants of Currency........................................... 101
9.12 Currency in India................................................. 101
9.13 Plastic Money........................................................ 103
9.14 Legal Tender Money........................................... 103
9.15
Blockchain and Distributed Ledger
Technology (DLT)................................................ 104
9.16 Crypto Currencies .............................................. 104
9.17
National Payment Corporation
of India (NPCI)...................................................... 106
9.18 Digital Payments.................................................. 106
9.19
Funds and Indices Related To Digital
Payments................................................................. 109
9.20
Digital Transaction
Ombudsman (2019)........................................... 109
9.21
New Umbrella Entity (NUE) for
The Payment System.......................................... 110
9.22 Merchant Discount Rate (MDR).................... 110
9.23
Initiatives To Promote A Cashless or
Less-Cash Economy............................................ 110
9.24 Labels of ATM in India....................................... 111
9.25 Concept of Demonetization............................. 111
9.26 Black Money........................................................... 111
10. The Banking System in India....................113
10.1
History and Evolution of
Banking in India................................................... 113
10.2 Evolution of Banking.......................................... 113
10.3 Core Banking Solution (CBS).......................... 114
10.4 Scheduled Commercial Banks........................ 114
10.5 Private Sector Bank............................................ 115
10.6 foreign Bank........................................................... 115
10.7 Regional Rural Banks (RRB)........................... 116
10.8 Local Area Bank.................................................... 116
10.9 Scheduled Co-Operative Banks...................... 117
10.10
Nationalization of
The Banks: I & II................................................... 120
10.11 Banking Sector Reforms in India................. 120
10.12 Consolidation of Public Sector Banks........ 121
10.13 Differentiated Banks.......................................... 121
10.14 Universal Banking in India.............................. 123
10.15
Marginal Cost of Funds Based
Lending Rate (MCLR)......................................... 124
10.16
Net Demand and Time Liabilities
(NDTL)..................................................................... 126
10.17 Demand and Supply of Money....................... 126
10.18 NPA and Stressed Assets.................................. 127
10.19
(Sarfaesi) Securitization and
Reconstruction of Financial Assets
and Enforcement of Security
Interest Act 2002................................................. 128
10.20 Insolvency and Bankruptcy Code, 2016.... 128
10.21
Prompt Corrective Action (PCA)................... 129
10.22 Mission Indradhanush....................................... 129
10.23 Project Sashakt..................................................... 130
10.24 Miscellaneous: NPA............................................. 130
10.25 Bad Banks............................................................... 130
10.26 Basel Norms........................................................... 131
10.27
Systemically Important
Financial Institutions (SIFI)............................ 132
10.28 Non-Banking Financial
Institutions (NBFI).............................................. 132
10.29
Swift System: Society for Worldwide
Interbank Financial
Telecommunication............................................ 134
vii
11. Rbi and Monetary Policy in India............135
11.1 Meaning of Central Bank.................................. 135
11.2 History of RBI........................................................ 135
11.3
Evolutionary History of Rbi Since
Independence........................................................ 135
11.4
Institutional organisation
of RBI........................................................................ 136
11.5
Structure of Reserve Bank of India.............. 137
11.6 Functions of RBI................................................... 138
11.7 Subsidiaries of RBI.............................................. 140
11.8 Publications of RBI.............................................. 142
11.9 Minimum Reserve System of RBI.................. 142
11.10 Sources of Income of RBI................................. 142
11.11 Expenditure of RBI.............................................. 143
11.12 Rbi Surplus Transfer.......................................... 144
11.13 Autonomy and Independence
of The RBI............................................................... 144
11.14 New Initiatives By RBI....................................... 146
11.15
Monetary Policy of Reserve
Bank of India.......................................................... 146
11.16 Monetary Policy Stances................................... 148
11.17 Tools of Monetary Policy of India................. 148
11.18 Monetary Policy in India.................................. 151
11.19 Unconventional Monetary Policy.................. 153
11.20 The Monetary Authority- New
Emerging Challenges.......................................... 154
11.21 Monetary Policy Transmission...................... 155
11.22 Rbi and Digital Currency.................................. 156
11.23 Timeline of India and Cryptocurrency....... 157
12. Financial Institutions in India..................159
12.1
National Bank for Agriculture and
Rural Development (NABARD)...................... 159
12.2
Small Industries Development
Bank of India (SIDBI)......................................... 160
12.3 Exim Bank............................................................... 161
12.4 National Housing Bank (NHB)....................... 162
12.5
Export Credit Guarantee
Corporation Ltd (ECGC).................................... 162
12.6 Mudra....................................................................... 163
12.7
Financial Stability and
Development Council (FSDC)......................... 163
13. Insurance Sector........................................165
13.1
13.2
13.3
13.4
viii
Origin of Insurance............................................. 165
Risk and Hazard................................................... 165
Proximate Cause.................................................. 165
Insurable Risks..................................................... 165
13.5
Definition of Insurance and
Basic Its Characteristics.................................... 166
13.6 Basic Principles of Insurance......................... 166
13.7
Insurance Sector in India:
Data and Figures.................................................. 167
13.8
History and Evolution (Including
Nationalisation) of Insurance Sector ......... 167
13.9
Economic Reforms and Reopening of
The Insurance Sector......................................... 169
13.10
How Insurance Is Different From
The Banking Sector?........................................... 169
13.11 Types of Insurance.............................................. 170
13.12
Key Distinctions Between Life and
General Insurance............................................... 171
13.13 FDI Reforms in LIC.............................................. 172
13.14 Disinvestment of LIC.......................................... 172
13.15
Employees’ State Insurance
Corporation (ESIC).............................................. 172
13.16
Deposit Insurance and Credit Guarantee
Corporation (DICGC).......................................... 173
13.17
Export Credit Guarantee Corporation
of India (ECGC)..................................................... 173
13.18
Regulatory Institutions: Pension Fund
Regulatory and Development
Authority (PFRDA).............................................. 174
13.19
Regulatory Institutions: Insurance
Regulatory and Development
Authority of India (IRDAI)............................... 175
13.20 Reinsurance........................................................... 176
13.21 Micro-Insurance................................................... 177
13.22
Concept of Insurance Penetration
and Insurance Density....................................... 178
13.23
Reasons for Poor Insurance Penetration...... 178
13.24
Need and Importance of
Insurance Sector.................................................. 179
13.25
Challenges To Insurance Sector .................... 179
13.26 Way Forward......................................................... 179
13.27 Insurance Sector Reforms................................ 180
13.28
Favourable Policy Measures To
Promote Insurance Sector............................... 181
13.29
Committees To Revamp and Reform
The Insurance Sector......................................... 182
14. Financial Market in India.........................183
14.1 Concept of Financial System........................... 183
14.2 Concept of Financial Market........................... 183
14.3 Role of Financial Markets................................. 184
14.4 Functions of Financial Markets..................... 184
14.5 Types of Financial Markets.............................. 184
14.6
Money Market Vis-Vis Capital Market........ 191
14.7
Primary Vis-A-Vis Secondary Market.......... 192
14.8 Instruments of Capital Market....................... 193
14.9
Difference Between Debt and Equity.......... 194
14.10 Forward Contract Vis-A-Vis
Future Contract.................................................... 195
14.11
Angel Investors Viz-A-Viz
Venture Capitalist................................................ 195
14.12 State Development Loans (SDL)................... 195
14.13 Exchange Traded Funds (ETF)....................... 196
14.14
External Commercial Borrowings................ 196
14.15 Security Market in India................................... 197
14.16 Stock Exchange in India.................................... 199
14.17 International Stock Exchange........................ 200
14.18
Securities and Exchange
Board of India (SEBI)......................................... 201
14.19 Commodity Exchanges...................................... 202
14.20 Commodity Markets........................................... 202
14.21 Strategic Disinvestment.................................... 203
14.22
Real Estate Investment Trust (REITS)........ 204
14.23
Infrastructure Investment
Trusts (INVITS).................................................... 205
14.24
Difference Between REIT and INVIT........... 206
14.25 Depository Receipts (DR)................................ 206
14.26 Credit Default Swap (CDS)............................... 207
15. Public Finance
(Budget & Fiscal Policy)............................208
15.1 Meaning of Public Finance............................... 208
15.2 Meaning of Budget.............................................. 208
15.3 Constitutional Provisions Related
To Budget................................................................ 209
15.4
Constitutional Provisions for Funds............ 210
15.5 Vote on Account.................................................... 210
15.6 Interim Budget...................................................... 210
15.7
Objectives of Government Budget................ 211
15.8 Variants of Budgets............................................. 211
15.9
Various Approaches of Budgeting................ 212
15.10
Issues and Challenges With
Indian Budgeting................................................. 215
15.11
Components of Government Budget........... 215
15.12 Finance Ministry and Its Dept........................ 218
15.13 Concept of Deficit and Its Types.................... 219
15.14 Concept of Deficit Financing........................... 221
15.15 Deficit Financing in India................................. 221
15.16 Monetized Deficit................................................. 221
15.17
Fiscal Responsibility and Budget
Management Act (FRBM), 2003.................... 222
15.18 Public Expenditure............................................. 223
15.19 Public Debt/National Debt.............................. 223
15.20 Fiscal Policy............................................................ 225
15.21 Fiscal Consolidation........................................... 226
16. Indian Taxation System.............................228
16.1
General Scenario of Indian Taxation........... 228
16.2
Evolution of Taxation in India........................ 228
16.3
Constitutional Distribution
of Taxation Power................................................ 229
16.4 Distribution of Tax Revenues......................... 229
16.5
Canons of Taxation By Adam Smith ............ 229
16.6 Types of Taxes....................................................... 230
16.7 Methods of Taxation........................................... 230
16.8 Direct Taxation System .................................... 232
16.9 Tax Buoyancy ........................................................ 237
16.10 Laffer Curve............................................................ 237
16.11 Tobin Tax................................................................. 238
16.12 Pigovian Tax .......................................................... 238
16.13 Surcharge................................................................ 239
16.14 Cess............................................................................ 239
16.15 Issue of Cess and Surcharge ........................... 239
16.16 Indirect Taxation ................................................. 240
16.17 Goods and Service Tax (GST) ......................... 243
16.18 Tax To GDP Ratio.................................................. 247
16.19
Eco-Survey 2019: Behavioural
Economics Improve Tax Compliance.......... 248
16.20
Recommendations By CEA
Subramanian K..................................................... 249
16.21 Tax Evasion............................................................. 249
16.22 Tax-Avoidance ...................................................... 250
16.23 Round-Tripping.................................................... 251
16.24 Double Taxation Avoidance
Agreement (DTAA).............................................. 251
16.25
Base Erosion & Profit Shifting (BEPS)........ 252
16.27 Transfer Pricing ................................................... 253
16.28
Place of Effective Management
(POEM)..................................................................... 254
16.29
General Anti-Avoidance Rule (GAAR)......... 254
16.30 Tax Terrorism and Harassment���������������������255
16.31
Taxpayer Charter and Budget 2020 ............ 256
16.32
Case of An Independent Ombudsman
in India – To Ensure Enforcement of
Taxpayers’ Rights ................................................ 257
16.33
Global Minimum Tax (GMT) ........................... 258
ix
17. Inflation.....................................................260
17.1 Concept of Inflation............................................ 260
17.2 Concept of Deflation........................................... 260
17.3
Comparison: Inflation Vs Deflation.............. 260
17.4 Concepts Related To Inflation........................ 260
17.5 Causes of Inflation............................................... 262
17.6
Demand-Pull Vs Cost-Push Inflation........... 262
17.7 Types of Inflation................................................. 263
17.8
Comparison: Headline Vs. Core
Inflation................................................................... 263
17.9 Base Effect.............................................................. 263
17.10
Measurement of Inflation: WPI and CPI.... 264
17.11 Cost Inflation Index (CII).................................. 265
17.12 Producer Price Index (PPI).............................. 265
17.13 Housing Price Index (HPI)............................... 265
17.14 GDP Deflator.......................................................... 265
17.15
Inflation Targeting: Recent Update on
Fluctuation in Range of Inflation.................. 266
18.19
Bilateral Investment Treaty and BIPA........ 280
18.20 Regional Trade Agreements ........................... 280
19. Exchange Rate System...............................282
19.1 Concept of Exchange Rates.............................. 282
19.2
Objectives of Exchange Rate
Management in India......................................... 282
19.3
Determinants of The Exchange
Rate of India........................................................... 282
19.4 Exchange Rate Regimes in India................... 282
19.5
Evolution of The Exchange
Rate Regime in India.......................................... 283
19.6
Concept of Effective Exchange Rates........... 283
19.7
Liberalised Exchange Rate
Management System ......................................... 284
19.8
Concept of Devaluation of A Currency........ 285
19.9
Concept of Depreciation of A Currency...... 285
17.16
What Are The Most Recent
Inflationary Trends?........................................... 266
19.10 Devaluation Vs Depreciation.......................... 285
17.19 Conclusion.............................................................. 268
19.14
Current Wave of De-Dollarisation................ 286
17.17
Effects and Consequences of Inflation........ 266
17.18 Measures To Control Inflation........................ 267
18. External Sector..........................................269
Introduction.................................................... 269
18.1 Open Economy...................................................... 269
18.2 Closed Economy................................................... 269
18.3 Balance of Payment............................................ 270
18.4 India’s BOP Crisis in 1991................................ 272
18.5
Balance of Trade/Trade Balance................... 273
18.6 Balance of Services............................................. 273
18.7 Balance of Transfer............................................. 273
18.8 Currency Convertibility ................................... 273
18.9 Currency Speculation......................................... 275
18.10
Interest Rates and Exchange Rates.............. 275
19.11
Concept of Currency Appreciation............... 286
19.12 Depreciation Vs Appreciation........................ 286
19.13 Global Reserve Currency.................................. 286
19.15
Concept of Currency Revaluation................. 287
19.16 Currency War........................................................ 287
19.17
IMF Special Drawing Rights (SDR)............... 287
19.18
Concept of Purchasing Power
Parity (PPP)............................................................ 288
20. Infrastructure............................................289
20.1 Energy Infrastructure........................................ 292
20.2 Road Infrastructure............................................ 293
20.3 Railway Infrastructure...................................... 295
20.4 Aviation Infrastructure..................................... 297
20.5
Ports and Waterways Infrastructure........... 300
18.11 Income and Exchange Rates........................... 275
21. Logistics Sector..........................................305
18.13
Internationalization of Rupee
and Its Benefits..................................................... 276
21.3 Significance of The Logistics Sector............. 306
18.12
Transitions in The International
Exchange Rate Management Systems......... 275
18.14
Concept of Hard and Soft Currency............. 277
18.15 Forex Currency Reserves/Assets.................. 277
18.16
Concept of Quantitative Easing and
Federal Tapering.................................................. 278
x
18.18
Sovereign Wealth Fund/ Sovereign
Investment Fund.................................................. 279
18.17 Remittances........................................................... 278
21.1 Logistics: Objectives........................................... 305
21.2 Logistics: Data/Facts.......................................... 305
21.4 Issues and Challenges of The
Logistics Sector..................................................... 306
21.5 Way forward.......................................................... 307
21.6 Government Steps............................................... 307
21.7 Conclusion.............................................................. 308
21.8 PM Gati Shakti Mission...................................... 308
21.9 New National Logistics Law............................ 309
21.10
Multi-Modal Logistics Park
in Assam.................................................................. 310
21.11
National Logistics Policy (NLP) 2022......... 310
21.12
Unified Logistics Interface
Platform (ULIP).................................................... 310
22. Investment Models....................................311
22.1 Introduction and Concept of
Investment.............................................................. 311
22.2 Investment Models Used In
India Since Independence................................ 311
22.3 Present Status....................................................... 312
22.4Prominent Investment
Models Used........................................................... 312
22.5 Solow Swan Model.............................................. 312
22.6 Feldman Mahalanobis Model......................... 312
22.7 Rao-Manmohan Model...................................... 312
22.8
Importance of Investment in The
Economy.................................................................. 313
22.9
Factors Affecting The Investment................. 313
22.10 Sources of Investment....................................... 313
22.11
Models Used in The
Investment Process............................................. 313
22.12
Sector Specific Public
Private Partnership (PPP)................................ 316
22.13
Cluster-Based Investment Models............... 317
22.14
Vijay Kelkar Committee Report on
Revisiting and Revitalising PPP Model....... 318
22.15 foreign Investment Models.............................. 319
22.16
Investment Models Followed By India....... 321
22.17 Niti Aayog: ‘Strategy for New India@75’..... 321
23. Agriculture Sector in India.......................322
23.1
Basic Fundamentals of Agriculture
& Allied Sector...................................................... 322
23.2 UN-SDG and Agriculture .................................. 323
23.3
Indian Constitution and Agriculture........... 323
23.4
Current Status of Indian Agriculture........... 323
23.5
Significance of Agriculture Sector
for India................................................................... 324
23.6
Issues in Agriculture
Sector in India....................................................... 324
23.7
Consequences of Agrarian Crisis.................. 325
23.8 Fragmented Land Holdings............................. 326
23.9
Doubling Farmer’s Income: Dalwai
Committee and NITI Aayog............................. 327
23.10
Challenges of Price Fluctuations in
Agricultural Products......................................... 328
23.11 Farmer’s Suicide................................................... 329
23.12 Horticultural Sector ........................................... 330
23.13 Precision Farming............................................... 332
23.14
Rainfed (Dry Land) Agriculture.................... 333
23.15
Zero Budget Natural Farming (ZBNF)........ 334
23.16
Integrated Farming
System (IFS)........................................................... 335
23.17 Agricultural Education...................................... 336
23.18
Research and Development
In Agriculture ....................................................... 338
23.19 Agriculture Extension ....................................... 338
23.20 Farm Mechanization........................................... 339
23.21 Seed Industry........................................................ 341
23.22
Value Chain and Rural Infrastructure......... 342
23.23
Impact of Covid-19 on Agriculture ............. 342
23.24
Animal Husbandry Infrastructure
Development Fund (AHIDF)........................... 343
23.25 Irrigation System in India................................ 344
23.26 Cropping Patterns in India.............................. 352
23.27
Storage, Transport & Marketing of
Agricultural Produce.......................................... 355
23.28
Agricultural Credit and Finances.................. 367
23.29
Issues Related To Direct and Indirect
Farm Subsidies..................................................... 370
23.30 Minimum Support Price (MSP)..................... 377
24. E-Technology in Aid of Farmers...............383
24.1
Significance and Importance of Adopting
E-Technology in Agriculture............................ 383
24.2
Uses Of E-Technology for Farmers............... 384
24.3
Artificial Intelligence (AI)
in Agriculture........................................................ 384
24.4
Initiatives Related To E-Technology in
Agriculture.............................................................. 385
24.5
State-Level Initiatives Involving
Farmers and Electronic Technology............ 386
24.6 Case Studies and Best Practices.................... 386
24.7
Challenges and Constraints in The
Adoption of E-Technology in Agriculture..... 387
24.8 Way Forward......................................................... 387
24.9 Conclusion.............................................................. 387
25. Green Revolution......................................388
25.1 Introduction and Background........................ 388
25.2 Need for Green Revolution.............................. 388
xi
25.3
Components of The Green Revolution........ 388
25.4 Phases of Green Revolution ........................... 389
25.5
The Positive Impact of The
Green Revolution................................................. 389
25.6
Negative Impacts of The
Green Revolution................................................. 390
25.7 Case Study: Punjab Region.............................. 390
25.8 Way forward.......................................................... 390
25.9 Conclusion.............................................................. 391
25.10
Second Green Revolution for
Sustainable Livelihood...................................... 391
25.11
Bringing Green Revolution in
Eastern India (BGREI)....................................... 391
25.12
Four Pillars That will Enable A Shift
To Green Revolution 2.0.................................... 392
25.13 Evergreen Revolution........................................ 392
25.14
Schemes Under Green
Revolution (India) .............................................. 393
26. Economics of Animal Rearing..................394
26.1
Introduction To Animal/
Livestock Rearing................................................ 394
26.2 Objective of Animal Rearing........................... 394
26.3
Potential of Animal Rearing
Economy in India................................................. 394
26.4 20th Livestock Census....................................... 394
26.5
Significance/Importance of
Animal Rearing..................................................... 395
26.6
Challenges in The Livestock
Development......................................................... 395
26.7
Measures To Promote Livestock Sector..... 396
26.8
NITI Aayog: India@75 Recommendations
on Animal Husbandry........................................ 397
26.9
Important Initiatives By Government
To Promote Livestock Sector.......................... 397
26.10
Livestock Sector As A Key To
Poverty Reduction Strategies......................... 398
26.11
Atma Nirbhar Bharat Package
for Animal Husbandry Sector-2020............ 398
26.12 Conclusion ............................................................. 398
26.13
Fisheries Sector: Blue Revolution................. 399
26.14
Dairy Sector: White Revolution
(Operation Flood)................................................ 400
27. Food processing and Related Industries
in India.......................................................403
xii
27.1
Introduction To Food Processing.................. 403
27.2
Status of Food Processing in India............... 403
27.3 Types of Food Processing Food..................... 404
27.4 Scope of Food Processing................................. 404
27.5
Significance of Food Processing
Industries................................................................ 404
27.6 Upstream and Downstream
Requirements of Food Processing
Industries................................................................ 405
27.7
Constraints/Issues in The Development
of Food Processing Industries in India....... 406
27.8
Solutions/Measures Needed for The
Development of Food Processing
Industries................................................................ 406
27.9
Government’s Initiative To
Promote Food Processing Sector.................. 407
27.10 Pink Revolution in India................................... 408
27.11
National Food Processing
Policy (2021)......................................................... 409
27.12
NITI Aayog: India@75 on Food
Processing Industries........................................ 410
27.13 Supply Chain Management.............................. 410
28. Public Distribution System.......................413
28.1 Introduction........................................................... 413
28.2 Background of PDS............................................. 413
28.3 Objectives of PDS................................................. 413
28.4 Importance of PDS.............................................. 413
28.5 Functioning of The PDS..................................... 413
28.6
Issues Associated with PDS in India............ 414
28.7 Reforms for PDS................................................... 414
28.8
Measures To Improve The Efficiency
of PDS........................................................................ 415
28.9 Food Security......................................................... 416
28.10 Global Hunger Index (GHI).............................. 416
28.11 National Food Security Act (NFSA) 2013......417
28.12 NFSA Ranking 2022............................................ 418
28.13
International Initiatives In
Ensuring Food Security..................................... 418
28.14
Case Study: BOLSA Familia (Brazil) ............ 418
28.15
One Nation one Ration Card
Scheme (ONORC)................................................. 418
28.16 Buffer Norms......................................................... 419
28.17 Buffer Stock............................................................ 420
28.18 Conclusion.............................................................. 421
29. Industrial Sector........................................422
29.1
The Current Trend in The
Industrial Sector.................................................. 422
29.2 Classification of Industries.............................. 422
29.3
Composition of Industrial Sector.................. 423
29.4
Facts and Figures Based On
Economic Survey 2022-23............................... 423
29.5 Industrial Policies in India............................... 423
29.6
The Major Features of Most of The
PRE-1991 Policies............................................... 426
29.7
New Industrial Policy
(Nip), 1991............................................................. 426
29.8 Public Sector Undertakings............................. 428
29.9 Disinvestment....................................................... 429
29.10 The Current Disinvestment
Policy (2023-24).................................................. 431
29.11 Special Economic Zone (SEZ)......................... 432
29.12
Tools To Measure The Performance of
Industries................................................................ 433
29.13
Index of Industrial Production (IIP)............ 433
29.14 Index of Eight Core Industries....................... 433
29.15 Annual Survey of Industries........................... 434
29.16
Purchasing Manager’s
Index (PMI)............................................................ 434
29.17 MSME Sector.......................................................... 435
29.18 Industrial Revolution 4.0.................................. 436
29.19 Industrial Corridors........................................... 438
29.20
National Investment and
Manufacturing Zone (NIMZ)........................... 440
29.21 Steel Industry ....................................................... 440
29.22 Aluminium Industry........................................... 441
29.23 Apparel and Footwear Sectors....................... 441
29.24
FDI Policy Measures Pertaining To
Industrial Sector.................................................. 442
29.25 Ease of Doing Business...................................... 443
29.26 Ease of Doing Business 2.0.............................. 443
29.27
Labour Law Reforms: Labour Codes........... 443
30. Service Sector............................................446
30.1
Jurisdiction of The Service Sector................ 446
30.2
Economic Survey 2022-23 and Service
Sector........................................................................ 446
30.3
Factors Responsible for The High
Growth of The Service Sector......................... 446
30.4 Champion Services Sectors ............................ 446
30.5 Service Sector Performances.......................... 447
30.6
Information Technology and Business
Process Management Services ...................... 448
30.7 Communication Sector...................................... 449
30.8 Ports and Shipping Services........................... 449
30.9
Current Challenges in Service Sector ......... 449
30.10 Government Initiatives...................................... 449
31. Economic Reforms in India......................451
31.1
Different Types of Development
Strategies................................................................. 451
31.2
Economic Reforms Gained Popularity........ 452
31.3
Need for Economic Reforms in India.......... 452
31.4 Nature of The Reforms...................................... 452
31.5
Were The Reforms Voluntary
or Obligatory?....................................................... 452
31.6
What Were The Fears Related To These
Reforms At The Time?....................................... 453
31.7
These Reforms Were Basically of Two
Categories............................................................... 453
31.8
Positive and Negative Impact of
Economic Reforms.............................................. 453
31.9 Redefining The State’s Role in Terms of
Economic Reform................................................ 454
31.10
India Vs China: A Comparison Study........... 454
31.11 The LPG Reforms................................................. 454
31.12
Generations of Economic Reforms............... 456
31.13
Review of Economic Reforms in India........ 457
31.14
Unfinished Agenda of Economic Reforms..... 457
31.15
Transformational Reforms Centered
on Economic Growth.......................................... 458
32. Land Reforms in India..............................459
32.1 Introduction........................................................... 459
32.2 Land Structure in India..................................... 459
32.3 Objectives of Land Reforms............................. 459
32.4 Phases of Land Reforms.................................... 460
32.5 Need for Land Reforms..................................... 460
32.6
Success of Land Reforms in India................. 460
32.7
Reasons for Failures of Land Reforms
in India..................................................................... 461
32.8 Advantages of Land Reforms ......................... 461
32.9 Drawbacks of Land Reforms........................... 461
32.10 Hurdles in Land Reforms................................. 462
32.11 Way forward.......................................................... 462
32.12 Women and Land Rights................................... 463
32.13 Model Tenancy Act 2021.................................. 463
32.14
Niti Aayog Action Agenda: Agricultural
Land Policy - Leasing and Records............... 464
32.15 Digitization of Land Records.......................... 464
32.16
Land Reforms and Agriculture
Productivity........................................................... 465
xiii
33. Human Development in India..................467
33.1
Meaning of Human Development................. 467
33.2
Dimensions of Human Development.......... 467
33.3
Approaches To The Human
Development......................................................... 467
33.4
Measuring Human Development.................. 468
33.5
Human Capital Vs Human
Development......................................................... 471
33.6 Demographic Dividend..................................... 472
33.7
Union Budget 2023-24 and Human
Development......................................................... 473
35.6 Issues and Challenges with WTO.................. 488
35.7 Wto and Subsidies Regime.............................. 489
35.8 Categorisation of WTO Subsidies ................ 489
35.9 Agreement on Agriculture (AOA)................. 490
35.10 Market Access....................................................... 490
35.11 Domestic Subsidies............................................. 490
35.12 Export Subsidies.................................................. 491
35.13 Peace Clause Under WTO................................. 491
35.14 Most Favoured Nation (MFN) Status........... 491
34. Bretton Woods Institutions.......................475
35.15
Trade-Related Aspects of Intellectual
Property Rights (TRIPS)................................... 492
35. World Trade organisation (WTO)............486
35.18 WTO and Indian Agriculture........................... 493
34.1
International Monetary Fund (IMF)............ 475
34.2
World Bank and World Bank Group............ 480
35.1
Introduction and Timeline of
The Evolution of WTO....................................... 486
35.2 Objectives of WTO............................................... 486
35.3
Functioning of WTO............................................ 486
35.4 Governing Structure of WTO.......................... 486
35.5 Principles of WTO................................................ 488
xiv
35.16 Geographical Indications (GI)........................ 492
35.17
India’s Trade Concerns and WTO................. 492
35.19 Conclusion.............................................................. 493
36. International Financial Institutions.........494
36.1 Asian Development Bank (ADB)................... 494
36.2
Organization for Economic Co-Operation
and Development (OECD)................................ 495
36.3 B
RICS (Brazil, Russia, India, China
and South Africa)................................................. 496
1
Basics of Economics
1.1DIFFERENCE BETWEEN ECONOMY
AND ECONOMICS
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z
z
z
z
z
z
z
Consumption
On the other side, Economics is an academic
discipline that studies economic activity in general
and strives to make it achievable even when there
are scarcities.
z
Production
The word comes from two Greek words Oikos (family,
household, estate) and Nomos (law or norms).
According to British economist Lionel Robbins;
economics is a “science of scarcity”.
z
Exchange
WHY STUDY ECONOMICS?
Economics is a discipline based on scarcity. There
exists most of the time, a scarcity of resources (food,
land, fuel, money etc) while the needs seem to be
endless.
z
Thus, it is important to balance the needs with
the available resources. The economy allows us
to rationally manage scarce resources and make
priorities.
Economic rationality now also includes equity and
sustainability along with the traditional studies of
production, distribution and consumption.
The initial focus of economics was only on wealth
creation by any means. The human dimension was
missing.
This created misery and inequality. There was a
hue and cry about the overworked and underpaid
population, the inhuman conditions of work and
so on.
After some time, when the society was prosperous
enough and democracy strengthened; the focus of
economics shifted to welfare.
ECONOMICS AND ITS SUBDIVISION
z
When people come together to stock, produce, trade,
distribute and facilitate the spending of goods and
services in an economy as a social activity; it is known
as an economy. The activity is meant for buying and
selling or bartering.
1.2
z
1.3
Distribution
This is the origin point of
economic activity as it dictates
demand. The demand is dealt
with based on consumer
behaviour along with surplus
and diminishing marginal utility.
It is the process in which input
is transformed into output. It
covers the factors of production,
namely land, labour, organization
and capital. It also deals with the
relationship between inputs and
outputs.
It deals with the determination of
prices in different market forms.
It covers trade and commerce.
Consumption depends on the
product ending up with the
consumer.
Any kind of production is the
result of land, capital, labour
and organization. These four
factors of production deserve
a share in wealth. The reward
for factors of production (rent,
wages, interests and profits) and
their prices are studied in this
sub-division.
1.4 CONCEPT OF POSITIVE ECONOMICS
AND NORMATIVE ECONOMICS
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z
z
Economics is considered both- an art and a science.
Positive economics analyses the facts as they are
and examines the causes of a situation. E.g. Why have
prices of services and goods increased?
Whereas, normative economics is prescriptive in
nature. It asks “What should be the prices of articles?”
Hence it is subjective and depends on social, cultural
and political realms.
Thus, positive economics is concerned with “how”
and “why”. While normative is concerned with “what
ought to be”.
z
Examples of Positive
Economics
Examples of Normative
Economics
The injection of money
into an economy will
lead to prices rising.
z
Better irrigation and
fertilizer access will
lead to increased food
grain production.
z
An increasing birth
rate and decreasing
death rate imply the
population growth rate
is increasing.
z
z
z
z
Inflation in an
economy is
preferable over
deflation.
z
Government should
target reducing
inequalities in an
economy.
If a less developed
economy is
witnessing large
production of luxury
and sin goods; it is
not desirable.
The great depression (the 1930s) divided the
domain into macroeconomics and Microeconomics.
The former which dealt with issues at a much greater
scale came into prominence.
John Maynard Keynes is considered the father of
macroeconomics.
z
z
For a better understanding, if microeconomics is a
tree in a forest, then macroeconomics is the entire
forest.
z
Importance of Studying
Macroeconomics
z
z
Microeconomics
z
z
z
2
z
Macroeconomics
1.5MACRO, MICRO AND MESOECONOMICS
z
z
Micro
z
z
Difference between Micro and MacroEconomics
Microeconomics
z
z
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z
and
Microeconomics helps us
understand the operations of
an economy.
It provides tools for policy
and decision-making. E.g.
price determination.
It helps us understand the
economy’s level of economic
welfare.
It helps in the efficient use
and allocation of resources.
We can make predictions
based on microeconomic
studies.
Macroeconomics helps us
understand the functioning
of an economy at a larger
level.
It helps us develop suitable
strategies to solve basic
problems in an economy.
We can understand future
problems and needs that may
arise and develop strategies
accordingly.
We can make comparisons
and do analyses of various
economic indicators.
Studying
macroeconomics
can help us avoid and predict
future crises.
z
z
z
Macroeconomics
Microeconomics
takes into account
small components of
the whole economy.
It deals with matters
of individual agents.
Like why a consumer
or producer makes a
certain decision.
Bottoms-up approach
to analyze the
economy.
Microeconomics is
also known as ‘Price
Theory’.
E.g. It will try
to understand
consumer choices
and their decisions.
Evolved from
the theories of
how prices are
determined.
There are no
competing schools of
thought here.
z
z
z
z
z
z
Macroeconomics is the
study of the economy
as a whole.
A top-down approach
to analysing the
economy.
Macroeconomics is
also known as ‘Income
Theory’.
E.g. It will try
to understand
the dynamics of
national income,
employment, inflation,
poverty, inequality,
investment and saving,
capital formation,
infrastructure
development,
international trade, the
balance of trade and
balance of payments,
exchange rate and
economic growth.
Macro is based on
empirical observations
that theories alone
cannot explain.
It has a competing
school of thought
like- New Keynesian or
classical.
Indian Economy
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z
z
Both micro and macro are interdependent and
complementary since there were many overlapping
issues.
 For example, a rise in inflation will cause a rise
in raw materials leading to price rises which
consumers will pay. Similarly cesses, taxes and
inflation targeting policies etc.
Meso-economics means studying the intermediate
level of economics between the macro and the micro.
Eg auto sector, infrastructure etc.
There are many schools of thought and approaches in
this discipline. Lately, behavioural economics, welfare
economics and sustainability are also emerging as
centres of theories.
Economic Agents or Units
These are individuals or institutions that make
economic decisions.
z
Consumers decide what goods and services & in
what quantity they consume.
z
While producers decide what and how much of a
good or service they produce. Both are economic
agents or units.
z
They can also be governments, corporations,
banks etc which can decide interest rates, taxation,
investment in a sector etc.
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1.6DIFFERENT APPROACHES TO STUDYING ECONOMICS
Approaches to Study
Economics
Political
Economics
Liberal and
Neo-liberal
Economics
Political Economics
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z
z
z
Keynesian
Economics
Socialists and
Communists
Economics
According to this approach, politics and economics
are studied together to understand why a
particular public policy takes a certain direction.
For example, land reforms may be a political
decision; but the impact it has is also on the
economic situation of the country, on agriculture,
investment, livelihood etc.
This approach helps us understand why a certain
decision was taken and the context behind it.
E.g. Liberalization, privatization and globalization
happened close to the demise of the USSR and
communism as an economic system.
In China, the political system decides the priorities
and policies of the economy. Politics sets the values
but economists set the prices.
Liberal and Neo-liberal Economics
z
Adam Smith proposed the idea of an “invisible hand”
in the economy; meaning people working for their
z
Features of
Capitalistic Economy
z
z
z
z
z
z
Mixed
Economy
Gandhian
Economics
Developmental
Economics
own self-interest produce unintended social benefits
and the public good.
Economic rationality: This philosophy is based on
the belief that individuals take rational decisions
within an economic system. Each individual’s selfinterest becomes a common interest for all.
Role of the State: Based on the above principles,
Adam Smith said that the state should limit itself
to providing support services like infrastructure,
defence, judiciary etc.
Laissez-faire approach: The economy should be left
to the market forces. (French meaning- let people do
as they wish).
The early 20th century USA is a good example
of a liberal economy. Whereas, UK post-Margaret
Thatcher and India post-LPG reforms are examples
of neo-liberal economies.
Law of inheritance and Private ownership of property: All resources like land, capital,
mines and machines etc. are owned by private individuals and they can use, keep, and
sell these as per their wish. This property can be transferred to their heirs.
Freedom of choice and enterprise: Individuals can carry out any trade or occupation at
the place of their choosing. Similarly, consumers are free to buy products and services
as per their wishes.
Profit as the main motive: The aim of every producer is to maximize profits. It is the
force behind all economic activity.
Basics of Economics
3
z
z
z
z
z
z
z
z
Merits of the principle
z
z
z
z
z
Demerits of the
principle
z
z
z
Free competition: Government has no control over buyers’ and sellers’ choices. It can’t
prevent them from buying and selling in the market. There is competition between them.
Price mechanism: The market forces i.e. demand and supply determine the prices.
Role of government: It only provides basic services like defence, public health, education
etc. and has a very limited role.
Inequalities of income: It is observed that the rich get richer and the poor get poorer
thus increasing economic inequalities.
Less government interference: Market forces dominate and individuals are in control.
Efficient use of resources for production: As profit is the motive, resources are best
utilized to avoid loss.
Incentivizes hard work: To make the best use of opportunities and maximize profits.
Economic progress: Production and productivity are very high and thus capitalist
countries have high living standards.
The consumer is valued: consumer satisfaction is the ultimate goal of every producer.
Higher rates of capital formation: Savings ultimately lead to investments for the
production of resources. Thus, capital production happens rapidly.
Development of new technology: To maintain market dominance and improve
production; new technology is developed regularly.
Profit maximization: Economic rationality is for profit maximization; irrespective of
the harm it does to society or the environment.
Business cycles: Market failure is a relevant issue i.e., inefficient distribution of goods
and in turn services in a free market with negative implications.
Inequality in information: Information is not equally available or accessible to all.
Thus, economic rationality will vary from person to person.
Wastage and sin goods: Duplication of products leads to large wastage of resources.
Even harmful goods are produced if there is a demand for it.
Class-based society: The society is heavily stratified based on income and as capitalists
and workers.
The above limitations created massive inequalities and
poverty. But the ideas of liberalism made a comeback
in the late 20th century after the communist model
failed, and was termed Neoliberalism.
It is best summed up in the line- “that government
is the best that governs the least”.
After the economic crisis post-Covid pandemic;
the neo-liberal policies of privatisation and lesser
government role in key sectors are being questioned
again.
z
z
z
Keynesian Economics
z
z
z
4
It is centred around the same principles as the
liberal school holds, but a key difference is the
state intervention whenever required.
Pump priming: The nation is expected to provide
economic stimulus during periods of de-growth or
slowdown. E.g. The Government of India announced
the Atma Nirbhar Bharat package of around 20 lakh
crore ($275 billion).
The government is expected to spend on certain
sectors to create an economic activity which will
attract private investment, create jobs, and increase
z
z
demand and business. E.g. PM Gram Sadak Yojana
or MGNREGA.
The central bank is expected to lower interest rates
to increase borrowing and thus positively affect;
the demand and supply which will boost economic
activity.
This approach is a time-tested approach and was
practised globally in the aftermath of the 2008
crisis.
Socialists and Communists Economics
z
z
Economics of Community: This concept of private
property doesn’t exist. The national economy is
completely in the hands of the government. E.g.
Erstwhile USSR, Cuba, Laos, China etc.
Socialist Economics: It believes that a large part of
the economic resources should be in the hands of the
government. This approach believes it is important
that the means of production remain partly in
control of the workers. E.g. Pre-LPG reforms in India,
Nepal, etc.
Indian Economy
z
One example of socialist economics is Nehruvian economics.
 The state owns the basic sectors- banking, infrastructure, communication etc.
 It has centralised socio-economic planning.
 India went for this because we had a bad experience with the capitalist model and we lacked a private sector
presence.
 Also, PM Nehru wanted India to be a welfare state. The Soviet “planned economy” model was working well
at that time.
z
z
z
Features of Socialist Economy
z
z
z
z
z
z
z
Merits of Socialist Economy
z
z
z
z
z
Demerits of Socialist Economy
z
z
z
Mixed Economy
z
z
Public ownership of the means of production: Government owns the means
of production.
Central planning: All major decisions are in a top-down manner and by a
central authority. E.g. erstwhile planning commission in India, and Polit
Bureau in China.
Maximum social benefits: Wealth distribution is a major goal and not wealth
production.
Non-existence of competition: Thus, the consumers have limited choices.
Absence of price mechanism: Prices are determined by the government and
not by market forces.
Equality of income: Private property and the law of inheritance is either
regulated heavily or do not exist at all.
Equality of opportunity: Free health, education and other facilities ensure
equal opportunities.
Classless society: Everyone is supposed to be equal in terms of economic
status in the eyes of the state.
Reduction in inequalities: The Exploitation of the poor and resources by
the rich is not allowed.
Rational allocation of resources: Central authority plans distribution thus
reducing wastage.
Absence of class conflicts: There is no conflict between the rich and the
poor as the society is classless.
End of trade cycles: Less economic fluctuations as economic growth is
planned by a central authority.
Promotes social welfare: wealth distribution is to be done by the state in
an impartial manner.
Red tape of the bureaucracy: There are delays due to inefficiency, corruption
and favouritism.
Absence of incentives: There is little benefit of working hard as the state
doesn’t allow competition and profits are discouraged.
Limited freedom of choice: The consumer and producer both have fewer
choices as the state determines demand and supply.
The concentration of power: Local empowerment and representation are
absent.
Poor quality of service: Wealth creation is slow and little and thus technology
development and efficient governance suffer.
In it, both private and public sectors co-exist and work together towards economic development. It is a
combination of both capitalism and socialism. It tends to eliminate the evils of both and choose the positives of
both capitalism and socialism.
E.g. India, China, Vietnam and even Western capitalist economies that have welfare programs.
Basics of Economics
5
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Features of mixed
economy
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Merits of a mixed
economy
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Demerits of a mixed
economy
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Gandhian Economics
Means of Production and Ownership of Property: Owned by both the public and the
private sector. Although the state has the upper hand in decision-making.
The public and private sector co-exists: Private sector takes care of industries where
profit is the motive while the government is in sectors which can ensure welfare.
Economic planning: National-level planning for both the public and private sectors.
The solution to economic problems: Price mechanism and state intervention solves the
problems of how much, what and for whom need to produce and how to distribute.
Freedom and control: The state has the ultimate control over how much freedom the
private sector will enjoy.
Rapid economic growth: This allows the fulfilment of both public as well as private
goals (welfare and profits).
Balanced economic growth: Different sectors get adequate attention as the state is
not as disengaged as the capitalist economy.
Proper utilization of resources: Government controls how much the private sector
expands. Thus, whenever needed, the state steps in.
Economic equality: Taxation is progressive and the wealth distribution is better.
Other advantages: The government protects the interests of the poor and the weaker
sections via labour laws, taxation, subsidies etc.
Lack of coordination: Since both the private and the public sectors have different
motives; coordination is difficult.
Competitive attitude: Both government and private sector compete more often than
cooperate.
Inefficiency: Lethargic bureaucracy and corruption keep the system inefficient.
Fear of nationalization: Discourages private players from investing in technology
upgradation and a large investment.
Widening inequality: since ownership of resources, laws of inheritance and private
properties are allowed; thus, inequalities are large.
This is based on a set of ideas of Gandhi about the
distribution and economic management of wealth.
Although it is socialist in content; it does not
recommend a centralised approach.
Supports decentralised growth based on equal
participation of labour and some moral prescriptions.
It recommends local economies where local
resources fulfil local needs and employment is
available everywhere equally.
It does not object to machines in general but is
against technologies that replace labour.
Gandhi was impressed by Tolstoy and John Ruskin
when he proposed that every man should be able to
do some labour to earn his own bread. He didn’t see
manual labour in contempt.
“Trusteeship” is another principle. Here he always
recommends, after keeping aside enough for personal
need or investment, the owner should make a trust
of the surplus for the welfare of the poorest of poor.
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Developmental Economics
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On the basis of per capita income, the Human
Development Index, and the Happiness Index, the
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nations have been divided into developed, developing,
and underdeveloped groups.
Post the 2nd World War, the countries that gained
independence inherited a devastated economy and
large population that was poverty-stricken.
These nations didn’t have any private sector and
there was no model for the solution to their problems.
These poor economies were the focus of the
developmental school. The concern was not just
economic growth or structural changes; but also the
well-being of the people.
This school focused on health, education and
employment; either through private or public or a
mix of both.
Some prominent economists of this school are Amartya
Sen, Jean Dreze, Joseph Stiglitz and Jeffery Sachs.
1.7BEIJING CONSENSUS OR STATE
CAPITALISM OR CHINESE MODEL
OF DEVELOPMENT
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It refers to the policies followed by Deng Xiaoping
of China since 1978 which were forwarded as an
alternative to the Washington Consensus.
Indian Economy
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The idea of this consensus was propagated by Joshua
Cooper Remo in 2004.
Here, the authoritarian state is a dominant player
that allows capitalism or a market economy and
controls businesses.
Three main pillars of this consensus are:
1. Constant experiments and innovation.
2. Peaceful, distributive growth with slow gradual
reforms.
3. Self-determination with the inclusion of selective
foreign ideas.
It drew attention when the Western economies were
struggling while China was rising. It is capitalism with
Chinese characteristics.
Some experts proclaimed that the “death of the
market” had occurred. But with economic growth in
China slowing down; economists recommend caution
in following this model blindly.
Criticism:
 What worked for China may not work for every
economy.
 Some blame rise of protectionism and reduced
globalisation on the countries that had tilted
towards Beijing consensus to witness rapid growth.
1.8
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Impacts
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Basics of Economics
These prescriptions led to the process known as
Liberalization, Privatization and Globalization.
Countries that went to ask for help from the IMF or
World Bank due to the Balance of Payment crises;
ended up with a reduced role of the State in economic
affairs and the greater role of the private sector.
It also led to reduced tariffs through the promotion
of globalization by international bodies like the WTO.
Countries were nudged to produce products and
services where they had a competitive advantage.
Limitations
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WASHINGTON CONSENSUS
This was a policy reform suggested by the IMF,
World Bank and the US Treasury Department. It
recommended structural reforms to increase the
role of market forces in exchange for immediate
help.
The term was first coined by a US-based economist
named John Williamson in 1989. It had policy
prescriptions for developing countries that needed
economic help.
It had a 10-point reform policy prescription:
1. The fiscal discipline to avoid fiscal deficits.
2. The Public expenditure priorities toward areas
offering both high economic returns and the
potential to improve income distribution. As
primary health care, primary education, and
infrastructure.
3. Tax reform to reduce marginal rates and broaden
the tax base.
4. Interest rate liberalization as per the market.
5. A competitive exchange rate
6. Trade liberalisation
7. Liberalisation of FDI inflows
8. Privatisation
9. Deregulation
10. Secure property rights
In later times, it came to be associated with terms like
“Neoliberalism, market fundamentalism and even
globalisation”. It was seen as an extreme belief that
markets can handle everything.
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Free trade is advantageous to countries only when
domestic industries are able to compete. Otherwise,
it is harmful.
One size doesn’t fit all. Some countries can grow faster
and better through state intervention. Like China and
Vietnam.
Privatisation before the basic social needs are fulfilled
can leave a nation with few consumers and deter
investors as their income levels are low. E.g. Bolivia
privatized its water industry under IMF pressure and
many could no longer afford water.
Increased deregulation can make economies more
vulnerable to financial disasters. The sub-prime crisis
of 2008 impacted economies that had invested in the
housing market
The South East Asian economic crisis of the 1990s
made these principles unpopular as they were seen
as the US dictating terms of economic development
for sovereign nations.
India and the Washington Consensus
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To maintain a balance in fiscal matters and attain
macroeconomic stability; India has shown prudence
and fiscal consolidation.
This was made legally mandatory to follow after Fiscal
Responsibility and Budget Management Act 2003
(FRBM Act).
But, the pandemic put a lot of strain on economies
worldwide. This led to the IMF and World Bank
suggesting governments all over the world spend
more putting aside fiscal deficit threats.
India also undertook massive spending measures to
boost economic growth and keep the economy on
track.
This is an expansionary of fiscal policy which is
expected to increase growth.
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Latest Trends
Since the pandemic posed unique problems to the
economies of the world; the IMF and WB suggested
a deviation from fiscal consolidation. They
recommended increased government spending.
India mostly has a higher growth rate than the rate
of interest. Thus; this policy will help boost growth
and not lower it. It will also reduce our debt-toGDP ratios.
India’s basic indicators are strong and thus the
economy can handle such aggressive spending for
at least till 2030.
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1.9
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1.11 BEHAVIOURAL ECONOMICS
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SANTIAGO CONSENSUS
This is considered an alternative to the Washington
Consensus for developing countries.
It was recommended by the then World Bank Group
president James Wolfensohn.
It focuses on economic as well as social inclusion and
thus is closer to the Beijing consensus which also has
social overtones.
The World Bank proposed apart from financial aid,
harnessing the power of global best practices and
information technology to suit local conditions.
It enabled governments to focus on socioeconomic
development and inclusive growth. We see this
happening in India as well.
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1.10 MERCANTILISM
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It is a school of thought which thinks that
government should have policies that promote
exports.
It expects that forex reserves build-up will bring in
more investment, make loans cheaper and other
benefits.
This was the dominant thought in Europe between
the 16th and 18th centuries. A country with the
most gold was expected to dominate the whole world.
One model of mercantilism was followed by China
since the 1980s where; it allowed foreign companies
to build in China for export purposes. This led to
Chinese companies coming up to compete.
But China didn’t follow the import substitution policy;
i.e., in order to export it had to import.
Another model is of the USA under the Trump
administration. Trade wars were used to cut the US
trade deficit with the rest of the world. It involved:
 Renegotiating trade agreements.
Imposing high tariffs on imports.
Using state power to open markets for US-made
products.
Weakening the multilateral bodies like WTO.
Tightening the immigration norms.
It is a school which uses the methods and learnings
of various fields to study the economic behaviour
of people and influence the same.
While Adam Smith’s invisible hand assumes that
people make “rational” decisions; this school denies
this as a fact.
Richard Thaler (Nobel in Economics, 2017) says
there can be anomalies in the behaviour of people
which can’t be explained by the existing rational
theories.
This school promotes “nudges” to bring desirable
changes in the behaviour of people. These nudges
can have an impact on both macro as well as
microeconomics.
Its uses can be - bring better adherence to tax laws,
cleanliness, volunteer social work etc.
The Economic Survey 2019 has drawn on Nobel
Laureate R. Thaler’s Behavioural Economics Theory
to lay out what it describes as an “ambitious agenda”
for the behaviour change that will bring in social
change, which in turn, will help India transit to a $5
trillion economy by 2024-25.
It has been used in India, in schemes like the Swachh
Bharat Mission, Jan Dhan Yojana, Beti Bachao Beti
Padhao, etc.
1.12 GREEN ECONOMICS
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This school informs us about the costs in terms of
the land, air and water pollution that come with
economic growth without keeping in mind the
environment.
It warns us about growth that is unsustainable
and that causes productivity losses. It advocates
harmony between nature and economic growth.
It promotes advancing all three together i.e.
economic, social and environmental well-being.
In India, we have had growth that has not been
sustainable. e.g. the green revolution which caused
land degradation and water scarcity in large parts of
the country.
Thomas Malthus’ “An Essay on the Principle of
Population” of 1798 is among the earliest warnings.
The Limits to Growth report of 1972 by the Club of
Rome also reminded us about unsustainable growth.
Brundtland Commission report titled “Our
common future” of 1987 of a UN body defined
Indian Economy
sustainable development as “A development
which meets the needs of the present without
compromising the ability of the future generations
to meet their own needs.”
William Nordhaus (Nobel in Economics 2018)
integrated climate change into the long-run
macroeconomic analysis.
Lately, different bodies and governments have come up
with new indices to measure the Green economy- Green
GDP, Social Progress Index, and Environmental
Performance Index are a few examples.
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1.13 HEALTH ECONOMICS
It is a branch of economics concerned with
efficiency, values and behaviour in the healthcare
sector.
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It covers-
1.14SECTORS AND TYPES OF ECONOMIES
Health indicators
Preventive and curative measures
Medical research and education
Rural Health Missions, Drug Price Control
Neonatal care, Maternity and Child Health
Budgetary allocation for health etc.
Health economists study the healthcare system and
those behaviours that affect health. For e.g. smoking,
drinking etc. They determine how to improve the
outcome of measures targeting this sector. Multiple
costs, financial expenditures and charges are evaluated
in health economics.
As per economic activity; there are the following sectors in an economy:
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Primary Sector
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Secondary Sector
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Tertiary Sector
Quaternary Sector
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Quinary Sector
This sector involves economic activities that take place in exploiting natural
resources.
Agricultural activities, mining, oil exploration etc. are all sub-sectors that belong
to this sector.
When agriculture contributes a minimum of 50% or more to the national income
and livelihood; the economy is called an “Agrarian Economy”.
It involves all those economic activities that involve the processing of the raw
materials extracted from the primary sector.
Manufacturing is a sub-sector which has been a large job-providing sector.
If the contribution of manufacturing is a minimum of 50% to the national income
and employment; the economy is called an Industrial Economy.
This sector is dominated by services-led economic activities; such as education,
banking, healthcare etc.
An economy can be said to be a “Services Economy” when it is dominated by the
activities of the service sector.
It decides the quality of human resources an economy has. It is also called the
“knowledge sector”.
The bureaucracy and the corporate sector; where all high-level decision-making
happens, fall under this category. The people involved are few but enjoy high status
in society due to their role.
Knowledge-Economy
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Here, innovation based on research and development is capitalized upon in the forms of patents and other forms
of intellectual property.
In a knowledge economy; the commercialisation of science and academic scholarship takes place.
It is mostly present in very highly developed countries and depends on skilled labour, communication networks
and incentives present for innovation.
Basics of Economics
9
On the basis of ownership; the economy can be divided into the following three sectors:
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Public Sector
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Private Sector
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Public-Private
Partnership
(PPP)
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It has organizations and bodies that are controlled, owned and managed either fully or
with a majority stake of central or state governments or local bodies.
The main focus is to serve the public and their welfare.
It is run based on capital from tax collection, duties, excise, etc.
This sector provides job security, housing and other benefits, allowances and pension.
This is a preferred sector for jobs in India because it provides the above-mentioned benefits
and chances of getting fired on non-performance are low.
Some major areas of the public sector are railways, defence, police, civil administration,
health, education etc.
Here the ownership, management and control lie with either individuals, groups or
privately-owned companies.
Government has no interference in the day-to-day business and running of this sector.
The main focus is not public welfare but profits. Hence, cost-cutting efficiency is a
hallmark of this sector.
The private sector runs on the capital of promoters/owners, loans, issuing shares,
debentures etc.
This sector offers better salaries, merit-based promotion and recognition of good
work. It has incentives to work hard.
Employees can be sacked if they don’t perform or if the company decides to cost-cut or
downsize. It has a competitive environment and employees get bonuses as incentives.
Some major areas of the Private sector are IT, finance, consulting, services-based industries,
the pharma industry, hospitality and tourism etc.
It is a partnership between one or multiple public and private sector bodies usually to
develop a long-term project.
It helps in attracting funding and expertise for a certain project which is usually for the
benefit of the general public. E.g. Metro, airports, telecom infrastructure etc.
As the demand for delivering faster and better governance expands with the challenge
grows in complexity and scale. Thus, PPP tries to combine the best of both sectors.
The benefits of this model are as follows:
Accountability of the public sector and efficiency of the private sector: The private
sector brings better consumer satisfaction, newer technology and innovative approach.
The public sector brings confidence in completion, accountability and reduced red-tapism
Time and cost-bound of completion work: The private sector adopts technology faster
and is more efficient with expenses and time.
Resource availability: The government is finding it increasingly difficult to mobilize the
resources alone. Thus, inviting investors (foreign and domestic) is a wise step.
The different kinds of PPP projects that are undertaken are in the health sector (linking
private medical colleges with districts to increase the number of available doctors), power,
railways (Tejas express), urban infrastructure etc.
On the basis of working conditions; the economy can be divided into the following two:
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Organised Sector
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In this sector, the working conditions are good and are fixed. The employees also have
social security benefits (Provident fund, pension, health insurance etc.)
Jobs in this sector are registered with the government and various laws and rules apply
to them.
Employees have job security, fixed working hours and extra pay if they decide to work
extra hours. E.g. banking, teaching, nursing etc.
The prevalence of jobs in India in this sector is very low.
Indian Economy
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Unorganized Sector
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This sector includes those workers who are self-employed, gig economy workers
and daily wagers.
Those workers from the organised sector that are not covered under welfare schemes
mentioned in the “Unorganized Workers Social Security Act” 2008 are a part of this
sector.
The employment is casual and seasonal and hence workers are non-unionized and
depend entirely on their daily earnings (in most cases).
There is no legal or unionized protection and a lack of stable income and employment.
Even if protections are brought in; it is difficult to implement as the workers are scattered.
All of the above doesn’t mean that this sector is not important. It contributes almost
60% to the national income.
1.15 DOMESTIC ECONOMY AND ITS SECTORS
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An economy can be divided into domestic and external/rest of the world. A domestic economy includes all resident
economic units. These are:
 Households: A group of people who share accommodation, save collectively, consume certain goods and services
and may engage in productive activity.
Legal entities: are those that engage in economic transactions, decision making and concluding contracts in
their own rights. They can be Governments, enterprises or Corporations, Non-profit entities (legal or social
entities), etc.
The domestic economy may be divided into three larger sectors namely:
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General government
sector
It includes all those departments that provide free services to the people. The inclusion
of a department in this sector is based on objectives and functions and not ownership.
Its functions are:
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Real sector
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Financial sector
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Provide households with certain goods and services financed through taxes or
other incomes.
Redistribute wealth by means of transfer.
Produce non-market goods and services.
Examples are governance, defence, national security, health, education etc.
It refers to all real or non-financial elements of an economy.
It consists of-
Enterprises (non-financial corporations)- Those domestic units that are involved
in the production of market goods (those that are sold at market prices) and nonfinancial services.
Households.
Non-profit institutions serving households.
It is the sector which holds money or the money-holding sector.
It is the economy’s money-issuing corporations included principally in financial
activities and intermediations.
E.g. a bank, an institution that borrows and lends, an institution that attracts funds
from shareholders to invest in equities/shares, or a body that invests in securities
from funds raised from policyholders.
It does not include those corporations that don’t incur liability on their own account
for provisioning financial assets. E.g. brokers, dealers, stock exchanges, foreign
currency exchanges, securities markets etc.
Basics of Economics
11
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It helps in understanding how these two variables
change as an economy turns industrial from primarily
agricultural.
It shows that income inequality first increases and
then decreases after reaching a peak as per capita
income increases.
Rapidly industrialised economies of England, Sweden,
France and Germany appear to follow the curve. But
the Netherlands and Norway didn’t and had a different
experience of inequality.
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Services Led Growth in India
India transitioned from agriculture to a services
economy directly; thus skipping the industrial
economy during the 1990s.
This is one of the major reasons for India witnessing
a phase of “jobless growth” because manufacturing
generates more jobs than services.
Even
within
services,
modern
services
(communications, IT, financial, business etc.) have
dominated over traditional services like the retail
and wholesale markets
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1.17 ENVIRONMENTAL KUZNETS CURVE
A modification of the Kuznets curve has become
popular to chart the rise and subsequent decline
in pollution levels of developing economies.
First developed by Gene Grossman and Alan
Krueger and later popularised by the world bank.
It follows the same pattern as the original curve.
As per the modified curve, environmental indicators
deteriorate as an economy industrializes until a
turning point is reached.
Indicators then begin improving again with the aid of
new technology and more money.
For example, sulphur dioxide levels decreased in the
USA with increased regulation even as the number of
cars on its roads held steady or increased.
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Which of the following activities include the real sector
in the economy?
(2022)
1. Farmers harvesting their crops.
2. Textile mills converting raw cotton into fabric.
3. A commercial bank lending money to a trading
company.
4. A corporate body issuing rupee-denominated
bonds overseas.
(a) 1 and 2 only
(b) 2, 3 and 4 only
(c) 1, 2 and 4 only
(d) 1, 2, 3 and 4 only
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Trade-Offs
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1.16 KUZNETS CURVE
It is a hypothetical inverted U-curve that plots
economic inequality against income per capita over
the course of economic development.
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Inequality
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Since the basic assumption of economics is
“scarcity”; there have to be trade-offs.
It is the policy decision which prioritises one goal
and compromises on one goal to achieve the other.
For example; the Reserve Bank of India will hike
the interest rates to target inflation, even though
the move will limit economic growth.
Similarly, the government can borrow to subsidise
some agricultural expenses. This increases
government debt but addresses poverty and
ensures stability.
OpinionMatters
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Income per Capita
Simon Kuznets was the economist who propagated
this curve.
v
12
v
Do you think the headwinds in the global supply chain
can impact the microeconomic and macroeconomic
credentials of India?
v
Indian Economy
2
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Salient Features of The
Indian Economy
professions such as trade, hotel, transport, insurance,
real estate, tourism etc. India has been among the top
10 countries in providing services in different sectors.
 The tourism industry contributes significantly to
our economic growth through economic growth,
foreign exchange, and so on.
 Indian IT Industry is the top export service
provider in the country. Software and Engineering
are growing rapidly and contributing to revenue.
 Space sector is growing rapidly and changing the
demand-driven model.
 Ports services are promoting growth in the
country through import-export services, increased
cargo capacities and port-led development.
The Indian economy is a growing market economy
with a middle income. It has the world’s fifth-biggest
economy in terms of nominal GDP and the thirdlargest in terms of Purchasing Power Parity (PPP).
2.1SALIENT FEATURES OF INDIAN
ECONOMY
2.1.1 Strengths of Indian Economy
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Mixed nature of Economy: The Indian economy
exemplifies how the private and governmental sectors
may work together to advance the economy. It is a
combination of a socialistic economy and a capitalistic
economy. For example, The profit motive in the
private sector and the welfare motive in the public
sector. Liberalization helped in the limitation of the
role of Governance in the private sector.
Pre-dominance of Agriculture: Two-thirds of
India’s population is involved in agriculture directly
or indirectly and the agriculture sector accounts for
the maximum GDP percentage in comparison to the
services sector.
Emerging Economy: India is a developing economy
and has gained its place in the world economy through
strong economic growth, trade volume, increased
liquidity, high per capita income, FDIs, debts markets
etc. It is quite likely to surpass Japan and become the
2nd largest economy in Asia by 2030.
Demographic Dividend: Potential of economic
growth with the help of population structure. India’s
working population share in the world (people from
age 14 to 65) is more than the non-working population
age (above 65). India is known as a Youthful nation
with an average age of 28 years compared to other
countries.
Rapid Urban Growth: Growth is inevitable and
people migrate from the countryside to the city due
to economic, demographic, social etc reasons. Every
country has experienced urbanization and is still on
the rise. The Indian population is rapidly increasing
and more than 75% of national income is generated
by cities.
Fast Growing Service Sector: Largest and fastestgrowing sector which covers a wide variety of
2.1.2 Weaknesses of Indian Economy
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Low per Capita Income: India’s per capita income is
very little in size as compared to developed countries.
Central Statistics Office (CSO), The per capita income
rose by 18.3 per cent to Rs 1.5 lakh during 202122. In 2021-22, per capita income at constant prices
remained below the pre-COVID level, at Rs 91,481.
Large population base: Indian population is
increasing rapidly and a UN report said that in 2023,
India will surpass China to become the most populous
country in the world. The high rate of Population
growth worked against the growth rate of the economy.
Inequality and Poverty: The economic disparities
of the Indian economy where the top 10% of Indians
hold the maximum portion led to an imbalance in
society. COVID-19 has increased poverty, with a large
number of individuals now living below the poverty
line (BPL). Due to this unequal distribution, the rich
become richer and the poor become poorer and
impeding the economic progress of the nation.
Obsolete technology: New technologies are
expensive and require skilled forces to operate them.
The deficiency of human capital and the absence
of skilled labour are major hurdles to spreading
technology in the economy. Poor farmers and micro
or small industries cannot afford modern and more
productive technologies which adds woes to economic
growth.
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Inadequate employment generation: With a
growing population, the percentage of unemployed
youth is also increasing. The growth of our economy is
not helping in job creation but rather characterized by
jobless growth. Nearly half of the working population
is engaged in agriculture and the Unemployed working
population contributes to the economic issues.
 According to the Public Labour Force Survey
(PLFS), the unemployment rate will be 4.2% in
2020-21, down from 4.8% in 2019-20.
 Rural regions had a 3.3% unemployment rate, while
metropolitan areas had a 6.7% unemployment
rate.
Low rate of Capital Formation: Lower level of
income is due to a low rate of capital formation and
the only way to improve the standard of living is to
increase the rate of gross capital formation. India
always faced the problem of capital and required a
gross capital formation of more than 15 per cent to
balance depreciation. However, real gross fixed capital
formation (GFCF) is expected to record a large decline
of 9.8 per cent in 2020-21; it is projected to grow by
6.8 per cent in 2021-22.
Lack of basic infrastructural facilities: Including
transportation, communication, electricity generation,
banking and credit facilities, health, educational
institutions, etc. The underutilization of natural
resources in India contributes to the country’s
economic problems.
2.2INDIAN ECONOMY DURING
BRITISH TIMES
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Before the British administration in India, the
Indian economy was self-sufficient and well-known
for its handicraft industry. The present-day of our
economy has its origin in the long period of British
rule. The purpose of colonial rule was to exploit
India’s resources and use them as a supplier of raw
materials for Britain’s expanding industrialization.
Before British rule, the main livelihood of most
people was agriculture. The Indian handicraft sector
was well-known in international markets for the high
quality of its cotton and silk fabrics, precious stones,
spices, metals, sugar, and other products. For example,
Muslin was a type of cotton famous in Bengal and
places around Dhaka which gained popularity and
was called Malmal.
During colonial rule, economic development
reduced India’s independent economy to that
of a supplier of raw materials and consumer of
finished products manufactured in Britain. The
economic policies used by them were protecting
and promoting the economic interests of Britain.
The economic policies of colonial rule were more
of protection and promotion of the economic
interests of British rule. They never made a serious
attempt to estimate India’s national income. Indian
economist estimators who tried to expose the reason
behind India’s economic drain were Dadabhai
Naoroji (Poverty and Un-British Rule in India),
V.K.R.V Rao and R.C. Desai.
Agricultural Sector
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The majority of the country’s population was
agricultural, with 80% living in villages and earning
a living from agriculture.
A large population was involved in the Agricultural
sector but continued to face stagnation and low
productivity. The deterioration was caused due to
various land revenue settlements.
Zamindari system was implemented in the then
Bengal and parts of eastern states and profit out
of the agriculture went to zamindars instead of the
cultivators. Not only the colonial authority but also
the zamindars did whatever to improve agricultural
conditions. Their main interest was to collect rent
without paying any attention to improving the
agricultural land.
Land holdings were small and scattered, making it
difficult to cultivate. The level of productivity output
per hectare was also low.
Agriculture was overly reliant on rainfall for
excellent output, but inadequate rainfall resulted in
poor output.
Commercialization of agriculture, demand for the
productivity of cash crops, lack of irrigation facilities,
insufficient use of fertilizers etc. all added to intensify
the gloomy picture of agricultural productivity and
aggravated farmers’ plight.
Agricultural production faced setbacks due to
partition which led to an adverse impact on India’s
production because of the highly irrigated and fertile
land that went to Pakistan. A similar fate was faced in
Jute production when the maximum jute-producing
area became part of Bangladesh (erstwhile East
Pakistan) where India enjoyed a monopoly and now
suffered heavily.
Industrial Sector
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The Indian handicraft industry could not
transform its industrial base in the colonial period
even after gaining worldwide popularity and demand
for textiles. The colonial government policy of
de-industrialization led to the decline of handicraft
industries and no other industry came up to replace it.
The purposes of the colonial government behind
deindustrialization were:
 To exploit India as a low-cost supplier of raw
materials for companies being established in
Indian Economy
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Britain, and to sell British products at a higher
price in the Indian market.
 To use the Indian market as a dumping ground
for the finished products of those industries and
continue their expansion to help their home
country.
The decline of India’s handcraft industry resulted
in huge unemployment. This raised the demand for
commodities in the Indian market, which was satisfied
by imports of low-cost manufactured goods from the
United Kingdom.
Fewer capital goods industries were present to aid in
the promotion of industrialization. Few cotton and
jute textile mills established by a few Indians were
mostly found on the west coast of Maharashtra and
Gujarat, but they did not help to replace traditional
handicraft industries.
The contribution to the growth rate of the new
industrial sector to GDP was very low and very
limited to help the public sector. A few operations
taken by the colonial government which they
developed for their advantage and later turned out
to be useful for the public sector were railways, power
generation, communications, ports, postal system etc.
Objective of British rule was to never develop such
an industry that could compete with the British
industry. It always wanted to make the Indian industry
subservient to British industry for capital goods.
Foreign Trade
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Goods and services exchanged between two or more
countries. India has been trading with nations
since ancient times but it all changed due to
restrictive policies, trade and tariff duties imposed
on exports affecting India’s foreign trade. India was
a net exporter of raw silk, cotton, wool, sugar, indigo,
jute, spices, and other commodities, but it became a
net importer of completed goods such as cotton, silk,
and woollen clothing.
Britain maintained control over India’s exports and
limited most commerce to it and a few surrounding
nations such as China, Ceylon (Sri Lanka), and Iran
(Persia).
Most important part of the trade was the export
surplus which affected India’s economy severely.
The export surplus did not result in an inflow of gold
or silver; rather it was used to make the payments
for expenses incurred by offices set up in Britain.
The expenses of war fought by colonial governments
inside and outside India and the import of invisible
items led to a drain of wealth.
Foreign trade has been impeded by discriminatory
tariffs and trade policies. The opening of the Suez
Canal aided in maintaining control over India’s
overseas commerce.
Salient Features of The Indian Economy
Demographic Conditions
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The census of the population of India was conducted
through 1881 and showed the differences in India’s
population growth.
Overall literacy level was less than 16% which
increased to 74% in 2011.
Parts of India were severely affected by famines and
income was spent on necessities for the satisfaction
of their needs.
High birth and mortality rates (the number of children
born and killed per thousand in a given year).
Lack of public health infrastructure facilities and
widespread diseases.
High infant mortality rate (the number of newborns
dying before the age of one year per thousand live
births).
Extensive poverty during the colonial period
showcased the worst condition of India’s population
under their rule.
Occupational Structure
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There was no notable change in the occupation
because agriculture employed the bulk of the people
(70-75 per cent).
Manufacturing and the services sector’s share were
10-15 percent respectively.
Orissa, Rajasthan and Punjab saw an increase in the
share of the workforce in agriculture.
Infrastructural Sector
Basic infrastructure facilities such as railways,
telegraphs, posts, ports etc. were developed not for
the people but the real purpose was to expand the
reach and fulfil colonial interests.
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Roads were constructed during the colonial period
to mobilise the Indian army and move raw commodities
from the countryside to the nearest railway station for
export to England and other foreign territories.
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Introduction of railways in India happened in
1854 and was one of the most crucial contributions
done by the British. But the social benefits gained by
railways were outweighed by economic loss and the
benefits of exports never reached the Indian people.
z
It helped people to travel long distances and broke
cultural and geographical barriers.
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It also helped in the commercialization of Indian
agriculture which affected the self-sufficiency of
Indian villages from the produce.
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Inland trade route development of water and sea was
inadequate and built at a huge cost to the government
exchequer.
At the moment of independence, British colonial control
was unmistakable. The agricultural sector saw excess
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15
labour and severely poor productivity, while the industrial
sector was far from modernization, diversification, and
investment. Poverty and unemployment required public
policies for the welfare of people. In short, socioeconomic
challenges were enormous to overcome.
2.3INDIAN ECONOMY POSTS
REFORMS OF 1991
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India has been following a mixed economy by
uniting the features of both the market economy
and the planned economy system.
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The crisis raised the prices of vital items and compelled
the government to implement new policy regulations
to assist in shifting development strategies.
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The central bank’s (RBI) foreign exchange reserves,
which are used to keep the trade balance in control
and to purchase fuel and other essential products,
have fallen to inadequate levels for even a month.
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Gains
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Failures
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During the first three decades of
planning, the growth rate accelerated slowly, with an average
growth rate of 3.5-4 per cent.
Because of agrarian society and
the potential of multifunctional
projects like dam construction,
Green Revolution, and so on,
agricultural sector development
was projected as high, with a
growing rate of roughly 23-25
per cent.
Development of the heavy capital goods sector, irrigation projects, thermal power production
projects, and public transportation improvements.
Employment
generating
opportunities were few. India
was facing the problems
of Under­
employment and
Unemployment.
More than 75% of the population
was living below the poverty line
(BPL), and decades of planning
had failed to eliminate poverty
and promote growth for all.
Agriculture productivity was
at an all-time low, and land
reforms had failed.
A weak, uncompetitive industrial foundation was ineffective in promoting capital goods
industries.
Economic Crisis of the 1980s
In 1991, India suffered an economic crisis caused
by an increase in external debt, which meant that
the government was unable to repay its foreign
borrowings.
PRE-1990 Reforms Period
16
z
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Government expenditure was more than the
revenue that the government borrowed to finance the
deficit through banks.
Loans were obtained from both domestic and foreign
financial organisations.
Price increases for vital commodities.
Imports increased at an alarming rate while exports
remained unchanged.
Decline in foreign exchange reserves sufficient to
finance imports of gasoline, luxury products, and so
forth.
Not enough foreign exchange currencies to pay
interest as repayment to international lenders.
The government did not produce more money by
spending on development activities.
To alleviate the crisis, India sought the International
Bank for Reconstruction and Development (IBRD),
also known as the World Bank, and got a $7 billion
loan to handle the situation. These foreign institutions
required a few adjustments in the country’s economic
policy decisions in order for the loan to be approved.
Conditions
changed
for
International
organizations were:
 Introduction of New Economic Policy, which
included a more competitive economic climate.
 Firms’ access and exit barriers are being removed.
 Maintain enough foreign exchange reserves and
keep growing costs in check.
 Improving
the economy’s efficiency and
international competitiveness by reducing
rigidities from diverse areas.
 Reduction in the import tariff rate.
 Hike in excise duties to neutralize revenue
shortfalls.
 Cut down government expenditure by 10 per
cent.
Reasons for Economic Reforms
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Rise in inflation from 6.7% to 16.7% caused an
increase In money supply.
Rise in fiscal deficit due to increased nondevelopment expenditure and which increased
public debt.
Indian Economy
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Balance of Payments (BOP) was adversely affected by the due increase in imports.
Increase in petrol prices due to the Iran-Kuwait war (1991).
PSUs became a drain on government coffers and were underperforming in terms of increasing government
investment.
Foreign Exchange Reserves have fallen to their lowest level, leaving them unable to cover import costs.
Liberalization-Privatization-Globalization (LPG) Framework
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Liberalization
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Privatization
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Globalization
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Greater freedom to give private sector industries and businesses to trade. Reduction
in the government control on the same.
To allow various sectors of the economy to open up by decreasing the regulations
and restrictions.
Removal of Industrial Licensing and Registration.
Bringing down the restriction levels on imports and import duties.
Decrease in personal and corporate taxes.
Liberalized rules for FDIs and FPIs.
Allowing private players to enter into the public sector such as power, energy,
telecom, transport etc.
When the sale of shares (51% and above) of state-owned assets i.e. the ownership
is transferred to the private sector is called privatization. Another way was the
withdrawal of the government from ownership and management of public sector
companies.
Deregulation of the state and introduction of reforms in markets and public services.
State assets were made open to private sectors.
Disinvestment and ownership transfer from the state to the private sector.
Sale of assets to improve the financial system and adopt modernization.
To incorporate the private capital and utilization of managerial capabilities to
improve the performance of PSUs.
To attract FDI inflow in the country.
Autonomy to PSUs in making managerial decisions without government interference
at the management levels.
Increase in economic integration and interdependence among nations. Unrestricted
movements of goods and services, capital and labour through international borders.
Globalization links economy and society in a way that the occurrence of an event in
one corner of the earth can have its influence in another part of the world, creating
a borderless world. (Vasudhaiva Kutumbakam in Sanskrit).
To open the domestic markets for the inflow of foreign products by reducing the
customs duties on imports.
Abolition of import licensing and Elimination of tariff barriers to encourage trade
activities.
The economy’s opening resulted in a quick expansion in FIIs, FDIs, and Foreign
Exchange Reserves.
The GOI permitted the infusion of foreign finance through stock in several
enterprises.
TRIPS (Trade Related Intellectual Property Rights), TRIMs (Trade Related
Investment Measures), and other international agreements were inked with the
WTO.
Salient Features of The Indian Economy
17
Effects of Globalization on the Economy
Positives Effects of Globalisation
Negatives Effects of Globalisation
Increase in India’s share in foreign trade.
Increase in foreign investment through FDI and FII.
Foreign currency reserves will grow (to more than
600 billion US dollars by 2022).
Technological advancement as a result of the influx
of foreign firms, which facilitated the influx of
current superior technology. For example, Maruti
Suzuki, Hero Honda, and so on.
Improvement of quality, product value and
marketing helped in brand development.
Foreign companies helped in solving the employment
issue. For example- MNCs, BPOs etc.
Reduction in the percentage of brain drain.
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Globalization with the help of Liberalization and
Privatization policies has a mixed bag i.e. negative and
positive results. Innovation and advancement should be
seen as growth by comparing it with our previous self
from where we started and where we have reached.
LPG reforms helped India as well as other countries too
through unlimited opportunities, high technology and
increased possibilities for developing countries to become
important players.
4. The growth rate in rural employment decreased.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 and 4 only
(c) 3 only
(d) 1, 2 and 4 only
2. Which of the following has/have occurred in India
after its liberalization of economic policies in 1991?
(2017)
1. The share of agriculture in GDP increased
enormously.
2. 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
**Note: Reforms of 1991 have been dealt with in detail in
the “Economic Reforms In India” chapter.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the Indian economy after the 1991
economic liberalization, consider the following
statements:
(2020)
1. Worker productivity (per worker at 2004 -05
prices) increased in urban areas while it decreased
in rural areas.
2. The % age share of rural areas in the workforce
steadily increased.
3. In rural areas, the growth in non -the farm economy
increased.
v
18
Loss to domestic industries and increase in domestic
competition.
Exploitation of labour due to labour-intensive
technology.
Exploitation of the unorganized labour sector
through long working hours.
Adverse effect on culture and value system.
Increase of pressure on domestic industries due to
the entry of international industries.
OpinionMatters
v
Do you think a consistent and steady GDP growth of
India can eradicate the roots of poverty and inequality
in Indian society?
v
Indian Economy
3
3.1
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National Income Accounting
CONCEPT OF INCOME
Income is the money that an individual or entity
receives for their labour or product.
It can be defined in different ways depending on
the context: Wages, salaries, returns on investment,
rents, royalties, interests, profits, gifts and donations.
Individuals’ gross income is defined as the total value
of their salary/payment minus any outflows.
For tax purposes; income means all revenue that is
eligible to be taxed.
3.3CONCEPT OF FACTORS OF
PRODUCTION
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There are four factors of production; namely:
Land, Labour, Enterprise and Capital
Land includes not just the site of production but also
the natural resources above or below the soil.
Capital can come in many forms, such as physical,
technological, human, social etc.
z
3.2CONCEPT OF FACTOR AND NONFACTOR INCOMES
z
z
z
Factor Income
z
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Non-Factor
Income/
Transfer
Incomes
z
z
Here the word “factor” means
“factors of production”. Land,
Labour, Capital, and Entrepre­
neurship are the four production
factors.
Each of the above factors earns
income for their owners in terms
of rent, wages, interests and profits simultaneously. This is called
a “factor income”. While the price
that the producer bears are the
“factor cost”.
Thus, factor income can be defined
as the income of the owner of
“factors of production” instead of
certain services.
Incomes that do not require the
owners to provide any service
in return are called Non-Factor
Income. E.g. donations, gifts,
charities, fines etc.
Since these incomes merely
involve the transfer of money
without any service being
provided; they are also called
Transfer Income.
These are not included when
calculating a country’s national
income. Only factor income is
considered.
Land
z
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Labour
z
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Capital
z
z
Also known as “natural
resource” in economic terms;
it includes all-natural gifts
over or below the earth’s
surface.
Over the surface use of land can
include- agriculture, industrial,
residential, dams, bridges, sun,
moon, wind, rain etc.
Mineral resources, mining,
water, and other resources
can be found beneath the
land’s surface.
The income that a landowner
gets is called ``rent” in national
income accounting.
All physical and mental
activities that produce goods
and services are called labour.
A worker gets in return for his
labour- “wages and salaries”
as factor income.
It is called “compensation” in
national income accounting.
It includes all those manmade assets that are used
to produce a certain good
or service. Like machines,
vehicles, equipment etc.
While the land is a natural gift;
capital is produced by man
and can be reproduced.
The owner of capital gets
“interest” as a factor in income
in terms of national income
accounting.
z
z
Entrepreneurship
z
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3.4
z
z
z
It tells us about the growth of an economy by
measuring the rate at which its real national income
grows over some time.
National income thus serves as an instrument of
economic planning.
Historical Developments
z
1867-68
1931-32
z
1948-49
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1949
z
MEANING OF NATIONAL INCOME
3.5
National Income is commonly defined as the total
monetary value of all final goods and services
produced in a country over a given period. The concept
was developed by Nobel laureate Simon Kuznets and
is considered to be one of the most important in
macroeconomics.
z
z
It gives a comprehensive picture of the economic
activities of a nation and tells us about the country’s
purchasing power.
Transfers
Households
Consumption
z
Government
The book “Poverty and Un-British Rule
in India” by Dadabhai Nauroji provides
an economic critique of colonial rule
as well as the first estimate of national
income.
First scientific estimate of national
income by Professor VKRV Rao.
The Ministry of Commerce estimates
national income for the first time.
P C Mahalnobis headed a national
income committee.
CIRCULAR FLOW OF INCOME
It is a macroeconomic model that depicts the
interdependence of various economic sectors.
It depicts the flows of income, goods and services,
and production factors (land, labour, capital, and
entrepreneurship) among economic agents such as
firms, households, governments, and nations.
National accounts and macroeconomics are built on
circular flow analysis.
Taxes
Government
purchases
Government
borrowing
Disposable
income
Private
Savings
Imports
20
z
Entrepreneurship is defined
as when an individual or a
group of individuals start and
organise a business while
accepting all of the risks
involved.
The factor income in this case
is “profits” under the national
income accounting. But the
entrepreneur may also run
into losses.
An entrepreneur employs the
production factors of land,
labour, and capital for a single
profit-making purpose.
In doing so; they create jobs
and wealth.
Financial
Institutions
Investment
Borrowing
from abroad
Rest of
the World
Exports
Total income
= Total production
= GDP
Firms
Consumption
plus net exports
Indian Economy
Three Models
z
1. Two-Sector
Model
z
z
z
z
2. Three-Sector
Model
z
z
z
3. Four-Sector
Model
z
z
z
z
z
z
For mixed and closed economies with households, firms and governments.
Here, the government levies taxes on households and firms. It sources its goods and services
from the firms. While it gets its factors of production from the households.
Government transfers pensions, subsidies etc. to households.
Government also makes payments to firms for its purchases of goods and services from
them.
For an open economy with households, firms, governments and the external sector. In real
life, only four sector economies exist.
External sector comprises exports and imports.
Expenditure of the entire economy includes domestic expenditure (Consumption +
Government expenditure + Investments) + Net Exports (i.e. total exports-total imports)
However, none of the above models represent
reality accurately. For example; we assume in the
above models that households don’t save. It only
highlights essential features of an economy.
3.6
z
z
For representing a simple economy with only households and firms.
In this case, households are the sole purchasers of goods and services as well as the sole
suppliers of production factors. It makes money by supplying firms with production factors.
Firm generates revenue by selling entire goods and services to households. It hires factors
of production from households.
z
HOUSEHOLD SAVINGS
These constitute the majority of savings in our
economy and can be accomplished in the form of
 Money and bank deposits
 Bonds, mutual funds, pension funds
 Insurance and investments in small savings plans,
for example,
 When we add all the above savings; we get Gross
Household Financial Savings.
 When we deduct the liabilities (loans) from the
Gross Household Financial Savings; we get Net
Household Financial Savings.
Importance:
 It helps in securing investment. Banks lend the
money we deposit as savings for productive
purposes (education, business etc.)
 It helps in capital formation thus helping in largescale production, innovation and an increase in
GDP.
 It can help during times of stress- unemployment,
inflation, poverty, BoP crisis etc.
Individuals’ and households’ savings depend on their
ability, willingness and opportunity to save.
Higher per capita income of a country, lower taxation,
high individual income and higher interest rates aid
in saving more.
Peace and security and political stability allow people
to save more. Also, government initiatives like the
National Income Accounting
z
Provident fund instil a behaviour of savings in people
that can help them in times of need.
It is a major factor in economic growth. As per the
Harrod-Domar Model, Savings allows investments;
which leads to high capital growth; which again leads
to high economic growth which in turn leads to higher
savings.
Recent trends in saving:
 During the early days of the pandemic; people
saved their earnings to protect themselves against
job losses and sudden health expenditures.
 But as the economy opened up; they went on
“Revenge Spending” and depleted their savings.
The savings fell to the lowest levels in the last 5
years as of March 2022.
 It would have been desirable but not in a situation
when jobs are not being created and the income
levels haven’t increased as much.
 To increase investment without borrowing
more and thus impacting the fiscal deficit; the
government must hope for savings to increase.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the Indian economy, consider
the following statements:
(2022)
1. A share of the household financial savings goes
towards government borrowings.
2. Dated securities issued at market-related rates in
auctions form a large component of internal debt.
Which of the above statements is/are correct?
(a) 1 only
(c) Both 1 and 2
(b) 2 only
(d) Neither 1 nor 2
21
3.7 MEANING OF ECONOMIC (DOMESTIC)
TERRITORY
It is a territory which is administered by a
government where capital, goods and people
circulate freely.
It is different from the political meaning of a territory
which is designated by boundaries. For example;
Indian embassies in foreign countries are considered
Indian economic territory (and vice-versa).
A domestic territory of a country includes the
following:
 Geographical boundary, airspace and territorial
waters (12 Nautical Miles from the coast) of that
country.
 Ships, fishing boats, and aircraft operated by that
country, even when they are in another country.
For example, an Air India plane in Tokyo or a flight
between two foreign cities such as Paris and Tokyo.
 Oil rigs, and other floating platforms in foreign
lands are considered domestic economic territory.
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z
z
Embassies, consulates and military bases in
foreign countries.
Private properties or companies operating in a foreign
land are not considered domestic territory.
The sum of all the factor income produced in a
domestic/economic territory of a country gives us
Domestic Income. Here we don’t look at whether
the person earning is a resident or a non-resident.
We only look at the domestic territory where he
earns.

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3.8METHODS OF CALCULATING
NATIONAL INCOME
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3.8.1 Calculating the GDP of a Country
In 1934, American economist Simon Kuznets
proposed the concept of calculating Gross
Domestic Product (GDP). This method tries to
calculate the income of a country at the domestic and
national levels.
Both, the gross and the net income are calculated in
terms of GDP, NNP, NDP and GNP.
There are three different methods for calculating the GDP of a country:
z
1.
2.
3.
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
22
Income method: GDP is calculated by adding all the following:
z
Wages and salaries
z
Rents and royalties
z
Profits of entrepreneurs
z
Interests earned from productive loans taken
z
Mixed income of retailers, traders, barbers etc.
Product method/Value added method: (Total value of output - intermediate consumption)
The total annual value of goods and services produced (mostly) during a fiscal year is computed.
z
The term value added is used to describe a company’s net contribution. (VA= value of production-value
of intermediate good)
z
Intermediate goods are those raw materials that are completely consumed in the process of making a
product. E.g. flour used by the baker to bake bread, tea leaves used by a tea shop, a tyre used in a car.
z
As long as it is being consumed for a final good, an intermediated good is subtracted from the total output
to avoid double counting.
z
Ideally, the results of all three methods should be
the same. But it is not because:

z
Expenditure method: Here all the expenditures made are counted. We have read about this method above as
C+I+G+N.
Goods that are produced and stored but not yet
sold.
Payments may be pending for salaries, rent and
so on.
Only newly produced goods are counted in GDP
calculations; the resale of existing goods is not. i.e.
second-hand goods are not accounted for in GDP as
they have already been once.
z
z
However, for resold goods; the commission that the
agents charge for their services is accounted for.
All the houses are assumed to be rented by the
government. As there is no literal way to know which
and for how long a house is being rented. (Process is
called Imputation)
3.8.2 Gross Domestic Product (GDP)
z
A country’s GDP is the total value of all final goods
and services produced within its borders in a given
time period, which is usually a year.
Indian Economy
z
z
z
z
z
z
z
Case: If Aggarwal Sweets (India) is producing sweets
in India and Nestle (Swiss) is producing chocolates
in India; both will be considered in India’s GDP
calculations as the production is happening within
Indian territory.
“Final” means that there is no known chance of any
value addition in the product or service after this
point.
It is calculated by Expenditure, Income and Value
Added Approach.
By expenditure method, we calculate GDP at market
price by adding C+I+G+N
 National private consumption (C)
 Gross investment (I)
 Government spending (G)
 Net exports i.e., Exports minus imports (N)
The concept of GDP has multiple uses:
 Per annum change in it tells us the growth rate of
the economy. For example; if India has a GDP of
105 rupees (assume) in 2021 and it is 100 rupees
in 2020; then the growth rate is 5%.
 GDP per capita has a positive correlation with the
living standards of the people in a country over a
period of time.
 It tells us whether the economy is expanding or
contracting and enables us to take action.
 It allows people to analyse the impact of monetary
and fiscal policy, taxation policy, economic shocks
etc.
Drawbacks of using GDP as an indicator of
economic growth:
 Underground/parallel economy: It does not
calculate the impact of the underground or illegal
economy which can be significant in some countries.
This also includes cash or barter transactions that
are not calculated officially.
 Doesn’t calculate well-being: The sole focus
is on economic output and thus environmental
degradation and inequality caused aren’t accounted
for or adjusted in this calculation.
 Quantitative and not qualitative: Increased
product or service quality isn’t accounted for in
GDP. For example, one can get a better smartphone
at the same price next year.
 Geographical limitation: Citizens and companies
creating output abroad and non-citizens and
foreign companies doing the same in India are not
included in this calculation. (Calculated by GNP).
In a globalised world; these figures are massive.
The IMF ranks India’s GDP in PPP terms third (after
the United States and China). While by the prevailing
exchange rate of the rupee vis-a-vis the US dollar;
India’s GDP is ranked as the 5th largest in the world.
National Income Accounting
Purchase Power Parity (PPP)
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Gustav Cassel; a Swedish economist, developed
this concept.
It is a method of calculating the correct/real
value of a currency which may not be the same
as the market exchange rate of a currency.
It helps in comparative studies of different
economies by using a common currency (say USD).
It can help us understand the living standards of
different countries. This method was introduced
by the IMF and WB in the 1990s.
This method assumes that the price of a commodity
(say a tennis ball) is the same in different markets if
measured in the same currency (Law of one price).
If not; then we know that the purchasing power of
the two currencies is different.
For example; if the price of 1 kg sugar in the US is
1 dollar and in India is INR 20; we say that at PPP
1 USD = 20 rupees.
This concept helped “The Economist” magazine
in the UK to introduce “The Big Mac index”. It
compares Mcdonald’s Big Mac prices in different
economies.
Limitations: For calculating the PPP of a currency;
a common basket of goods is to be selected of
identical quantity and quality which is very difficult.
“The law of one price” has flaws. Transportation
costs, local taxes, production levels etc are not
accounted for here.
3.9SECTORAL COMPOSITION OF
INDIA’S GDP
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Primary Sector
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Secondary
Sector
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It consists of Agriculture and
allied, forestry, fishing, mining
and quarrying. These are
sectors where natural resources
are used directly.
Its contribution has been
estimated to be 21.85% of GVA
at current prices.
There has been a continuous
reduction in the average land
sizes and the number of small
and average farmers are a
worry.
It includes the manufacturing
and industrial sectors, as well
as electricity, gas, water supply,
and other utilities.
Industry has a share of 28.3%
in total GVA (2021-22).
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Tertiary Sector
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There has been >5% growth
consistently
in
industrial
output.
Manufacturing sector share in
total GVA is 15.3% (2021-22).
It is also called the services
sector and is the largest sector
of the Indian economy.
Its contribution to GVA has
been estimated to be 53.90%
in 2021-22. Down from earlier
55% between 2019-20. In 12
out of 33 states, UT’s services
sector has more than 50% share.
The highest is in Chandigarh
and the lowest is in Sikkim.
India’s share in global services
export increased from <0.5%
in 1991 to 4.2% by 2021.
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3.10 GDP DEFLATOR
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Index of Industrial Production (IIP)
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It is an index that displays the growth rates in
various industry groups within an economy over
a given time period.
The National Statistical Office (formerly the
Central Statistical Office) of the Ministry of
Statistics and Programme Implementation
(MoSPI) compiles and publishes it annually.
Base year for IIP is 2011-12. It measures growth
rates of broad and use-based groups of industries.
E.g. mining, electricity, capital goods etc.
There are 8 core industries in India that
represent 40% weight of the items included in
the IIP.
As per their weightage in the IIP; these 8 core
sectors are: Refinery Products > Electricity >
Steel > Coal > Crude Oil > Natural Gas > Cement
> Fertilizers.
It is the only index that reveals the physical
volume of production.
It is used for policymaking by the government, the
RBI, and other organisations.
It is very important for quarterly and advanced
GDP calculations.
Adjusted Gross Revenue (AGR)
and Related Controversy
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The Department of Telecom levies usage and
licencing fees on telecom operators. This is divided
into two parts: “Usage Fee” and “Licencing Fee.”
This is called AGR.
According to the DoT, the charges are calculated
based on the total revenue earned by the telcos.
Non-telecom sources such as asset sales, property
rents, deposit interest, and so on are included.
The telcos were opposed to using non-telecom
sources to calculate AGE.
The matter went to the SC and as a result, the
government brought in the changes in revenue
sharing along with other changes.
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It is a price index which helps us take out the
inflation from the value of total output.
It helps us arrive at real GDP.
It is obtained by inferring national income data from
two comparable periods.
When it is negative, it implies that nominal GDP
is less than real GDP. It means there is deflation
(negative inflation) in the country.
It is a price index which covers the entire economy,
unlike the CPI and WPI which are restricted to a
certain basket of goods and services.
Its downside is that there is a long lag in its availability
and hence it has limited use for policy making.
3.11 NOMINAL GDP AND REAL GDP
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Nominal GDP
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Nominal GDP is a GDP that hasn’t
been adjusted for inflation. For e.g.
even if the amount of production
this year is exactly the same as
last year; the GDP figures can
increase or decrease depending
on the inflation and deflation in
the present year.
Nominal GDP is used when we
compare our GDP to any other
factor, unadjusted to inflation.
For e.g. debt is always measured in
current prices; thus, a comparison
of a nation’s debt to its GDP will
use nominal GDP.
Indian Economy
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Real GDP
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Real GDP is a GDP that is
adjusted for inflation. When we
appraise the products and services
produced in this fiscal year at the
previous year’s prices, we get real
GDP.
Real GDP is considered a better way
to assess economic performance.
The reason becomes clear from a
case below:
Assume a country had a nominal
GDP of $100 billion in 2010. By
2020, the nominal GDP was valued
at 150 billion dollars. But in the
same decade, inflation reduced
the value of dollars by 50%. Thus,
what appears to be an increase of
50 billion in nominal GDP value in
10 years is actually a reduction of
25 billion in real GDP.
In years of positive inflation; real
GDP will always be lesser than the
nominal GDP.
The opposite will occur in years of
deflation (negative inflation).
Real GDP is favoured by investors
before investing in a country as
it shows how much inflation has
eaten into the GDP.
Real GDP = Nominal GDP divided
by GDP deflator
3.12 CONCEPT OF GREEN GDP
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Green Gross Domestic Product, or Green GDP, is a
measure of a country’s economic growth that takes
into account both economic and environmental
parameters.
It is a conventional GDP measure which accounts
for the environmental costs of economic activities.
William Nordhaus and James Tobin first proposed
the concept in 1972.
China announced in 2004 that Green GDP would
replace the Chinese GDP index as a performance
measure for top-level government and party
officials.
China abandoned this in 2007 when it became clear
that the growth rates had been reduced due to new
measurements.
Need for Green GDP
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The current GDP calculation methods don’t account
for biodiversity losses or unsustainable development
caused by due focus on economic growth only.
National Income Accounting
Ecosystem services and resources, such as mineral
deposits and soil, are assets that have traditionally
been excluded from national accounting.
Traditional calculations could only show “economic
growth” without accounting for the decline in natural
assets, such as forest destruction and overfishing.
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Do You Know?
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India’s financial year or fiscal year is from 1st April
to 31st March. For example, Financial Year 2022
(FY22) means the time period between 1st April
2022 to 31st March 2023.
A Quarter is formed when a 12-month fiscal year is
divided into four three-month segments.
In Net exports (N); we subtract exports from
imports because it subtracts what we spend on
imports (not produced in the country) and adds
what we spend on exports (produced but not
consumed) in the country.
“Gross” means total.
“Domestic” refers to all economic activities
conducted within the borders of the country and
using our own capital.
“Product” means both, goods and services
Implications of Green GDP
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Loss of biodiversity can be monetized.
It can account for losses caused by climate change.
Resource depletion and environmental degradation
can be subtracted from traditional GDP figures.
It will help take care of both- economy and the natural
resources.
Limitations of GDP Calculation Method
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Parallel economy: There is black money circulation
due to tax evasions and illegal income sources
(smuggling, illicit trade etc) which are not accounted
for. For e.g. Flats in Mumbai at a point cost more than
those in major US cities due to black money circulation
in real estate.
Barter economy: In rural areas, a lot of small
transactions happen as barter which is not covered.
Informal sector: India’s economy is dominated by
the informal sector which is 86% of India’s workforce
(small and marginal farmers, vegetable vendors,
landless labourers, domestic maids etc). GDP/GNP
doesn’t account for this sector.
Care economy: A large majority of women are
engaged as homemakers and housekeepers. This is
not accounted for in the GDP.
Social services: Charitable work is not accounted for
while calculating GDP as they are unpaid work.
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Quality of data: Environmental costs, poverty,
inequality and health and education status are not
captured in GDP figures.
GDP is merely a measure of “growth” and not
“progress” or “development”. But growth is a
precondition for welfare.
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3.13 NET DOMESTIC PRODUCT
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NDP is the value of GDP calculated after adjusting it
for “depreciation”.
NDP = GDP - Depreciation
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Depreciation is the natural wear and tear that
happens in any product over the time period that they
are used. The governments decide the rate at which
assets depreciate. In India, this is done by the Ministry
of Commerce and Industry.
In the external sector; depreciation occurs when
a domestic currency (say rupee) falls in value in
comparison to (say) the USD.
NDP is used for the following purposes:
 To comprehend the economic loss caused by
depreciation.
 To investigate the impact of depreciation on
various industries.
 It tells us the Capital Consumption Allowance,
or the resources used in a given time period to
maintain our economy’s current productivity
levels.
 NDP accounts for net investment in an economy
and thus provides a more complete picture of
economic health. The economy grows if the net
investment is positive, and vice versa.
 If the difference between GDP and NDP is
increasing; it tells us that the capital stock’s value
is deteriorating and that it signals economic
stagnation.
NDP is not used to compare different countries’
economies. This is due to the fact that different
governments set different rates of depreciation.
3.14 GROSS NATIONAL PRODUCT (GNP)
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When we add the “income from abroad” into the
GDP of a country; we get GNP.
It is citizen-centric i.e. it calculates everything
produced by citizens of a country; whether in the
domestic territory or abroad.
GNP = GDP + Income from abroad
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The “Income From Abroad” includes the following:
 Private remittances: (Transfers by Indians
working abroad to India) minus (Transfers by
foreigners working in India to their countries).
India has been a gainer here since the 1990s.
Indians send remittances mostly from the middle
east, US and Europe.
 Interest on external loans: This is the net outcome
of the interest payments i.e. (interest received on
external loans India has given minus interest paid
on loans taken by India from external entities). In
our case, it’s always been negative since we are a
“Net Borrower”.
 External grants: The net external grants i.e.
grants to India minus grants from India. We get
grants from UN bodies, other countries and other
bodies. As our diplomatic outreach increases, the
outflow of grants from India will increase e.g. to
African and small island nations.
The above three factors of “Income From Abroad”
may/may not be positive for a country. In India’s
case, it’s mostly been negative due to:
 Heavy outflow of forex due to trade deficit i.e. we
import more than we export.
 Interest we pay on external loans we have taken.
Thus “income from abroad” is subtracted from
the GDP in India’s case to get GNP. i.e. GNP = GDP
+ ( - Income From Abroad); which upon resolving
becomes (GDP - Income From Abroad).
Hence in our case, GNP has mostly been lower than
the GDP.
GNP can be used in a variety of ways in an economy,
including It tells us about the internal as well as external
strength of the economy. It is not only quantitative
but also qualitative.
 It tells us about a country’s dependence on its
internal and external productions in terms of
the balance of trade.
 It tells us about the skill and standard of our
human resources vis-a-vis other countries; by
means of remittances, inflows and outflows.
 An increase in absolute and per capita GNP may
only reflect the economic growth of a small portion
of society, leaving the majority of the population in
poverty and unemployed.
 It also informs us about the financial support
we receive and give to the world, by means of
interests received/paid on external lending and
borrowing.
 The larger the difference between the GDP and
GNP of a nation; the more globally integrated it is.
 If GNP is larger than the GDP of a country; it signals
positive net inflows or net income from abroad.
Indian Economy
PREVIOUS YEAR QUESTION (PRELIMS)
1. Increase in absolute and per capita GNP do not connote a higher level of economic development, if __________
(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.
(2018)
3.15 GDP VS GNP
Parameters
Meaning
Coverage
Emphasis
Highlights
Scale
Exclusions
GDP
GNP
The Gross Domestic Product, or GDP, represents The Gross National Product, or GNP for short, is
the total number of products and services that a the total value of goods and services produced by
nation produces throughout the course of a fiscal a country’s residents during a fiscal year.
year.
It measures only domestic production.
It measures only the national production.
It places a premium on domestically produced It concentrates on the output that is generated by
goods.
the citizens living in various countries.
Highlights the strength of the country’s economy. It highlights the contribution of the residents to
the development of the economy.
Local scale
International scale
The products and services that are generated The goods and services produced by foreigners
outside the economy are excluded.
living in the country are not included.
3.16 NET NATIONAL PRODUCT (NNP)/
NATIONAL INCOME (NI)
Know About Base Year
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NNP of an economy can be obtained by deducting
from GNP the depreciation.
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NNP = GNP – Depreciation
or
GDP + Income From Abroad - Depreciation
It is the “National Income” of our economy. Even
though GDP, GNP and NDP are also considered ways
to account for “national income”; only NNP is written
with capital initials (NI).
We can calculate Per Capita Income by dividing the
NNP by the total population of the country. (This
is inversely proportional to the depreciation rate
decided by a country i.e. higher depreciation means
lower Per capita income.)
The “Base Year” along with the method of calculating
the national accounts was revised in the year 2015.
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Do You Know?
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From the above discussion, one can see that
wherever we use the word “Gross”; something is
being added.
Whenever we use the word “Net”; something is
subtracted.
National Income Accounting
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The year that is chosen as a benchmark to make
certain calculations of indices, GDP, GNP, NNP etc.
In 2015, the government changed it from 200405 to 2011-12.
A base year must not be an “exceptional year”
due to war, pandemic, recession etc.
It is also preferred that it is as close as possible
to the present year. The data for the base year
should be available reliably.
The Ministry of Statistics and Programme
Implementation is considering resetting the
base year for national accounts calculations to
2017-18.
3.17 FIXED VS CHAIN BASE METHOD
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The government is considering switching to a chain
base method from the present fixed base method.
The fixed base method is when the government
compares GDP estimates using a specific year.
 This is revised every 5 years.
 In the fixed base method, the weightage assigned
doesn’t change even if there have been significant
changes in the economy.
 It doesn’t factor in the changes in prices and
demand.
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Chain based method is where we compare this
year’s GDP estimates with the previous year. Here the
structural changes to the economy are captured more
comprehensively and rapidly.
It is the current best international practice and
thus will make a comparison of economies easier.
3.18CONCEPT OF FACTOR COST (FC)
AND MARKET PRICE (MP)
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The total value of an economy’s products can be
calculated at either factor cost or market cost.
In the process of producing; a producer has to incur
some cost (on raw material, interests on loans taken,
labour, electricity, rent etc.) All of these are termed
Factor costs and are also called Input Costs,
Production Costs and Factory Prices
The product’s Market Cost/Market Price is calculated
after the indirect taxes are deducted. That is, the price
at which it enters the market.
Earlier, we used to calculate National Income at Factor
cost; since 2015, CSO has switched to market price.
This is the measure used internationally.
inflation during this time was 50% a year; the
purchasing power of that rise would be reduced
substantially. Here constant prices would give a clear
picture of improvement.
3.20 CONCEPT OF VALUE ADDITION
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GDP at MP = GDP at FC + Net
Indirect Taxes
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Current vs Constant price: The only difference
between the two is that in the current prices we
account for inflation of the present day; while in the
constant price, we use inflation of the base year.
Current price basically tells us the MRP of a product.
MP = FC + (Indirect Taxes – Subsidies)
3.19MEANING OF CURRENT AND
CONSTANT PRICE
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Income can be calculated using two different prices:
Constant and current. The distinction between the
two is made only by the impact of inflation.
Inflation is taken as constant or stands still at the
base year (also called the year of the past) in the
calculation of constant prices. (i.e. inflation of base
year will be used).
In the current prices calculation; present-day
inflation is added. It is basically the MRP printed on
the goods we buy in the market.
Thus, constant prices help us realise the actual
change in output and not just because of an increase
in inflation.
Case: If your wage increased from 40,000 rupees
to 70,000/month; it would seem a very good
improvement in the standard of living. But if the
The difference between the prices of a good or
service and the cost of producing it is defined as
value added. Prices are determined by consumer
perception and willingness to pay.
It is the additional value that is added to a product or
service before the consumer gets it.
This helps boost revenue and profits. It can be done
through a brand name or any other innovative way.
For example, a BMW car is more expensive because
of its reputation and the price the consumer is willing
to pay for it.
For the economy, the value added of an industry is the
contribution made by the private or public sectors to
overall GDP.
Case: In an economy, there are only two kinds of
producers- farmers and bakers. The farmer doesn’t
need any input except labour (assumption). They sell
a part of the wheat to the bakers who don’t need any
other raw materials than wheat to produce bread. The
farmers produce 100 rupee worth of wheat in a year.
They sell 50 rupee worth of wheat to the baker. The
bakers use this wheat to produce 200 rupee worth
of bread.
 What is the value of total production in the
economy?
 300 if we simply aggregate the values of different
sectors.
 But that would count the 50 rupee worth of wheat
twice.
 Hence the value added = net contribution of
farmer + net contribution of a baker.
 Value added = 100 + (200-50) = 250
3.21 GROSS VALUE ADDED (GVA)
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GVA is a supply side method to calculate GDP. Here,
the value added by different sectors of the economy
(agriculture, manufacturing, etc.) is added up to get a
Gross value added.
The formula for calculating GVA is as follows:
GVA = GDP + (Indirect Taxes - Subsidies)
Or
GVA = GDP + Net Indirect Taxes
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The uses of this method are:
It helps us compare different sectors within an
economy.

Indian Economy
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


It gives a better picture of the quarterly growth
data.
It is the total of the basic prices of all the goods and
services produced in an economy. (Basic Price =
Market Price - Indirect Taxes)
It helps us understand the link between GDP and
taxation.
If GVA and GDP growth rates are unequal; it means
there is a discrepancy in Tax Buoyancy. This
could imply that either the non-taxed sectors are
growing or there is tax evasion.
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Tax Buoyancy
It is the relationship between changes in the
government’s tax income and GDP potential. It has to
do with the sensitivity of revenue from taxes to GDP
fluctuations.
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3.22CHANGES IN NATIONAL INCOME
(NI) CALCULATIONS DONE IN 2015
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The base year was changed from 2004-05 to
2011-12 as per the recommendation of the National
Statistical Commission (NSC).
The Central Statistics Office (CSO) changed the
method of calculating GDP at Factor Cost (FC) to
GDP at Market Price (MP).
GDP will mean GDP at constant market prices
rather than GDP at factor cost.
Gross Value Added (GVA) will now be calculated at
basic prices and not factor costs.
The MCA21 database; an e-gov initiative of the
Ministry of Corporate Affairs, will be utilised to account
for activities that the companies undertake, other than
manufacturing. This ensures comprehensive coverage
of both manufacturing and services.
Information from the accounts of stock brokers, stock
exchanges, mutual fund companies, asset management
firms, Pension funds, SEBI, PFRDA and IRDA will be
utilised for a complete coverage of the financial sector.
Activities of the local governments and autonomous
organisations will also be documented.
3.23 REVISED GDP SERIES
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The new GDP series followed since 2015, has 201112 as its base year.
Based on this series, it was discovered that GDP data
of 2004-05 was underestimating industrial growth.
New GDP series witnessed an increase in the share
of different sectors in 2004-05:
 Manufacturing to 15.8% from earlier 11.8%.
 Agriculture to 17.2% from 16.8%.
National Income Accounting
India’s per capita income saw an estimated rise of
10% in the year 2018-19.
GDP data from 2012-13 was recalculated based on a
new method from 2015. This is called “Back Series
Data”. This was for both quarterly and yearly data.
Reasons behind this move are:
 Comparable to global practices.
 Greater representation of the Indian economy.
 More reflective of the real estate sector.
Debate against back series data:
 A study by the former Chief Economic Advisor,
Arvind Subramanian claims that the economic
growth between 2011-17 is overestimated.
 The government claims that India grew at around
7% per annum while the CEA’s opinion is that it
only grew at about 4.5%.
 His analysis is based on 17 key economic indicators.
Whenever a new series of national income is
introduced; it is also used to see the output of
previous years based on the new base year. It helps
in understanding the economy, size, growth rate etc.
Hence the back series was released.
PREVIOUS YEAR QUESTION (PRELIMS)
1. The national income of a country for the given period
is equal to the (2013)
(a) Total value of goods and services produced by the
nationals.
(b) Sum of total investment and consumption
expenditure.
(c) Sum of personal income of all individuals.
(d) Money value of final goods and services produced.
PREVIOUS YEAR QUESTION (MAINS)
1. Explain the difference between the computing
methodology of India’s GDP before the year 2015
and after the year 2015. (2021)
3.24INSTITUTIONS FOR MEASURING
NATIONAL INCOME: CSO; NSSO;
NSC
3.24.1 Statistics Related to National Income
in India
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The Central Statistical Office under the Ministry
of Statistics and Programme Implementation
(MoSPI) is in charge of gathering information for
National Account Statistics.
The Directorate of Economics and Statistics collects
Gross State Domestic Product (GSDP) and other data
at the state level for various states.
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Statistics for various macroeconomic indicators such
as GDP, GSDP, NDP, consumption, savings, capital
formation, public sector transactions, per capita
income, and so on are released in both current and
constant prices.
CSO releases quarterly as well as annual data.
Since 2015, GVA data has also been released.
The growth data for the current fiscal year is released
in January (before FY ends in March) and is called
“Advance Estimates (AE)” of National Income. These
aid in the budget estimates for the upcoming financial
year.
The data is revised multiple times until final
estimates are released years later.
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According to critics, the merger may have an impact
on the institution’s independence because the newly
formed NSO will be led by a MoSPI secretary-level
official.
3.24.3 National Statistical Office (NSO)
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In 2019, the National Sample Survey Office and the
Central Statistical Office were merged by MoSPI to
form “NSO”. This is expected to provide more synergy
to the whole process of data collection.
3.24.2 Merger of National Sample Survey of
India (NSSO) and Central Statistical
Organisation (CSO)
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The NSSO was an institution under the Ministry of
Statistics and Programme Implementation. It was set
up in 1950 to conduct large-scale surveys in India;
mostly socio-economic.
Its employees were mainly from the “Indian Statistical
Service” (exams by UPSC) and Subordinate Statistical
Service (SSC exam).
In May 2019, NSSO and CSO were merged to form the
NSO or the National Statistical Office.
The responsibilities of the NSSO were as follows:
 Division of survey design and research
 Division of Field Operations
 Division of data processing
 Coordination and publication division
The NSSO used to plan, design and analyse surveys
and their results.
The CSO managed the statistical operations in India
and maintained and evolved statistical standards. It
was headed by a Director General rank officer.
Its responsibilities were:
 National Accounts Statistics.
 Annual Survey of Industries, Economic census and
its follow-up surveys.
 Index of Industrial Production (IIP) compilation.
 Consumer Price Index (Urban Non-Manual
Employees).
 Human Development Statistics.
 Gender Statistics.
 Imparting Training in Official Statistics.
 Publishing statistical information relating to
different sectors like industry, energy etc.
There were controversies regarding the findings of
NSSO about the MCA 21 data. It brought into question
the role of the private sector to the GDP.
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The NSO is headed by the Chief Statistician of
India.
CSO brings out data related to various macroeconomic
indicators while the NSSO does wide-scale surveys
about health, education and other socio-economic
indicators.
In 2006, a National Statistical Commission
was established in response to the Rangarajan
Commission’s recommendations.



It has 4 members and a chairperson.
Each of the above has experience in various fields
of statistics.
Its mission is to develop statistical policies,
priorities, and standards.
3.25PERSONAL INCOME (PI) AND
DISPOSABLE INCOME (DI)
z
Personal Income
z
z
Personal income is the
total income received by
individuals in a country
from all sources before
paying direct taxes in a
given year.
PI is never equal to National
Income as the former
includes transfer payments.
PI = National Income (social security contribution
and undistributed corporate
profits) + Transfer Payments.
Indian Economy
z
z
Disposable Income
z
z
Disposable Income is the
sum of the consumptions
and savings of the individuals
after the payment of income
tax.
It is also called “Disposable
Personal Income”.
Disposable
Income
=
Personal Income - Direct Tax
Also, Disposable Income
= Consumption + Savings
(as the entire income is not
consumed and some of it is
saved by households)
3.26 CAPITAL OUTPUT RATIO (COR)
z
z
z
z
z
The concept explains the relationship between the
investment made in an economy and the resulting
value of output or the increase in the GDP.
It denotes the amount of capital required to generate
one unit of output.
For example; If there is an investment of 100 rupees
in an economy and the output is 10 rupees; then the
capital-output ratio is 10%. This may seem low but
remember that the investment of 100 rupees will
remain for the next 10-12 years and will produce
multiple units of output per year.
Importance of the concept:
 It helps us understand the amount of investment
needed. For example; If the government targets
growth of 10%; and it knows that the capitaloutput ratio is 10; then it can be understood that
the investment needs to be increased by 100%
(10x10) i.e. doubled.
 It depicts the relationship between investment
levels and economic growth.
 G=S/V; where G is growth, S is savings as a
percentage of GDP and V is a capital-output ratio.
 A lower ratio of capital to output indicates that
capital is productive and technological progress.
This is desirable as a low level of investment is
producing desirable growth.
 Technology can play a major role in lowering the
capital-output ratio. As productivity will increase
due to better technology.
Incremental Capital Output Ratio (ICOR): This is a
variation of the concept that shows the additional
investment required to produce a higher level of
output. The original capital-output ratio changes with
increased investment and thus becomes inaccurate.
Here ICOR is useful.
National Income Accounting
3.27 TRANSFER PAYMENTS
z
z
z
z
z
z
These are one-way payments in return for which
no goods or services are sought.
The government uses these to redistribute income
through various social welfare programmes such as
old age pensions, social security, and so on.
They are part of personal income and are not
considered subsidies.
Subsidies are linked to commodity transactions (food,
fertilizers etc.)
Transfer payments can be conditional (like Indira
Gandhi Matritva Sahyog Yojana) and unconditional.
Subsidies and Universal basic income are not
calculated as transfer payments.
3.28 CONCEPT OF SEASONALITY
z
z
It simply means comparable time periods should
be compared i.e. data from the Oct-Dec quarter of
2021 will be compared with the Oct-Dec quarter of
2022.
It ensures that the true figures are reflected as features
like inflation, investment, employment etc are likely to
be similar in similar quarters. For e.g.
 Many important festivals, such as Dussehra, Diwali,
and Christmas, take place during the OctoberDecember quarter. As a result, more goods and
services are produced and purchased.
 This gives us data that can be acted upon. If private
consumption was less this year than the previous
year in this quarter; reasons can be easily found.
3.29 CONCEPT OF POTENTIAL GDP
z
z
z
z
z
z
z
The GDP figures that are mostly available to us is the
actual GDP.
Potential GDP is that GDP which can be achieved
without destabilising the major macroeconomic
indicators like inflation, fiscal deficit etc.
It is the optimum production that a country can make
in the long term.
GDP gap or Output gap = Potential - Actual GDP
It tells us whether we need to accelerate or reduce
the GDP growth to reach the optimum.
It is not usually achieved by short-term measures
and requires a durable way of growth.
Positive gap: When actual GDP is greater than the
potential GDP.
 It is inflationary as demand is greater than supply.
 Productivity rises and employment reaches
100% (theoretically, everyone who wants work
will get it).
31
Ideally, not a desirable situation as it is inflationary.
 Monetary and fiscal policies work to avoid this.
Negative gap: When actual GDP is lesser than the
potential GDP.
 Inflation comes down but unemployment rises.
Key factors for potential output:
 Human capital and skills.
 Infrastructure.
 Potential labour force.
 Technological development.
 Labour productivity.

z
z
3.30 PER CAPITA INCOME (PCI)
z
z
z
z
It is the amount of money earned by an average person
in a geographical region or a nation.
It can tell us about a person’s standard of living and
quality of life in a country/region, as well as how
wealthy a country is.
PCI = GDP or GNP divided by mid-year population
(of the corresponding year).
Downsides:

PREVIOUS YEAR QUESTION (MAINS)

1. Define potential GDP and explain its determinants.
What are the factors that have been inhibiting India
from realizing its potential GDP? (2020)

Doesn’t inform us about inequality in a country.
Doesn’t account for inflation, poverty, savings or
wealth distribution.
It also includes newborns and children who
usually earn nothing.
3.31FORMAL AND INFORMAL SECTORS OF ECONOMY
Formal Sector
z
z
z
z
z
They are registered with the government.
Many laws apply to them. For example, labour code,
wages code etc.
Factories with a minimum of 10 employees with
electricity or 20 employees without electricity fall
under the formal sector.
Large firms are also counted as organised sectors.
Their employees enjoy certain benefits like medical
leave, overtime payment, insurance etc.
Informal Sector
z
z
z
z
z
z
Splicing
z
z
z
It is the method by which new items are added
or old items are removed from the index of
certain items.
These are the adjustments that are made for better
comparison.
Changes in the items included in the calculation
of the CPI or WPI, for example.
3.32ISSUES ASSOCIATED WITH
NATIONAL INCOME ACCOUNTING
IN INDIA
z
32
Challenges with the income method:
 Owners’ occupancy of their own house: If A
rents his house to B; then A earns a certain amount
of rent. But if A is the owner and occupant of the
house, will the amenities of the house be included
in the national income? They are included by
z
Unregistered with the government.
It consists of small farmers, street vendors, domestic
help etc.
They are not covered by laws and are vulnerable to
exploitation like underpayment, long working hours
etc.
It contributes hugely to the economy and forms a huge
part of GDP.
All unorganized sectors fall under this category.
They don’t have any social benefits and depend solely
on manual labour skills to earn bread.
estimating the rent that the owner would earn if
the house has been rented out.
 Self-employed: It is very difficult to calculate
the inputs that she/he provides themselves. They
might be providing their own land, labour, capital
and entrepreneurship in their work. This is also
included in the national income.
 Goods for self-consumption: A farmer might
keep some of the produce for his self-consumption
rather than selling everything and then buying
food grains at market price. This is also included
in the national income as the unsold produce has
monetary value.
 In-kind salaries and wages, as well as free food
and lodging and other amenities are also part of
the national income because if the employers
had given money for these things; the employees
would have spent on these items anyway.
Challenges with the product method:
 Services
by homemakers/housewives are
innumerable but are not included in the national
Indian Economy
z
income. It is very difficult to accurately calculate
the value of all the work done in monetary terms.
Similarly, teachers teaching his/her own kids,
painters, dancers etc. are also excluded from the
national income.
 Intermediate and final goods are difficult to
estimate and sometimes despite best efforts;
there can be double counting which leads to an
overestimation of the currency. It should be noted
that only finished goods are to be included in
national accounting.
 Sale and purchase of second-hand goods, bonds,
shares and stocks are not included in national
income accounting as they already were accounted
for in the year they were produced. But the
commissions and fees for brokerage are taken into
account in national income accounting.
 Even though they have monetary value and
satisfy people’s desires, illegal activities such
as gambling and illicit alcohol production are not
included in national income accounting.
 Consumer services like doctors, actors, teachers
etc. who don’t produce any tangible commodity.
But they are included in the national income
accounting as they are considered final goods.
 Capital gains are gains made when a property,
house, stock, shares etc. are sold at a price higher
than what it was initially sold for. They are not
included in national income accounting and
neither are capital losses as they did not arise from
the current economic activities.
 Inventory changes (and not the total inventory)
are included in the national income accounting.
These changes can be both positive and negative.
 Depreciation creates a problem as it is difficult
to estimate the current value of a machine whose
expected life was say 30 years. Firms calculate
the depreciation value on the original cost. But
the prices change every year. It is still included in
national income accounting.
 Price changes are frequent. National income is
calculated by the value of final goods and services
at the current market price. National income may
rise with price rise and vice-a-versa but national
production may have fallen. Thus, we calculate
national income at constant prices.
Challenges with the expenditure method
 Government services are numerous. Like police,
defence, administration etc. There is a debate
about whether to consider them as final goods or
intermediate goods that allow the production of
final goods. In reality, it is impossible to distinguish
between final and intermediate goods. Thus all
government services are accounted for in national
income accounting.
 Transfer payments like food and fertilizer
subsidies, unemployment allowances etc. are not
v
National Income Accounting


included in the calculation of national income as
they do not add anything in the process.
Consumer durables are products like TVs,
scooters, bikes etc. which are bought in one year
but used for multiple years. There is confusion
over whether they should be treated as investment
expenditure or consumption expenditure. It is not
possible to measure their used-up value for the past
year and hence they are taken as final consumption
expenditure. The exception is a house which is
taken as an investment expenditure.
Public expenditure is the spending on the military,
police, roads, education, health etc. The problem
is in figuring out which expenditure is investment
expenditure and which is consumption expenditure.
But all these are part of the national income; they
include the salaries of armed personnel.
3.33SOLUTIONS TO ISSUES PERTAINING
TO NATIONAL ACCOUNTING
z
z
z
z
z
z
z
z
Availability of relevant statistics: There are many
services which are not included in the national income
accounting due to lack of data. For e.g. a plumber
doing work and earning in his spare time is hard to
include in the data set. Thus it is important to have
all relevant statistics.
Eliminate double counting: Despite best efforts,
there is always a possibility that double counting will
provide inaccurate data for economic growth.
Include non-marketed areas: Like services offered
by homemakers or housewives. These are services
without which the economy can’t function properly
but they are not yet included as they are unpaid.
Accurate calculation of depreciation: The
deductions made for allowances due to depreciation,
repair and replacement etc are tricky to make. But
these are important and should be done accurately.
Identify and include: non-monetized and unorganized
services in the national income accounting.
Price level changes: can change the national income
without any change in actual production or output.
Thus this needs to be corrected.
Systematic accounts maintained help in calculating
the national income. Not keeping details of sales made
can make this task difficult.
Clear occupational classification: Some people
work in multiple roles like carpenter, cleaner, painter
etc. As a result, categorising them and including them
in national income accounting becomes difficult.
OpinionMatters
v
GDP has been critiqued for not reflecting the exact
growth of the economy of a country. Do you think,
instead of bringing it down, incorporating additional
factors might give a more detailed view of people’s
wellbeing.
v
33
4
Economic Growth and
Development
INTRODUCTION
z
Initially the word “progress” was used in economics.
Then words like “Growth” and “Development” were
used more often and interchangeably. It was not
until the 1960s and 70s that economic growth and
economic development got separate meanings.
4.1
z
z
z
z
z
z
z
4.2FACTORS AFFECTING ECONOMIC
GROWTH
z
z
CONCEPT OF ECONOMIC GROWTH
Economic growth is defined as an increase in
economic indicators over time. Here the real per
capita income of a country increases over a period
of time.
It denotes an increase in total physical or real output,
or the production of goods to satisfy human desires.
E.g. the number of cars produced in an economy
increased year by year.
Growth is quantifiable, meaning it can be measured
in absolute numbers.
Although growth can be both positive and negative,
we use it generally in a positive sense.
It is the change in the value of an economy’s goods and
services from one time period to the next.
It is a quantitative change and is usually measured in
terms of GNP or GDP.
It happens usually in 4 ways:
1. Increase in the number of tangible capital goods.
2. Technological improvement.
3. Growth of the labour force.
4. Increase in human capital.
z
z
This is a highly complex activity and thus is
influenced by multiple factors:
Economic Factors
z
Natural resources are the principal factor affecting
an economy.
 These include land area and soil quality, forest
wealth, a good river system, minerals and oil
resources, a favourable climate, and so on.
 Their presence is a necessary but not a sufficient
condition for economic growth.
In low-income countries that are rich in natural
resources; they are unutilized, underutilized or
misutilized. E.g. African countries.
 Alternately, Singapore and Japan are not rich in
natural resources but are highly developed. These
are highly efficient countries.
Capital formation is another important factor in the
development of an economy.
 It is the process of investing a community’s savings
in capital goods such as plants, equipment, and
machinery.
 This in turn increases the nation’s productive
capacity and worker efficiency thus ensuring a
larger flow of goods and services.
 Not all of the income is spent on consumption but
some is saved and invested to form capital.
Technological progress is a very important factor in
determining the rate of economic growth.
 It is the study of new and better methods of
production, as well as the improvement of old
methods.
 Natural resources are sometimes made available
as a result of technological progress. However, it
generally leads to increased productivity.
 technological progress improves the ability to
make fuller use of natural resources. e.g. with the
aid of power-driven farm equipment, a marked
increase has been brought about in agricultural
production.
 The Western economies have greatly benefited
from this.
Entrepreneurship involves the capacity to identify
fresh investment possibilities, take risks and make
investments in new and growing business units.
 The majority of the world’s underdeveloped
countries are poor not because of a lack of
capital, infrastructure, skilled labour, or natural
resources, but because of a severe lack of
entrepreneurship.
Human resource development in the form of
spending on human capital formation via education,
health etc is very helpful in economic growth. It
increases the knowledge and skills of the population.

z
z
Population Growth: It helps with the labour supply
and it provides an expanding market for goods and
services.



z
Thus, more labour produces a larger output which
a wider market absorbs.
Output, income, and employment continue to rise
as a result of this process, and economic growth
improves.
4.3NEED FOR MEASURING ECONOMIC
GROWTH
z
z
It should however be normal and not sudden or
else it hampers economic growth.
z
Social overheads such as educational institutions,
hospitals, and other facilities produce a responsible
population which can take the country economically
forward.


z
z

Political factors are essential for economic growth.
A stable, strong and effective government, honest
administration with transparent policies and their
efficient implementation develop the confidence
of investors and attract domestic as well as foreign
capital that leads to faster economic development.
Social and psychological variables involve social
perspectives, social values and social institutions.
These change with the expansion of education and
transformation of culture. Contemporary ideas,
principles, and attitudes bring new discoveries and
innovations and consequently new entrepreneurs.
Education is the main vehicle of development.
Greater progress has been achieved in those
countries, where education is widespread. It plays
an important role in human resource development,
improves labour efficiency and removes the mental
blocks to new ideas thus contributing to economic
development.
A necessary prerequisite for economic development is the desire for material advancement.
Societies that place a strong emphasis on selfsatisfaction, self-denial, faith in fate, etc., restrict
risk and enterprise, which holds the economy back.
PREVIOUS YEAR QUESTION (PRELIMS)
Q. 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 capital formation in X.
(d) The volume of trade grows in the world economy.
Economic Growth and Development
Measuring growth is important because:

Non-economic Factors
z
Many important aspects of the economy like tax
collection, interest rates, inflation, foreign trade
etc. depend on how well we measure economic
growth.



z
It is important for setting targets, reviewing and
achieving them.
Growth rates can become unsustainable if we
don’t keep an eye.
Measuring growth helps us check inflation and
deflation to an extent.
It becomes possible to change the nature of our
economy; from agriculture to marketing to service
led.
We can aim for challenging goals like poverty
eradication and employment generation.
Makes it possible to predict tax revenues and make
estimates and budget allocations.
The private sector takes hints for investment from
the data published in the public domain.
In the 1930s, Simon Kuznets gave the concept
of GDP to encompass all of a nation’s economic
output.
4.4CYCLICAL AND STRUCTURAL
GROWTH
Cyclical Growth
z
z
Driven by short-term
factors like subsidies,
low global prices,
better monsoon, low
inflation etc.
If the above factors
are unfavourable, we
can have a cyclical
de-growth.
Structural Growth
z
z
Driven by longterm factors like
demographic
dividend, better
macro­economic
policies, employment
generation etc.
There can also be
structural degrowth
or negative growth
due to unfavourable
factors like an
ageing population,
bad microeconomic
indicators, high
unemployment etc.
35
4.5
GROWTH VS DEVELOPMENT
Basis of comparison
Growth
z
Concept
z
Effect
z
Factors
z
Time period
z
z
Government’s role
z
Change it brings
z
Relevance
an improvement in an economy’s
physical output of goods and services
over time.
z
It indicates growth in both the national
and per capita incomes.
z
Measurement of increase in real GDP
or per capita income or components
like consumption, exports, investments
etc.
Don’t consider qualitative metrics like
happiness.
z
An automatic procedure that might
or might not be the outcome of
government intervention or policy.
z
More relevant in developed economies
as basic development (health,
education etc.) has already taken place.
z
It is relevant for short-term periods
and is measured in a time frame.
z
Increase in indicators of growth means
GDP, investment, consumption etc. are
increasing.
z
4.6INDICATORS OF ECONOMIC
GROWTH
z
z
z
GDP, GVA and GNP are most popular for the
calculation of national income as they are used
globally and can be used to compare economies. But
they also have multiple limitations. With changing
times, these have proven to be inadequate and can
also show an inaccurate picture. Many alternatives
claim to provide not only the quantitative but also
the qualitative picture of the progress.
Note: Indicators of economic growth such as GDP, GNP,
NNP, GVA etc. have been covered in other sections.
Some of the indicators of economic growth are as
follows:
Per Capita Income
z
z
36
Development
A traditional and widely used metric of economic
growth is a rise in the real per capita income over a
period of time.
It tells us the level of economic activity in a country
and its economic size. Also, it reveals the average
output per head.
z
z
It is a positive change both quantitatively as
well as qualitatively in an economy.
Quantitative and qualitative: It denotes
positive changes in the lives of the citizens
related to improvement in their quality of
life.
Reduction
of
poverty,
illiteracy,
unemployment, measurement of HDI,
Happiness index, reduction of stunting and
wasting etc.
It is a long-term process and isn’t measured
in a fixed time period.
It usually requires targeted policies and
government intervention.
Progress here means there is progress in the
general quality of life of people.
More pertinent for evaluating the standard
of living and development in developing
nations.
Growth of real per capita GNP tells us the ability of a
nation to expand its output at a faster rate than the
population growth rate of that nation.
The world bank has categorized nations into
various groups based on GNI per capita:
Group
Low income
Lower middle income
Upper middle income
High income
Per Capita Income (2022)
<1036 USD
1036-4045 USD
4046-12535 USD
>12535 USD
Natural Resources Accounting
z
z
Biodiversity, soil, water and air are all-natural capitals
which don’t usually get the same importance in
accounting as man-made capital.
By accounting for the natural capital we can generate
sustainable income from the natural capital through
their judicious use.
Big Mac Index
z
Based on the Purchasing Power Parity (PPP) theory
and created by the London-based magazine Economist.
Indian Economy
z
z
Big Mac is a specific variety of burgers sold by
McDonald’s. It is used to compare two different
currencies as per their purchasing power wrt Big
Mac. (Say 5 dollars in the USA and 350 INR in
India).
The benefit of PPP comparison is that it is comparable
to the ground-level value of the currency and is not as
volatile as the exchange rate system.
4.7SHARE OF DIFFERENT SECTORS IN
THE ECONOMY
Sector
Primary
Sub sector
Agriculture, forestry
and fishing, Mining
and quarrying*
Secondary Manufacturing,
Electricity, gas, water
supply and other
utility services,
Construction
Tertiary
Trade, hotels,
transport,
communication
and broadcasting,
Financial, real estate
and professional
services, Public
administration,
defence and other
services
Share at the
current price
(approx. figures)
22%
z
z
z
In addition to rising national income, it also entails
changes in social, cultural, political, and economic
spheres that advance the material world.
z
For instance, economic growth in India resulted
in higher wages, greater household and individual
savings, better infrastructure and governance, and
a shift in the general public’s attitude.
z
It is a consistent improvement in society’s material
well-being. It encompasses more than just economic
expansion.
z
It is possible that a country can have economic
growth but not economic development. E.g. In
middle eastern countries, high-income growth was
not comparable to high development.
z
With the concept of the “welfare state” getting
popular; economic development became a large
concern of governments around the world.
z
26%
Welfare State
z
54%
*Note: Mining and quarrying are sometimes included in
the secondary sector as well.
4.8
economic conditions. It has both social and
economic aspects.
ECONOMIC DEVELOPMENT
For a long time, economics was focused only on
increasing the quantity of production and income of
a country. It was assumed that by merely increasing
production, a nation could increase its income and
thus improve the lives of its citizens.
Thus, there was no distinction between “growth”
and “development” till the 1950s.
Economic development is the quantitative
and qualitative shift that occurs in the lives
of individuals with an improvement in their
Economic Growth and Development
z
z
z
z
z
z
It is a governance system where the state or the
authority provides basic economic and social
securities for its citizens.
The government is responsible for the individual
and social welfare of the citizens. Its objective is
to guarantee equal opportunity and equitable
distribution of wealth.
The modern state is a welfare state that creates
economic and social overheads to ensure stability
both internally and externally; conserving resources
for sustainable development.
Modern states assume social responsibilities such
as healthcare, education, sanitation, insurance,
transport and communications, etc., besides
providing the minimum necessities of life.
Indian constitution has provisions of “fundamental
rights and Directive principles” which make welfare
a priority as per the constitution.
Gandhi’s thoughts have influenced the modernday welfare state. For e.g., concepts of Gandhi’s
talisman, trusteeship etc. have influenced the
Indian constitution.
The provision in the articles mentioned in the
constitution of India is also to enforce welfare
measures.
37
4.9INDICATORS OF ECONOMIC DEVELOPMENT
z
z
Gross National Happiness
(GNH)
z
z
z
z
z
z
z
Happiness Index
z
z
z
z
Genuine Progress Indicator
z
z
38
A term coined by the former king of Bhutan- Jigme Singye Wangchuck in the
1970s as an alternative to GDP.
It doesn't just emphasise economic expansion as the end result. It has the
following four dimensions:
1. Sustainable socio-economic development.
2. Cultural preservation.
3. Environmental conservation.
4. Good governance.
It is made up of nine domains (psychological well-being, use of time etc.)
measured in 33 indicators. Thus, it is a multidimensional index.
Its biggest advantage is that it is more focused on well-being than economic
growth. The drawback is that since happiness is a personal matter, a protracted
survey would take too much time.
Published under the Gross Happiness Report by the UN Sustainable
Development Solution Network; it aims to help nations to form policies for
the happiness of their citizens.
It is inspired by Bhutan’s Gross Happiness Index and was released for the first
time in 2012.
It is based mostly on the responses of the individuals.
It has six variables to assess well-being:
1. Income
2. Healthy life expectancy
3. Social support
4. Freedom
5. Trust
6. Generosity
World Happiness Report 2022
 Finland is again the happiest country for the fifth time in a row.
 2nd and 3rd positions are occupied by Denmark and Iceland.
 First three places are occupied by Scandinavian countries. India’s ranking
is 136.
 The most-unhappy country is Afghanistan.
Happiness curriculum was released in Delhi government schools in 2018. The
objectives are as follows:
 Self-awareness
 Mindfulness
 Inculcating skills of Critical thinking and inquiry
 Effective communication
 Life skills to deal with stressful situations
Taking inspiration from Delhi; MP, Andhra Pradesh, Uttarakhand, and a few other
states and countries like UAE planned to introduce similar initiatives.
Surveys from Delhi schools show that the curriculum was having a desirable
impact on the maturity and emotional well-being of the students.
Published by a US-based think tank called “Redefining Progress” to assess
national progress.
When determining a country's well-being, it takes social and environmental
factors into account.
It deducts costs of environmental loss, resource depletion, rising crime rates etc.
Indian Economy
z
z
Social Progress Index
z
z
OECD’s Better Life Index
z
z
Quality of Life Index
z
z
z
z
Physical Quality of Life Index
z
z
z
z
z
z
z
Human Development Index
(HDI)
z
This also includes social and environmental costs like the GPI, but the weighting
is different.
It is published by a non-profit organisation called Social Progress Imperative and
is based on writings of Amartya Sen and Joseph Stiglitz.
It focuses on three factors:
1. Basic human needs.
2. Foundations of well-being.
3. Opportunity.
This was published in 2011 by the Organisation for Economic Cooperation and
Development.
It takes into consideration eleven of the best metrics of well-being: Income,
Housing, Jobs, Community, Education, Environment, Governance, Health, Life
satisfaction, Safety, and Work-life balance.
There were various shortcomings of the income-based indicators of economic
development. QOLI focuses on several needs of the majority of people of a country.
It is based on different factors like availability of basic necessities of life like food,
shelter, clothing, equity in wealth distribution, clean environment, healthcare,
literacy, political and civil rights etc.
Developed in the 1970s by D. Morris; it has become a major index for quality of
life measurement.
This indicator takes into account thrice as many indicators as by the Quality of
Life Index (QOLI).
Life expectancy: The estimated lifespan of a newborn. It can be increased by better
pre and antenatal care, better health facilities and infrastructure, sanitation and
nutrition.
 Economic development leads to a higher life expectancy, which in turn
promotes further economic growth.
 It is measured in years and the more it is the better.
Infant mortality is the term used to describe deaths in children under the age of
one. It is desirable that it remains low. It is measured in months.
Literacy: It refers to the ability of reading and writing. The better the literacy
rate; the more opportunities people will have. It is measured in percentage terms.
PQLI= (life expectancy indicator + infant mortality indicator + basic literacy
indicator)/3
The values of the 3 indicators are normalized to calculate PQLI on a scale of
zero to one.
The UN HDI was developed by a Pakistani economist- Mahbub Ul Haq in 1990
with the assistance of Nobel-winning Indian economist Mr Amartya Sen.
It has been used in the annual UN Development Report since 1993.
This index gauges a nation's average progress in three key areas of human
development:
 Health: Measures by life expectancy at birth.
 Knowledge: Measured in adult literacy rate and gross enrolment ratio.
 Standard of living: Measured in GDP per capita in US dollars.
Components of HDI:
 A long and healthy life
 Knowledge: Measured by a combination of two variables:
1. Mean years of schooling
2. Expected years of schooling
Economic Growth and Development
39
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4.10 JOBLESS GROWTH
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Decent standard of living: Measured by a country's GNI adjusted for Purchasing
power parity.
HDI = third root over (Health index + literacy index + income index)
It has been released every year since 1993 and lists nations as per their
performance in the three sectors.
In 2010, for the first time, the “Inequality Adjusted” Human Development Report
was released. This factored in inequalities in all three areas - education, the
standard of living and health.
It is a phase in an economy where unemployment
remains high even as the economy grows.
Job creation has not kept pace with the GDP
growth. In both, the manufacturing and services
sectors; employment potential couldn’t be reached.
A 10% growth in GDP only produces a 1% growth in
jobs in India.
Reasons for Jobless Growth in India
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Covid impact: A large number of people have lost
their jobs and the recovery has failed to absorb the
unemployed, underemployed and people who have
only recently started looking for employment.
The labour force participation rate dropped to just
40% of 900 million Indians of legal working age.
Services led growth: Knowledge-based services
dominating the economy; which by nature is less job
intensive.
Lack of reforms on various fronts: Infrastructure
bottlenecks, complex and varying labour laws and
rules, hidden costs of doing business etc need to be
looked at.
Import dependence: India did not witness import
substitution policies early on. It depended on imports
and thus domestic industries didn’t develop.
Labour laws: India’s labour laws incentivise small
industries. Many states require industries with more
than 100 workers to take government permission
before retrenching/firing. These permissions are
rarely granted. According to a world bank study,
manufacturing employment has decreased by 25%
as a result of the Industrial Disputes Act.
Poor treatment and attention to medium and small
industries which are labour-intensive but lack access
to credit.
Incentives from the government for investments
are related to the amount invested and not jobs
generated.
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Solution
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The problem showed its symptoms recently as the
Agneepath scheme resulted in violent protests in
different parts of the country.
Better labour laws at central and state levels; with
a concentration on the Industrial Disputes Act, the
Industrial Employment Act and Trade Unions Act.
Link the initiatives for job creation with the
planned development of the country. For e.g. utilising
MGNREGA workers for larger infrastructure projects,
and linking AMRUT with employment schemes.
Reform the education sector with skill-based/
vocational training at intermediate and college levels.
Promoting labour-intensive sectors like food
processing, textiles, leather, gems and jewellery etc.
Structural changes should be accompanied by
re-skilling of the workforce; either by the government
directly or by sponsoring training by the industries
themselves. E.g. Trucks are idle because there is a
shortage of skilled drivers.
Steps Taken
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Impact of Jobless Growth in India
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As per the world bank, the number of working
women dropped from 26% to 19% between 20102020.
CMIE said that the female labour force participation
rate dropped to 9% by 2022.
The number of people employed in agriculture
was consistently falling until Covid reversed the trend.
India lacks skills even though labour is surplus. E.g.
Trucks lie idle as there are few drivers.
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Various states have increased the number of workers
that can be retrenched without the government’s
permission to 300. (Rajasthan, Andhra, Maharashtra
etc.)
Skill India programme: Announced in 2015 for
various skill development training programmes
to bridge the gap between industry demands and
availing skills.
PM
Employment
Generation
Programme:
Announced in 2008 with Khadi and Village Industries
as the nodal agency to provide employment in both
rural and urban areas.
Mahatma Gandhi National Rural Employment
Guarantee Act (MGNREGA): 100 days of guaranteed
work in a financial year to rural households, whose
Indian Economy
adult member is willing to do unskilled manual
labour.
The “Make in India” programme offers incentives
tied to production to encourage foreign direct
investment and manufacturing in India.
Focus on the MSME sector: Redefining the MSME
sector, RAMP scheme, and financial packages during
the Covid pandemic to promote exports from this
sector.
Atma Nirbhar Bharat Abhiyan: Focus on improving
manufacturing, supply and demand.
PM Mudra Yojana: provides up to 10 lakh rupees
collateral-free loan.
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PREVIOUS YEAR QUESTION (MAINS)
1. The nature of economic growth in India is described
as jobless growth. Do you agree with this view? Give
arguments in favour of your answer.
(2015)
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Okun’s Law
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Postulated in the 1960s by Yale University’s
professor Arthur Okun; one of the most
straightforward and convenient methods
of investigating the relationship between
economic growth and employment.
According to the logic, there is a positive correlation
between output and employment and a negative
correlation between output and unemployment
because the output is dependent on the amount of
labour used in the production process.
Positive relationship means if X increases Y will
most likely increase and vice-versa for a negative
relationship.
Total unemployment = Labour force - the
unemployed.
It looks at the statistical relationship between a
country’s unemployment and economic growth
rates.
It states that a country’s GDP must grow at 4%
rate for one year to achieve a 1% reduction in
unemployment.
4.11CONCEPT OF DEVELOPED,
DEVELOPING AND LEAST
DEVELOPED COUNTRIES
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The criteria like GDP, industrialisation, HDI,
infrastructure and standard of living are used to
categorize countries.
Developed countries have a highly developed service
sector and contribute greatly to the economy. These
are post-industrial economies i.e. they are past the
Economic Growth and Development
industry-led development age. (Thus India is not a
developed country).
An underdeveloped or developing country
witnesses low HDI, pockets of development, low
infrastructure base, low standards of living, high
demographic dividend, cheap labour etc.
 The countries that liberalized in the 1990s
are witnessing very rapid urbanization
and development and are termed as Newly
Industrialized Countries. Like India and China.
 They
are placed between developed and
underdeveloped countries and are investment
magnets.
According to the UN, the least developed nations
are those that satisfy three particular criteria:
1. Poverty: Per capita income is less than USD 1035.
2. Weak human resources
3. Economic vulnerability
The LDC criteria are reviewed every three years. Most
of the African countries are in this category.
World Bank Classification (2022)
Category
Capita (In USD)
Low income
> 1085
High-income
<13,205
Lower-middle income
Upper middle income
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1086-4255
4255-13,205
There can be countries that are categorized as high
income but are considered developing.
The reason is, they have pockets of an export economy
based on oil and gas (Gulf cooperation council
countries) but the rest of the economy is developing.
Common Features of Underdeveloped
Countries
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Low per capita income
Poor standard of living to the level that even the basic
necessities are absent.
High population growth rate leads to greater
consumption expenditure and lower savings and
investments.
Highly unequal income distribution
Prevalence of mass poverty due to high inequality and
low per capita income.
Low levels of productivity i.e. output per person
is very low due to:
 Inefficient and backward workforce
 Bad work culture
 Low use of capital in machinery
Low rate of capital formation and a low level of
savings.
41
Technological backwardness due to low-income level and incapacity to invest in technology.
High level of unemployment due to lack of capital and low level of development.
Low social indicators of development like low literacy rate, high infant mortality rate, low life expectancy etc.
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4.12 NITI AAYOG: INDIA@75- OBJECTIVE TO ENHANCE ECONOMIC GROWTH
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Current Situation
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Objectives
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Way Forward
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The share of manufacturing in India’s GDP is low compared to. average in lower- and
middle-income countries.
Capital-intensive sectors like automobile and pharma have witnessed the highest growth.
India has been struggling to capitalize on labour and skill cost advantages to develop a
large-scale and labour-intensive manufacturing sector.
Steady increase in GDP growth rate to achieve a target of 8% growth rate during 2018 to
2023.
Raise the investment rate from 29% to 36% of GDP.
Export of goods and services combined should be increased from USD 478 billion to USD
800 billion by 2022-23.
For raising investment rates:
Aim to increase the tax-GDP ratio to 22% by 2022-23.
Justify direct taxes on both corporate and individual income. Lighten the burden of tax
compliance.
Increase the government’s contribution to fixed capital formation to at least 7% of GDP.
Increased public investment in the housing and infrastructure sector.
Exit non-strategic CPEs to attract private investment.
Encourage PPP-based private infrastructure investment, as recommended by the Kelkar
committee.
Macroeconomic stability:
Gradually lower the government’s debt-to-GDP ratio.
Bring down the effective revenue deficit as soon as possible.
Targets for fiscal deficit should be based on prevailing economic conditions with the option
to escape the limit.
Limit inflation between 2% to 6%.
Efficient financial intermediation:
Deepen financial markets, make capital easily available, use financial markets to channel
savings and improve risk assessment framework.
Governance reform in public sector banks by establishing commercially driven and
independent bank boards.
Gift City should be leveraged to push for financial sector liberalization.
Alternative sources for long-term investment needs by the deepening of bond markets and
fiscal consolidation.
Focus on export and manufacturing:
Make the logistics sector more efficient.
Rationalize power tariff structures to ensure the global competitiveness of Indian industries.
Improve connectivity by completing projects that are already underway like DMIC and
dedicated freight corridor.
Make labour provisions flexible across all sectors and encourage states to implement fixedterm employment across all sectors.
Enhance 12 champion service sectors which include IT, ITeS, medical, travel, and audiovisual services, tourism.
Strengthen the governance and technical capabilities of Export Promotion Councils (EPC).
Closer integration with emerging South Asian and South East Asian countries.
Indian Economy
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Employment generation:
Generate sufficient employment for new entrants into the labour force and those migrating
out of the agriculture sector.
Large chunks of jobs can be generated in the manufacturing, construction and services
sectors.
Employability can be enhanced by improving health, education and skilling outcomes.
4.13INEQUALITY AND SOCIOECONOMIC INDICATORS
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Index of health outcomes has a positive correlation
with income inequality and per capita income across
the Indian states. (i.e. when health outcomes improve;
the condition of inequality improves and so does per
capita income)
The results are the same when we use the index of
education, life expectancy, infant mortality and crime.
Between Indian states, there is little correlation
between inequality or per capita income and drug
use. (i.e. drug usage increases don’t necessarily mean
improvement in levels of inequality or per capita
income)
Birth rate and fertility rate decline with
improvement in inequality and per capita income;
while death rates do not correlate at all with either
of the two.
A weak positive relationship between inequality in
asset ownership and inequality of corruption. (Both
are measured by the Gini coefficient). This implies
that the states with higher consumption inequality
have higher asset ownership inequality.
The disparity between wealth and consumption in
Indian states is much greater.
The permanent income hypothesis says that
individuals and households smooth their consumption
over time with savings or borrowings.
assets. Here, increases in inequality may be
accompanied by a reduction in poverty.
4.15CIRCULAR ECONOMY OR
CIRCULARITY
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Reduce
Environmental Green
Footprint
products
non-toxic, long-life,
recyclable
Recycle
waste,
reuse
resources
4.14RELATIONSHIP BETWEEN
INEQUALITY AND POVERTY
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The degree of disparity in the distribution of
assets, income, or consumption is referred to as
inequality.
Poverty refers to the assets, income or consumption
of those at the bottom of the distribution.
 Poverty can be both absolute and relative.
People can feel that they are poor if they have less
than what most people around them have.
 In the above view; poverty is a relative concept.
Here it is also a measure of inequality and thus no
need to distinguish it from inequality.
 The focus is on the low end of the distribution’s
absolute levels of consumption, income, and
Economic Growth and Development
It is an economic approach which takes a
comprehensive view of products and processes and
aims to eliminate wastage and reusing resources.
It is a system that is restorative or regenerative by
design.
Eliminating the “take, make, waste” cycle can help
us address issues like climate change, biodiversity
loss, waste, and other issues.
Most businesses use natural resources to turn it into a
product and ultimately end up as waste. This happens
due to its design and the type of process involved.
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Minimize
Waste
Generate
Cleaner
Increased
production
Income
using fewer
resources
Circular
Economy
Collect at
end-of-life,
remanufacture
Better service
to extend
lifespan
Reduce
Resource
Dependency
A circular economy includes 3 R’s - Reduce, Reuse
and Recycle. Thus focus is on productivity in terms of
efficient utilization of resources.
Out of the total waste produced in India; only
10-15% goes into the recycling process.
Digital India and Vehicle Scrappage policy is a step
in the right direction.
It is based on 4 basic principles:
1. Minimize waste and pollution.
2. Extension of the life of products and materials.
3. Regeneration of natural systems.
4. Replaces “consumer” with “user”.
43
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Importance:
 Minimises raw material supply to industry.
 Reduces input costs.
 Quality, cost, delivery and flexibility (QCDF) and
sustainability level of industries get improved.
Application:
 Construction sector: multiple uses of spaces,
reuse of building material once the building is
brought down.
 Food and agriculture: digital sharing of knowledge
and assets, urban farming and returning nutrients
back to the agriculture system.
 Transport and mobility: highly durable electric
vehicles, re-use of materials and parts, large mass
transit systems and last mile connectivity.
 Create
jobs and increase productivity:
while reducing carbon emissions and ensuring
sustainable development.
Benefits:
 It makes the production process more productive
and efficient while GDP growth is achieved more
sustainably.
 Solves the problem of waste disposal, solid waste
management, and air, water and land pollution.
 Lower costs for individuals, increased efficiency,
lesser negative externalities (pollution, smog etc).
v
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Limitations:
 The recovery and recycling process itself uses
energy and causes pollution which will rise as
the material to be recycled rises.
 Waste segregation is a major problem and it’s
difficult to decide who’ll do that. Consumers may
not have the time, skill or training.
 May turn out to be a utopian concept.
 There are many variables in the system. The
economic considerations of the actions have not
been fully understood.
Way forward:
 Take the circular economy into consideration
during the process of decision-making at
administrative and business levels.
 Innovate new products and business models.
 Promote collaboration across businesses and
value chains.
OpinionMatters
The notion of human development is primarily
concerned with assisting individuals to live better
lives as the ultimate objective of human endeavour. Do
you think this objective can be accomplished only by
increases in money or material well-being?
v
v
Indian Economy
5
Economic Planning In India
INTRODUCTION
5.1
The only thing to be happy or proud of when the British left
India in 1947 was freedom. The issues were many before
the Indian government and besides mass poverty, there
was the problem of food shortage and inflation. Other
significant issues the nation faced included illiteracy, a lack
of healthcare, a lack of infrastructure, etc. as an extended
strategy. ‘Planning’ for economic development was the
answer to solve these problems.
Preparation of
priorities
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Planning entails deciding how to achieve future goals
and how to allocate resources to accomplish them. At
the time of independence, it was important to plan
how the resources of the nation would be used. It
included specific and general objectives which will
be achieved with time.
Estimation of
resources
M. Visvesvaraya is regarded as a pioneer of
economic planning in India. His book “India’s Plan
for the Economy” published in 1934 suggested a tenyear plan, with an outlay of Rs. 1000 crore.
The Industrial Policy Statement published just
after independence in 1948 suggested the creation
of a Planning Commission and following a mixed
economic model.
Planning began with the creation of the Planning
Commission in 1950 and the formation of 5-year
plans (borrowed from the Soviet Union).
5.2
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Problem
Identification
Fixing a target
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MEANING OF PLANNING
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TYPES OF PLANNING
Directional planning: is opted for by countries
which follow the ideals of socialism. Under socialism
Distribution of resources are equal and things are under
the control of the state including, financial institutions,
the industrial sector, transport, infrastructure, etc. For
example, the Soviet Union.
Perspective planning: a long-term plan for a period
of 20 to 25 years. It gives a longer time span for the
development process to achieve targets in a phased
manner. There are two types of perspectives: shortterm plans for 5 years and long-term plans for 20-25
years.
Indicative Planning: works on decentralized
principles for the achievement of targeted plans. In
this planning, the targets for the public sector are
mandatory while for the private sector, they are only
indicative. For example, used in France and Japan.
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Execution and
review
Imperative Planning: When the government
controls all the economic activities and resources
of the country. The purpose of the planning is an
efficient use of available resources to complete the
targets. The government’s decision-making process
and policymaking are rigid processes but have to be
followed by the market players without alternative
options. For example Russia and China.
Centralized Planning: Central authorities frame out
plans and formulate planning activities. The authority
fixes plans for different sectors and industries as
well. The major investment decisions are taken
considering the goals and targets set by the plan’s
central authorities.
Decentralized Planning: When plans are
communicated to the grass root level and moved in
a hierarchy. Plans are prepared by central authorities
then the decisions are disseminated to the state level
or district level. Plans for industries are prepared
with the representatives of the stakeholders from the
industrial sectors.
5.3
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Mobilizing the
resources
MULTI-LEVEL PLANNING
By the mid-1960s, the Centre had given the states the
power to plan, advising them that they should promote
planning at the lower levels of the administrative
strata. By the early 1980s, India had become a country
of multi-level planning (MLP), with the following
structure and strata of planning:
First Strata:
Centre-Level
Planning
Second Strata:
State-Level
Planning
Third Strata:
District-Level
Planning
Fourth Strata:
Block-Level
Planning
Three types of Central Plans
had evolved over the years at
the centre-level planning level:
Five Year Plans, Twenty-Point
Programmes,
and
MPLADS
(Member of Parliament Local Area
Development Scheme).
By the 1960s, the states were
planning at the state level through
their respective planning bodies
(State Planning Boards), which
were chaired by the respective
CMs. The plans of the states were
for a term of five years and parallel
to the concerned Five-Year Plans of
the Centre.
By the late 1960s, all of the state’s
districts had their own plans, with
their own District Planning Boards
led by the respective District
Magistrate.
The District Planning Boards
served as the nodal body for
block-level planning as part of the
district-level planning.
Plans were being implemented
at the local level via blocks by
Fifth Strata: Local
the early 1980s, with the District
Level Planning
Planning Boards (DPBs) serving as
the nodal agency.
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5.4INDIAN ECONOMIC PLANNING
BEFORE AND AFTER
INDEPENDENCE
Pre-independence Economic Plans
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M. Visvesvaraya in his book “Planned Economy in
India” in 1934. He put together a plan for the growth
of India in 10 years. The idea behind the plan was to
shift labour from agriculture to industries. To double
up the national income in the next 10 years. This was
the first concrete plan at that time to work towards
planning.
Bombay Plan (1944): The known Industrialists
of Bombay Mr JRD Tata, GD Birla, Purshottamdas
Thakurdas, Lala Shriram, Kasturbhai, John Mathai etc
worked together and prepared “A Plan of Economic
Development for India” which was popularly known
as Bombay Plan. The objective of the strategy was to
double the per capita income in the next 15 years and
increase the national income during this period.
M N Roy’s People’s Plan was based upon Marxist
socialist ideology. The plan time period was 10 years
which focused the priority on Agriculture production
and the Nationalization of all agriculture.
Gandhian Plan (1944): Proposed by Sri Shriman
Narayan emphasized economic decentralization
with a primary focus on rural development through
developing cottage industries.
Sarvodaya Plan (1950): Drafted by Jaiprakash
Narayan getting Motivated by the Gandhian Plan
and the Sarvodaya Idea of Vinoba Bhave. The plan
emphasized on development of small cotton industries
and agriculture. Land reform and decentralised
participatory planning were also highlighted.
Post-independence Economic Plans
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Democratic Socialism
Nehru was greatly influenced by the achievements of
Soviet Planning; The philosophy was to not only check
the growth of monopolistic tendencies of the private
sector but also provide freedom to the private sector
to play for the main objective of social gain rather than
economic gain.
National Planning Committee (1938): This was
India’s first attempt to develop a national plan. The
committee was set up by the then Congress president
Subhash Chandra Bose.
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Economic Programme Committee (EPC) in 1948:
Formed by the All India Congress Committee (AICC)
with the aim of balancing the partnership of private
and public players and urban & rural economies.
In 1950, the Indian government established the
Planning Commission, which was tasked with
assessing and augmenting resources. Formulate
the plans for the effective utilization of resources
in a balanced manner on the basis of economic
priorities.
5.5
GOALS OF 5-YEAR PLANS
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Growth
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Modernization
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Increase
the
capacity
of
production of goods and services.
Increase in economic growth and
GDP.
Increase in industrial production
by
new
technologies
and
industries allowed to set up.
Increase in women’s participation
but at a minuscule level.
Indian Economy
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Self-Reliance
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Equity
5.6
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NEED FOR THE PLANNING
Means and ways: Planning is a technique to make
efficient use of resources for the fulfilment of targets.
Resources mobilization: Mobilization of resources
to continue the implementation and progress of
programmes developed by the authorities.
Prudent expenses: Making an underestimate of the
expenses during the planning process to avoid any
wastage of resources, minimize cost, and achieve the
targets on time with optimal utilization of resources.
OBJECTIVES OF PLANNING
Planning: Social and economic planning with in mind
the purpose of a welfare state.
Economic
modernisation and
stability
↓ Inequalities
↑ Standard of
living
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Equal benefits to every underdeveloped section of the society
to spread economic prosperity.
Meeting the basic needs of food,
housing, health care, water etc. to
reduce inequality.
Goals and Vision: To achieve pre-directed goals and
to carry out activities to achieve the same.
5.7
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A 5-year plan intended to make
the country efficient by reducing
dependence on imports to protect
the sovereignty of the country.
A belief and protectionist
ideology to promote economic
growth using its own resources
rather than imports from foreign
countries. Objectives
of Indian
Planning
Sustainable and
inclusive growth
Self-sufficiency
Employment
Generation
Regional
development
Economic growth and
development
Growth: To achieve Sustainable economic growth in
all sectors.
Poverty: Eradication & alleviation of poverty.
Opportunities:
opportunities.
Generation
of
Employment
Economic Planning In India
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Expansion: Modernizing the economy through
expansion in the agriculture sector through livelihood
and employment opportunities.
Ensuring economic equality: by being self-sufficient
and fulfilling the socio-economic-politico objectives of
DPSPs mentioned in the constitution.
Resources: Employment opportunities to utilize
human resources.
Self-reliance: Self Sufficiency was the aim of the plan.
To be self-sufficient and increase exports.
Opportunities: Reduction in Economic inequalities
through progressive taxation, and employment
opportunities generation.
Poverty: To provide social justice through plans
to alleviate the pollution from the poverty line by
providing them employment.
Technology: The lack of modern technology was the
major reason for the suffering of the Indian economy
with low productivity in agriculture and a lack of
industrial development.
5.8DILEMMA: AGRICULTURE VERSUS
INDUSTRIALIZATION
The government of the time chose industry to be India’s
primary economic driving force. Given the available
resource base, it appears an illogical decision, as India
lacked all of the prerequisites that would suggest industry
as its prime mover:
Industry: At the time, the government chose industry
as India’s primary economic moving force.
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Resources: Given the available resource base, it
appears an illogical decision, as India lacked all of
the prerequisites that could suggest the industry’s
declaration as its prime mover z
Infrastructure: The infrastructure sector has a low
presence.
z
Growth: Slow growth rate of industries such as iron
and steel, cement, coal, crude oil, oil refining and
electricity.
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Investment: Lack of investment opportunities- either
by the government or the private sector.
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Technology: Absence of required technology to
support the process of industrialization and lack of
research and development.
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Human resources: Shortage of skilled and semiskilled manpower.
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Job: Lack of entrepreneurship spirit among the people.
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Markets: Less access to markets for industrial goods.
The agriculture sector was an obvious choice as the
economy’s Prime Moving Force (PMF) because:
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Resources: The availability of natural resources such
as fertile land suitable for cultivation.
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Capital: Human capital did not need any kind of
higher training.
Development: With land ownership, irrigation and
other inputs to agriculture, India could have gone for
better prospects of development.
Poverty: An increase in purchasing power due to
remunerative income from agriculture would have
automatically led to the expansion of industries.
Economy: The developments were in favour of
industrialization – Opting for industrial growth was
necessary to industrialize the economy
5.9ACHIEVEMENTS AND SUCCESS OF
INDIAN PLANNING
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Increase in National Income and Per Capita Income:
National income has increased dramatically over
the planning period. From 1901 to 1947, the average
annual increase in national income was 1.2 per cent.
During 2018-19, per capita income at current prices
is expected to reach $1,26,406 (10,533.83 monthly).
National income has increased dramatically as a
result of economic growth. India has emerged as one
of Asia’s emerging economies. India has become the
fifth-largest economy in 2022, overtaking the United
Kingdom.
Employment Creation: Emphasis was placed on the
creation of larger employment opportunities, such
as the establishment of small and cottage industries,
the spread of technical education, the development of
self-employment schemes, the establishment of larger
industries, and the improvement of agriculture and
service sectors.
Development of Science and Technology: In the era
of planning, India has made much progress in the field
of science and technology.
India ranks: third when GDP is compared in terms of
purchasing power parity (PPP).
Improvement: in social indicators – IMR, MMR,
Literacy. Employment, remittances etc.
Price Stability: Attaining economic stability has been
considered one of the major objectives of economic
planning throughout the entire plan period.
Industrial Growth: Robust industrial growth and
other core sectors such as cement, fertilizers, steel,
pharma etc.
Agriculture growth: with an increase in production
and export of rice, wheat, sugar etc.
Global leadership: of India in the service sectors. For
example- Tourism, IT sectors etc.
Opportunities: Decrease in the level of Poverty
and increase in employment opportunities for the
population.
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Development of Transport and Communication:
During the planning period, much attention has
been paid towards the development of transport and
communication.
Social welfare: 5-year plans helped to decide why
little investment over the years in education, health,
labour welfare, and schemes for the upliftment of
backward classes would have a compounding effect
in development.
Capital Formation: In India due to the development
of agriculture, industry and defence, the rate of capital
formation has also increased.
5.10FAILURES AND SHORTCOMINGS OF
INDIAN PLANNING
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Price Increase: Price stability has been one of the
goals of India’s five-year plans. But almost all the plans
witnessed a considerable rise in the price level. Price level: The price level decreased in the first plan.
In all other plans, the prices recorded a steep rise.
Increase in unemployment: Unemployment
continued to rise during the five-year planning period.
At the end of the first five-year plan, 53 lakh persons
were unemployed.
Neglect of Agriculture: The five-year plans failed to
pay attention to the agricultural sector except for the
first five-year plan.
Agriculture: The share of agriculture in GDP declined
from about 50 per cent during 1950-51 to about
19.9% of the GDP in 2022.
Slow Growth in the Production Sector: Capitalintensive industries in urban areas were given
precedence over small-scale industries in rural areas.
In agriculture, the green revolution continues to be
confined largely to wheat and rice crops.
Inequalities in the Distribution of Income and
Wealth: The main objective of the five-year plan
has been to minimize inequality in the distribution
of income and wealth. The plan witnessed only an
increase in inequality not only in the industrial sector
but also in the agriculture sector also.
Widespread Poverty: Failure to address the problem
of unemployment has resulted in widespread poverty
in the country.
Shortcomings of first four-year plans: Failure
to address the issue of poverty. Various poverty
alleviation programmes were implemented during the
fifth five-year plan to directly combat poverty.
Inefficient Administration: Plans were developed
after extensive discussion and deliberation, but
their objectives were not met due to inefficient
administration, dishonesty, vested interests, and red
tape, among other factors.
Indian Economy
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Lack of a Strong Foundation: Despite the passage
of twelve five-year plans, the economic foundation
remains weak. We are still dependent on the weather
for a good harvest.
Political Instability: Political instability and inefficient
administration are the major hurdles in the successful
implementation of the plans.
Over-Ambitions: Indian plans were criticized on the
ground that their targets were very ambitious. Two
factors that may account for its criticisms were:
 Shortage of resources.
 Faulty implementation of the plans.
No increase in the standard of living: All of India’s
five-year plans aimed at raising the people’s standard
of living, and even basic necessities have yet to be
provided.
Population: On average, a normal healthy person
needs 2500-2700 calories per day (for men) but in
India per capita availability of food is 2200-2400
calories.
Research: R&D is low in comparison to developing
countries of Asia and globally (less than 1 % of GDP).
5.11NEHRU-MAHALANOBIS MODEL OF
GROWTH
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The turning point of India’s planning was seen in
the second five-year (1956-61) plan. The model
plan was known as Nehru-Mahalanobis based on
the investment in Capital goods and augmentation
of these goods to use them in further production of
goods.
The plan’s model is known as the Nehru-Mahalanobis
strategy of development because it was articulated by
5.12 INDIA’S 5-YEAR PLANS
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First Five-year
Plan
(1951-56)
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Second Five-Year Plan
(1956 to 1961)
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Jawahar Lal Nehru’s vision and was designed by P.C.
Mahalanobis.
Components of Model:
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
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Investment: It was based on the premise that
would attract investment and higher growth rate
targets.
Industries: Development of small-scale industries
to boost employment generation, alleviation of
poverty alleviation, increase in exports etc.
Import substitution policies, such as protective
barriers against foreign product imports, are
examples of policies. The reduced competition
will enable Indian firms to develop domestically
produced substitutes for imported goods.
Production: Development of small-scale industries
for the production of goods to meet domestic
consumer demands with equal importance to the
growth and enhancement of industries.
Rao-Manmohan Singh Model of Growth
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Economic reforms since 1991 are based upon
the Rao-Manmohan model (Narasimha Rao – PM
and Manmohan Singh – Finance minister). This
model presses for - the selective dismantling of
controls and permits, refocusing on social and
infrastructural development, external sector
liberalisation, integration of the Indian economy
with the global economy, creating competition for
PSEs, and accumulation of forex reserves, among
others.
Based on the Harrod-Domar model.
Its main focus was on the agricultural development of the country including irrigation
and power projects.
Targeted growth rate – 2.1 per cent.
3.6% growth rate achieved (higher than target).
Public sector undertakings (PSUs) received approximately 44.6 per cent of the plan
outlay.
The Community Development Programme was launched on October 2, 1952.
The Imperial Bank of India was renamed the State Bank of India in response to the
Gorwala Committee’s recommendations.
Rapid industrialization with a focus on heavy industries and capital goods.
Targeted growth rate – 7.5 per cent.
Achieved a growth rate of 4.1%.
It was based on the P.C. Mahalanobis Model.
Second Industrial Policy, 1955 – divided industries into three schedules.
The Target of achieving a “Socialistic pattern of society” in economic policies – failed
to achieve.
Economic Planning In India
49
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Third Five-Year
Plan
(1961 to 1966)
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Three annual plans
(plan holiday)
(1966 to 1969)
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Fourth Five-Year Plan
(1969 to 1974)
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Fifth Five Year
Plan
(1974 to 1979)
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Rolling Plan
(1978 to 1980)
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Sixth Five Year
Plan
(1980 to 1985)
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Also called ‘Gadgil Yojana’
The main target of this plan was to make the economy independent and to reach the
self-active position of take-off.
For the first time, it was considered the aim of balanced, regional development.
Established Food Corporation of India (FCI) in 1965
Major Events:
Two wars: one with China in 1961–62 and the other with Pakistan in 1965–66 along
the Gujarat border
Severe drought-led famine in 1965–66 had to be faced.
Focus was on Self-reliance.
During this plan, annual plans were developed with an equal emphasis on agriculture
& its allied sectors and the industry sector.
The Green Revolution ushered in this period. (1966-67).
Growth with stability and progressive self-sufficiency.
Targeted growth rate – 5.7 per cent.
Achieved growth rate of 3.3% (plan failed to achieve targeted growth rate).
The Fourth Plan (1969-74) provided a needed adjustment to the previous pattern which
helped particularly the stronger sections in agriculture as well as in industry to enable
them rapidly to enlarge and diversify the production base.
Indira Gandhi used the slogan “Garibi Hatao” during the 1971 elections as part of this
plan.
Major Events:
 Droughts and the Indo-Pak War of 1971–72 (Bangladesh Liberation War)
 Nationalization of 14 banks in 1969
Focus on poverty alleviation and self-reliance.
Targeted growth rate – 4.4 per cent
4.8% growth rate achieved (the plan was successful)
This plan was terminated in 1978.
Launched:
First population policy of India declared in 1976
Twenty-point Programme (1975)
Integrated Child Development Scheme (ICDS) launched in 1975- 76
Note: The plan period was badly disturbed by the draconian emergency and a change
of the government at the Center.
As a continuation of the fifth-year plan.
“Rolling Plan” concept was envisaged and coined by Prof. Gunnar Myrdal in “India’s
Economic Planning in its Broader Setting”
The Food for Work programme was launched.
Antyodaya scheme
New lease of life to Panchayati Raj Institutions (PRIs) (i.e., the 2nd Phase of the revival
of the PRIs);
Targeted growth rate – 5.2 per cent
Achieved growth rate of 5.7% (the plan was successful)
Objective: poverty eradication and Employment generation.
Famous Slogan: ‘Garibi Hatao’
Launched:
 National Rural Employment Programme (NREP) on 2 Oct 1980
 Integrated Rural Development Programme (IRDP)
 Nationalization of six banks in 1980 (Second round of nationalization)
 Establishment of NABARD in 1982 on recommendations of Sivaraman Committee.
Indian Economy
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Seventh Five-Year
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Plan
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(1985 to 1990)
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Two Annual Plans
1990-91 & 1991-92
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Eighth Five Year
Plan
(1992 to 1997)
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Ninth Five Year
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Plan
(1997 to 2002)
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Tenth Five Year
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Plan
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(2002 to 2007)
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Objectives: emphasized rapid food grain production, increased employment creation
and productivity in general.
Targeted growth rate – 5 per cent
Achieved growth rate of 6% (the plan was successful)
Indicative planning started for Sci & Tech.
Launched Jawahar Rojgar Yojana (JRY) in 1989 – first decentralized scheme
For the first time, the private sector gets priority over the public sector.
The Plan was not accompanied by a strong financial strategy, causing the economy to
enter a state of unsustainable balance of payments and fiscal deficits.
Eighth Plan (1990–95) could not take off due to the political situation of the country,
the Fiscal imbalances and the BOP crisis.
Uncontrollable fiscal deficit
Targeted growth rate – 5.6 per cent
Achieved growth rate of 6.8% (the plan was successful)
Objective: Development of human resources i.e., employment, education, and public
health.
Adoption of Indicative planning in totality
Narasimha Rao Govt. launched the New Economic Policies of India
Rao-Manmohan Model– LPG (Liberalization, Privatization, Globalization)
Constitution of Disinvestment Commission in 1996
Launching of – Mid Day Meal Scheme, MPLADS, National Social Assistant Programme
The 73rd and 74th Amendment acts of 1992 granted Panchayat Raj Institution
constitutional status.
Statutory Status to SEBI (Securities & Exchange Board of India) in 1992
Objective: “growth with justice and equity”.
The target growth rate is 7%. The achieved a growth rate of 5.6%
It was launched in India’s 50th year of independence.
Launched National Population Policy, National Population Fund and Population
Stabilization Fund in 2000.
Swarna Jayanti Shahari Rojgaar Yojana (SJSRY) and Swarna Jayanti Gram Swarojgaar
Yojana (SGSY) were launched.
Sarva Shiksha Abhiyan was launched in 2001.
Major Events:
 All round ‘slowdown’ in the economy led by the South East Asian Financial Crisis
(1996–97).
 Kargil War b/w India and Pakistan
The goal is to double India’s per capita income in the next ten years.
Targeted growth rate – 8 per cent
For the first time the Plan went to set the ‘monitorable targets’ for eleven select
indicators of development for the Center as well as for the states.
‘Governance’ was considered a factor of development
States’ role in planning to be increased with the greater involvement of the PRIs
Policy and institutional reforms in each sector - reforms in the PSUs, legal reforms,
administrative reforms, labour reforms, etc.
In 2002, the agriculture sector was designated as the economy’s prime moving force
(PMF).
Increased emphasis on the social sector – About 27% of the total outlay.
Economic Planning In India
51
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Eleventh Five-Year
Plan
(2007 to 2012)
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Twelfth
Five Year
Plan
(2012 to 2017)
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Objective: “faster and inclusive growth”
It was prepared by C. Rangarajan.
Targeted growth rate – 8.1 per cent
Achieved growth rate of 7.9%
Plan target of 9-10 per cent GDP growth.
Objective: “Faster, More Inclusive and sustainable growth”
Growth rate target is 9%
Broad Objectives of 12th Five Year Plan:
 To reduce poverty
 To improve regional equality across states and within states
 To improve living conditions for SCs, STs, OBCs, Minorities
 To generate attractive employment opportunities for Indian youth.
 To eliminate gender gaps.
Provide access to banking services to 90 per cent of Indian households by the end of
the Twelfth FYP.
By the end of the Twelfth FYP, the head-count ratio of consumption poverty is expected
to be reduced by ten percentage points over previous estimates.
Increase green cover (as measured by satellite imagery) by 1 million hectares every
year during the Twelfth FYP.
Increase infrastructure investment as a percentage of GDP to 9% by the end of the
twelfth FYP.
To conclude, India’s five-year plans did not achieve much
in terms of what they set out to do. The economic progress
that we have witnessed so far is, by and large, a result of
the opening up of India’s economy post-1991 BoP crisis.
Today, the private sector has surpassed the public sector
and taken the lead in a variety of economic sectors. There
are both positive and negative aspects to this.
5.13 NITI AAYOG
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PREVIOUS YEAR QUESTION (PRELIMS)
Q. 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 the 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 Fifth 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
2. 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.
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NITI Aayog replaced the Planning Commission
which was responsible for the economic needs of the
country. NITI AAYOG stands for National Institution
for Transforming India, which was formed via a
resolution of the Union Cabinet in 2015. The Governing
Council of NITI Aayog is chaired by the Hon’ble Prime
Minister and is made up of Chief Ministers from all
States and Union Territories with legislatures, as well
as Lieutenant Governors from the remaining Union
Territories.
It is now a policy-making institution to foresee
economic growth and construct a dynamic economy
to be competitive in this modern world.
Functions of Niti Aayog
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Vision of national development in tandem with
economic growth by giving importance to national
development priorities sectors and involvement of
States in the achieving of national objectives.
To improve federalism that is cooperative and
competitive through initiatives and supporting the
States in making a strong nation.
To integrate economic policies that also fulfil
national security interests as well.
Indian Economy
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Development of credible plans at the grassroots
level of the third tier and integration of these plans
with higher levels of government.
Cooperative
and competitive
federalism
Equality
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Participation
Pro-people
PILLARS
OF NITI
AAYOG
Inclusion of all
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Women
empowerment
Atal Innovation Mission
e-AMRIT Portal
Proactivity
Aspirational District Programme
Transparency
Work on society: Pay special attention to the
marginalised segments of society who may be
excluded from the over-period planning process.
To design and formulate strategic policies and monitor
efficacy.
To implement the agendas and planning for achieving
the national development goals.
It provides a forum for the resolution of crosssectoral and cross-departmental issues. accelerate
the implementation of these development agendas.
To actively monitor the requirements of the
resources in different sectors to increase efficiency
and timely delivery to respective programmes.
It is an educational and policy research institution
that maintains a cutting-edge Resource Centre that
houses research on good governance. It keeps in
check the best practices for sustainable and equitable
development.
Initiatives of
NITI AAYOG
School Education Quality Index
SDG India Index
District Hospital Index
Women Transforming India Award
Strategy for New India @75
Good Governance Index
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NITI Aayog Vs Planning Commission
Features
Acts as an advisor to encourage partnerships
between key stakeholders in national and international
markets.
India Innovation Index
Women Entrepreneurship
Programme (WEP
Through a collaborative community of national
and international experts, practitioners, and other
partners, it provides a knowledgeable, innovative, and
entrepreneurial support system.
It monitors and evaluates the implementation of
international programmes adopted. For exampleSDG INDEX, EODB Business etc.
NITI Aayog
Planning Commission
It is a think-tank and an advisory body which It had the power to impose policies on states
does not impose policies on states.
and projects approved by the commission.
Functions
Power to the allocation of funds under the It had the power to allocate funds to state
Funds allocation Finance Ministry.
governments and central ministries for
programmes.
Roles of states
Governing Body
Appointments
Status
Aims
Life term
Meetings
State governments are actively involved.
State government played a role only in the
implementation of the programmes.
Chief Ministers of states and Lt. governors of UTs. The commission reported to the National
development council which consisted of Chief
Ministers and Lt Governors.
The CEO is appointed by the Prime Minister who Secretaries were appointed by the same
is the chairman of the council.
process.
It is an Executive body established by an act of It was also an Executive body.
parliament.
To create for the development of this nation.
Ranging usually from 5-7 years.
To create for the development of this nation.
5 years and extended in unusual situations.
To gather annually for discussions and formulate To gather annually for discussions and
plans.
formulate plans.
Economic Planning In India
53
Similarities
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Primary motive: The main aim of both these boards
of people is to create for the development of this
nation.
Constitutional mandate: NITI Aayog, like the
Planning Commission, is a non-constitutional body
that is not accountable to parliament.
Planning tenure: Both of these boards create plans
for the long term ranging from 5-7 years.
Meeting period: Both boards gather annually to
discuss and formulate the plans.
Way Forward
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Criticism of NITI Aayog
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Limitations of transformation: NITI Aayog cannot
transform a deeply unequal society into a modern
economy that ensures the welfare of all its citizens,
regardless of social identity.
Limited role or Influence in policy making: It has
no role in influencing public or private investment. It
does not seem to influence policy-making with longterm consequences. For instance, demonetisation and
the Goods and Services Tax.
NITI Aayog is still in its infancy: It is trying to find
out what its role should be because the role of a think
tank is not an easy one.
Non-critical body: If it is a think tank, it must
maintain a reasonable intellectual distance from the
current government. Instead, we see uncritical praise
of the Govt-sponsored schemes/programmes.
It has limited answerability: It cannot answer
specific questions such as why 90% of people work in
the unorganised sector. Moreover, as of date, more and
more formalisation is taking place in the organised
sector.
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54
Not done much for women’s empowerment:
Women’s labour-force participation is declining,
while neighbouring countries such as Bangladesh are
increasing.
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Dedicated period helps in getting work done on time
keeping checks and balances.
Bureaucratic inertia interrupts the flow of the work
which needs to be improved by fixing accountability.
NITI Aayog could help to improve governance and
implement new approaches to public service delivery.
NITI Aayog should act as an opinion-based body
to persuade the centre not to try to control it. Its role
should be to promote solutions to national problems.
Decentralisation will benefit our diverse and
democratic nation. Thus, planning should include
State governments and even the third tier of city and
district governance.
It requires new methods to accelerate ‘organisational
learning’ among system stakeholders who must make
and implement plans together. Thus, having a plan
is not enough; there must also be a strategy for its
collaborative implementation.
PREVIOUS YEAR QUESTION (MAINS)
1. How are the principles followed by the NITI Aayog
different from those followed by the erstwhile
Planning Commission in India? (2018).
OpinionMatters
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Presently Indian economy is facing many structural
and non-structural issues. Do you think the planned
economic development approach of India is a failure?
v
Indian Economy
6
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Poverty and Inequality
Poverty is defined as the lack of monetary resources
and essentials for a basic standard of living by a
person or community.
Poverty is a multifaceted phenomenon in which a
person or community lacks the financial resources
and necessities for a basic way of life.
6.1DEFINITIONS OF POVERTY BY
VARIOUS INSTITUTIONS AND
ORGANIZATIONS
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World Bank: poverty
is a severe deprivation
of well-being that has
many dimensions. It
includes low income and
the inability to access
basic goods and services
required for a dignified
living. Poverty also includes a
education, not enough access
sanitation, insufficient physical
a voice, and a lack of capacity
improve one’s life.
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United Nations Organisation (UN): poverty
encompasses more than a lack of resources
and income to ensure sustainable livelihoods. It
demonstrates hunger and malnutrition, restricted
access to healthcare and additional necessities, social
exclusion and prejudice, and a lack of participation in
decision-making.
Poverty is defined by the United Nations Human Rights
Council as “a human condition characterised by the
sustained or chronic deprivation of the resources,
capabilities, choices, security, and power required
for the enjoyment of an adequate standard of
living and other civil, cultural, economic, political,
and social rights.”
In 2011, 21.9% of India’s population was living below
the national poverty line.
Do you know?
lack of health and
to safe water and
security, a lack of
and opportunity to
According to some nowcasts, the COVID-19 pandemic
caused the global poverty rate to spike from 8.3% in
2019 to 9.2% in 2020. This is the first time extreme
poverty has increased since 1998 and the largest
increase since 1990, and it has set back efforts to
reduce poverty by about three years.
6.2CONSTITUTIONAL MANDATE PERTAINING TO POVERTY AND INEQUALITY
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Fundamental
Rights
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Directive
Principles of
State Policy
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Article 16(1): There shall be equality of opportunity for all citizens in matters relating to
employment or appointment to any office under the State.
Article 17: Abolition of Untouchability - With an equal socio-economic profile, Article 17
aims to create a new social order.
Article 21: Protection of Life and Personal Liberty - Art. 21 is loaded with Poverty Jurisprudence.
It covers the poor’s right to basic needs as well as their welfare and development.
Article 24: Right against Exploitation - The provisions of Art. 24 apply to everyone (State
and Private Persons both). The original framers of the Constitution mandated education
for children up to 14 (get free education and prepare themselves to become useful and
responsible citizens).
These guiding principles are the clearest manifestations of the social justice framework in our
constitution, and they anticipate numerous provisions for the general welfare of society in
the areas of education, the environment, promoting justice, providing free legal aid, ensuring
living wages, protecting marginalized groups, protecting forests and wildlife, etc.
Article 39 (A): Promotion of justice, equal opportunities, and free legal aid; The state shall
direct its policy towards securing adequate mean of livelihood;
Article 41: Security of work, to education, and to public assistance in several cases;
Article 42: Security of just and humane conditions of work;
Article 45: Free and compulsory education to every child till the age of 14 years, etc.
6.3SUSTAINABLE DEVELOPMENT
GOAL (SDG) AND POVERTY
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SDG 1: The 2030 Agenda for Sustainable Development
includes eradicating extreme poverty for all people
worldwide by the year 2030 as one of its key objectives.
Poverty fell from 10.1% in 2015 to 8.6% in 2018, a
historical low for the period between 2015 and 2018.
6.4
Absolute
Poverty
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Relative
Poverty
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A state in which household
income falls below the level
required to maintain basic
standards of living (food, shelter,
housing). This condition allows
for
comparisons
between
countries and also over time.
Introduced in 1990, the
“dollar a day” poverty line
measured absolute poverty by
the standards of the world’s
poorest countries. The World
Bank raised it to $1.90 per day
in October 2015.
It is defined from a social
standpoint as a lower standard
of living in comparison to the
economic standards of the
surrounding population. As a
result, it serves as a measure of
income inequality.
Typically, relative poverty is
defined as the percentage of
the population earning less
than a certain percentage of the
median income.
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6.7ESTIMATION OF POVERTY IN INDIA:
COMMITTEES ON POVERTY
In India, the level of income or consumption is
a common indicator of poverty; if it falls below
a predetermined minimum level, the household is
considered to be below the poverty line (BPL).
Poverty Line Calculation: The NITI Aayog task force
currently calculates the poverty line in India using
information gathered by the National Sample Survey
Office (NSSO) under the Ministry of Statistics and
Programme Implementation (MOSPI).
Consumption vs. Income Level: For the following
reasons, poverty lines in India are determined using
consumption expenditures rather than income levels:
 Income
Variation: Although consumption
patterns are largely stable, the income of selfemployed individuals, wage workers, and others
varies greatly over time and space.
 Additional income: Even for people who earn a
regular salary, there are frequently supplemental
side earnings that can be challenging to account
for.
 Data collection: When using a consumption-based
poverty line, sample-based surveys ask families
about their consumption during a reference period
(let’s say, the previous 30 days), which is then used
to reflect overall consumption.
 Income trend: It is impossible to determine the
main income trend.
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PERSPECTIVES TOWARDS POVERTY
The Old Perspective: The traditional view holds that
poverty is both a result of an individual’s actions and
a result of providence.
The Modern Perspective: According to the modern
perspective, social system functioning is the primary
contributor to poverty, which is beyond the control
of an individual.
6.6
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TYPES OF POVERTY
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6.5
Poverty ratio or Headcount ratio (HCR): The
proportion of the population living in poverty, also
known as the headcount ratio (HCR).
International Poverty Line (IPL): According to the
2017 revisions, the World Bank considers someone
to be in extreme poverty if their daily income is less
than US$1.90.
Societal Poverty Line (SPL): To account for the
relative aspect of poverty, the World Bank introduced
the Societal Poverty Line (SPL) in 2018. The SPL is a
hybrid line that combines the absolute poverty line
of $1.90 USD per day with a relative component that
rises as the economy’s median income or consumption
does.
The poverty line set by the Asian Development Bank
is currently $1.51 per person per day.
The varied facets of poverty are impossible to
measure with a single indicator.
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CONCEPT OF POVERTY LINE
The traditional method of determining poverty is to
set a minimum amount of income (or expenditure)
needed to meet a set of essential goods and
services. The poverty line is this minimal level of
expenditure.
Reference Period
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The period during which the survey is conducted
and households are questioned specifically is
referred to as the reference period.
Indian Economy
Data Collection Methods for Poverty Estimation
Up until 1993–1994 the poverty line was based on URP data, which involved asking
respondents about their consumption expenditures during a 30-day recall interval. As
a result, the data was based on the recall of consumption expenditures in the previous
30 days.
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Uniform Resource
Period (URP)
The NSSO switched to an MRP technique in 1999-2000, which examines the consumption
of five low-frequency goods (clothing, footwear, durables, education, and institutional
health expenditure) in the year prior as well as all other goods over the previous 30 days.
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Mixed Reference
Period (MRP)
Pre-independence Poverty Estimation
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Dadabhai Naoroji
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National Planning
Committee
Bombay Plan
(1944)
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In his book “Poverty and Un-British Rule in India,” Dadabhai Naoroji calculated the poverty
line (between 16 and 35 per capita per year).
He advocated for a poverty standard based on the cost of subsistence or basic diet (rice or
flour, dal, mutton, vegetables, ghee, vegetable oil, and salt).
The National Planning Committee’s definition of poverty, which ranged from ₹ 15 to ₹ 20 per
capita per month, was also based on a basic standard of living that took dietary requirements
into account.
The National Planning Committee was founded by Subhash Chandra Bose in 1938 and was
presided over by Jawaharlal Nehru.
The proponents of the Bombay Plan (1944) proposed a poverty line of $75 per person per
year. A small group of influential businessmen in Bombay came up with a series of proposals
known as the “Bombay Plan” for the growth of India’s post-independence economy.
Post-independence Poverty Estimation
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V M Dandekar and
N Rath
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Alagh Committee
(1979)
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Lakdawala Committee
(1993)
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VM Dandekar and N Rath carried out a comprehensive analysis of poverty in 1971
using data collected from the National Sample Survey (NSS).
VM Dandekar and N Rath proposed that the poverty line be based on spending that
would provide 2250 calories per day in both rural and urban areas, as opposed to
previous estimates that focused on subsistence living or the bare necessities.
A poverty line for rural and urban areas based on dietary needs and associated
consumption expenditure was developed by the Taskforce established by the Planning
Commission, led by YK Alagh. The estimates would be revised the following years to
account for inflation by taking into account the level of prices.
The findings of the Lakdawala Committee were based on the hypothesis that the
consumption patterns of the poor were reflected in the baskets used to create the
Consumer Price Index-Industrial Workers (CPI-IW) and Consumer Price IndexAgricultural Laborers (CPI-AL).
Prof. D T Lakdawala (former Deputy Chairman Planning Commission) leads an expert
group on “Estimation of Proportion and Number of Poor.”
The Lakdawala Committee published a report in 1993 with the recommendations
listed below
The Poverty Line approach, which is based on caloric intake, is sustainable (fixed
consumption basket)
State-specific poverty lines should be established and revised according to the CPI-IW
in urban areas and the CPI-AL in rural areas, respectively.
Estimates of poverty shouldn’t be scaled using data from national accounts. The Expert
Group recommended using only NSS data.
With few modifications, the Lakdawala Committee’s recommendations were approved
by the Indian government in 1997.
Poverty and Inequality
57
z
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Tendulkar Committee
(2009)
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C Rangarajan
Committee (2012)
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Arvind Panagariya Task
Force (2015)
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NITI Aayog Task Force
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The committee, which was led by Suresh Tendulkar, made the following
recommendations.
Moving away from estimating poverty using calorie consumption
In both rural and urban areas of India, the poverty line basket (PLB) is the same.
To address the challenges of geographical and temporal price adjustment, the price
adjustment technique was reformed.
Private health and education expenses are considered when determining poverty.
Instead of the Universal Reference Period that was previously used by committees,
the Mixed Reference Period was used.
According to these standards, the committee determined that the poverty line in urban
areas was ₹ 578.80 per capita per month in 2004-2005, while it was ₹ 446.68 per
capita per month in rural areas.
In 2009–2010, it was ₹ 859.6 in urban areas and ₹ 672.8 in rural areas. In 2010–2011,
it was ₹ 1000 in urban areas and ₹ 816 in rural areas.
A new group was formed by the Planning Commission to calculate the poverty line.
Provide an alternative method for calculating poverty levels.
Look for variations between the aggregates from the National Accounts and the
consumption data from the NSSO.
The various methods for calculating poverty around the world are examined.
Suggest a connection between these strategies and being eligible for the various
poverty-eradication programmes offered by the Indian government.
The final report of the panel was presented in 2014. The Tendulkar Committee’s
assessment of the level of poverty in India was criticised in the report.
Three out of ten Indians were reportedly living in poverty in 2011–2012 when the
poverty rate was substantially higher at 29.5% of the population.
The task force proposed forming a committee to identify people living “below the
poverty line (BPL).” It also suggested that states participate. The paper discusses four
options for tracking the poor:
First, continue with the Tendulkar poverty line.
Second, switch to the Rangarajan or other higher rural and urban poverty lines.
Third, the bottom 30% of the population tracking over time
Fourth, tracking the bottom 30% on specific components, such as housing, sanitation,
electricity, nutritional intake, etc.
NITI Aayog favoured the Tendulkar line (21.9%)
SECC data will be used for entitlements, as suggested by the Saxena and Hashim
committee.
The Ministry of Rural Development established the Dr N.C. Saxena Committee
to advise it on the appropriate methodology for BPL Census and not for poverty
estimation.
The Planning Commission established a Working Group with the leadership of
Professor S. R. Hashim and recommended a detailed methodology for the identification
of families living Below the Poverty Line in urban areas.
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58
Impact of Welfare Programs: Poverty estimates
are crucial for tracking the effectiveness of various
government policies, particularly social welfare
programmes that aim to eradicate poverty, as well as
for academic purposes.
To determine which households are poor, the
Ministry of Rural Development (in collaboration
with the government) conducts a BPL Census.
Poverty Elimination Plan: To create poor-centric
poverty elimination plans, poverty estimates in the
form of poverty lines are used.
Constitutional Requirement: Poverty estimation is
a prerequisite for eradicating poverty, which in turn
creates the conditions for a just and equitable society.

6.8IMPORTANCE AND UTILITY OF
POVERTY ESTIMATION
z
z
Indian Economy
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z
z
Targeted delivery of services: Errors of exclusion
can deprive eligible households of benefits.
Evaluating policy success: Data collection aids in
evaluating all policies in terms of whether they meet
the needs of the majority. It will help transparently
evaluate only when the numbers of the poor are
known and established.
To assess rising inequality: Indians must have the
right to question whether there is a link and whether
the massive rise in wealth is not coincidental, but the
result of millions of poor people’s misery.
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6.9CHALLENGES IN ESTIMATING
POVERTY
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z
z
z
Components of PLB: Since the prices of the basket’s
constituents differ from state to state and period to
period, determining the components of the Poverty
Line Basket (PLB) is one of the difficulties in estimating
the poverty line.
Demographic
and
Economic
Dynamics:
consumption patterns, dietary requirements, and
component prices are constantly changing due to
macroeconomic and demographic dynamics.
Lack of consensus amongst states regarding the report
of the Tendulkar and Rangarajan committee:
 While some states, including Delhi, Jharkhand,
Mizoram, and West Bengal, supported the
Rangarajan report, others, including Odisha, West
Bengal, and the Tendulkar Poverty Line, did not.
 The Tendulkar poverty line, which is fixed at a
daily expenditure of 27.2 rupees in rural areas
and 33.3 rupees in urban areas, is the basis for
the current official measures of poverty.
 The majority of governments have put the
committee and panel reports on hold because this
issue not only has delicate political implications
but also more significant financial ones.
Problem of threshold determination: A low poverty
threshold would be detrimental to the government’s
financial stability, while a high threshold could exclude
many needed people.
6.11HIGHLIGHTS OF FIFTH-FIVE-YEAR
PLAN (1974-79): GARIBI-HATAO
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Redefining Poverty Lines: In order to account for
changes in income, consumption habits, and prices,
poverty lines must be recalculated.
Viable Poverty Line: It makes sense to set the poverty
line at a level that allows families to purchase two
square meals per day in addition to other essential
needs.
Poverty and Inequality
In the first year of this plan, the Minimum Needs
Program was launched to meet the basic minimum
needs. The MNP was prepared by D.P. Dhar.
As a result of an amendment to the Electricity
Supply Act in 1975, the state government is now
able to engage in the production and transmission of
electricity.
4.4% was the desired growth rate, but 4.8% was
achieved.
The newly elected Morarji Desai administration
rejected this plan in 1978.
6.12CONCEPT OF POVERTY BY
AMARTYA SEN
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6.10SOLUTION FOR EFFECTIVE
MEASUREMENT OF POVERTY
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Hybrid of Absolute and Relative Poverty
Measurement: This method would measure poverty
from the standpoint of both absolute poverty on a
global scale and relative poverty within individual
nations. In the case of a hybrid model, the poverty
line would be equal to the amount of money needed
to reach a particular welfare status, which includes
minimal nutrition and social inclusion.
Political-Economic Equilibrium: India’s political,
policy and administrative systems must adapt to the
new conditions brought on by the country’s move
toward middle-income status, where poverty is now
defined as the inability to earn enough income to
take advantage of the opportunities presented by a
booming economy rather than as a state of being on
the verge of hunger. Spending on public goods rather
than subsidies should be the main goal of government
spending.
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z
Development, according to Amartya Sen, is a process
of enhancing people’s capabilities by increasing their
actual freedoms. The most important factor, which
transcends the mere availability of goods, is the
capacity to function effectively.
According to the capability approach by Amartya
Sen, poverty is a state in which a person lacks the
fundamental abilities to live a decent life. In other
words, poverty compels the poor to live a limited
existence. Higher constriction results in diminished
abilities, which raises levels of misery.
Amartya Sen’s Capability Theory has had a significant
influence on recent discussions of progress and
development.
Sen’s capability approach emphasizes people and
their capabilities rather than products and resources
(the inputs) (the end-results).
59
Additionally, it offers an alternative and more
thorough viewpoint on problems that the economic
perspective hardly touches, such as poverty,
inequality, gender bias, and social exclusion.
In his seminal article “Equality of What,” he defined the
capability approach as one that emphasises positive
freedom, or a person’s actual ability to be or do
something, rather than negative freedom approaches,
which are common in economics.
Sen’s approach is people-centred, comprehensive,
and flexible. People are no longer just robotic
producers and consumers.
The capability approach explicitly acknowledges
the differences between individuals rather than
referring to some hypothetical equality of people or
viewing them in terms of numbers.
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Objectives of
SECC
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6.13SOCIO-ECONOMIC AND CASTE
CENSUS (SECC)
The SECC was carried out by the State Governments,
the Office of the Registrar General and Census
Commissioner, the Ministry of Rural Development, the
Ministry of Housing and Urban Poverty Alleviation,
the Ministry of Urban Development.
To distinguish between households with different
socio-economic statuses, SECC provides data on
housing, education, land ownership, people with
disabilities, occupations, asset ownership, SC/ST
households, incomes, and other factors.
In addition to using it for housing, education, skill
development, MGNREGA, the National Food Security
Act, and other purposes, the government has decided
to use SECC data in all of its programmes.
In its report, the Sumit Bose Committee advocated
using SECC-2011 data for rural development
programmes.
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Features of
SECC
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60
The SECC 2011 is India’s first
paperless census.
The temporary identification
number
and
household
information were taken from the
National Population Register.
There was a chance for openness
and grievance redress at every
stage.
Instead of using consumption,
the SECC methodology uses
deprivation to define poverty.
For the first time since 1931,
caste is taken into consideration
by SECC.
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Methodologies
used in SECC
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z
Additionally, it was intended to
ask everyone their specific caste
name for the first time since
1931, enabling the government to
reassess which caste groups were
economically the most and least
advantaged.
Based on their socioeconomic
status, households will be ranked.
A list of families that are below the
poverty line can then be prepared
by state governments.
To gather accurate data on the
country’s population’s caste
makeup.
To gather accurate data on
the socioeconomic standing,
educational attainment, and
caste/sectional makeup of the
population.
The NC Saxena committee
(for rural areas) recommended
a three-fold classification of
households and proposed a new
BPL census design.
Excluded It determined the
criteria to automatically exclude
a specific set of households. A car,
washing machine, refrigerator,
two-wheeler, and a pucca house
with four or more rooms are a few
requirements.
Automatically included: Those
with certain residential, social, or
occupational vulnerabilities, such
as those who are homeless or live
in unofficial housing; households
without any adults or people
with disabilities; or groups like
beggars, rag pickers, or sanitation
workers.
Others - Seven deprivation
indicators will be used to rank the
remaining households. (Indicated
under Indicators of Deprivation)
S R Hashim Committee (for
urban centres): The Hashim
Committee Expert Group was
appointed by the Planning
Commission to determine the
best way to conduct the SECC in
urban settings.
Indian Economy
6.14INDEXES/REPORTS PERTAINING TO POVERTY AND INEQUALITY
z
Global
Multidimensional
Poverty Index (MDP)
z
z
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Global Hunger Index
(GHI)
z
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World Development
Indicators (WDI)
z
z
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z
World Inequality
Report (WIR)
z
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State of Inequality in
India Report
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z
The Multidimensional Poverty Index (MDP) for the 107 developing countries was
developed by UNDP in collaboration with Oxford Poverty and Human Development
Initiative (OPHI) to address the issues with the poverty line.
MDP uses indicators related to health, education, and standard of living to assess the
prevalence and severity of poverty among a population.
Dimensions (Indicators):
Health (Child Mortality, Nutrition)
Education (Years of Schooling, School Attendance)
Standard of living (Cooking Fuel, Sanitation, Drinking Water, Electricity, Housing
Assets)
Every October, Concern Worldwide and Welthungerhilfe jointly release the index.
The global hunger index measures three dimensions of hunger: a lack of food
availability, deficiencies in children’s nutritional status, and mortality among children
(which is, to a large extent, attributable to undernutrition).
The index thus includes three equally weighted indicators:
The percentage of people who lack sufficient food energy, as determined by the FAO;
The prevalence of underweight in children under the age of five, as compiled by the
WHO;
The mortality rate of children under the age of five, as reported by UNICEF.
Developed by World Bank
Inequality can be measured in a variety of ways, just like poverty. The World
Development Indicators (WDI) databases offer a wide range of inequality indicators,
including the Gini index and the proportion of each quintile’s consumption or income.
The World Bank tracks growth in the consumption or income of the bottom 40% (the
poorest 40% of the population in each country) to track progress toward its goal of
boosting shared prosperity.
Similar objectives are outlined in SDG target 10.1, which calls for the bottom 40% of
the income distribution to grow faster than the national average by 2030.
The difference between growth in the bottom 40 per cent’s consumption or income and
growth in the population’s average consumption or income is used to gauge progress.
The World Inequality Lab, a research centre at the Paris School of Economics, has
released a report.
The WIR examines various types of financial data to determine how income and
wealth are distributed across nations and the globe.
Released by the Economic Advisory Council to the Prime Minister (EAC-PM).
The report compiles data on disparities in the areas of household characteristics,
the labour market, health, and education.
The study, which is divided into two parts called Economic Facets and SocioEconomic Manifestations, examines five major factors that affect the nature and
experience of inequality.
Five Crucial Areas: include household characteristics, household dynamics, income
distribution, labour market dynamics, Health and Education.
The Periodic Labour Force Survey (PLFS), National Family and Health Survey
(NFHS), and United Information System for Education Plus are the sources of the
data used in this report.
Poverty and Inequality
61
6.15 CAUSES OF POVERTY
z
Economic Factors:
Poor economic growth and development: As
a result of bad government policy, poverty is
pervasive in nations with slow economic growth.
Another factor contributing to poverty is a stagnant
or slowly advancing economy.
 Rising unemployment: Mass unemployment,
a major cause of poverty, can be brought on by
an unbalanced population-to-jobs ratio. In any
nation, the greatest threat to poverty brought on
by unemployment is an escalating and unchecked
population.
 Reduced agricultural output: Unpredictable
weather patterns might be to blame. Reduced
agricultural output exacerbates inflationary
pressures. No nation can reach economic
equilibrium without a strong agricultural
foundation. A large portion of a nation’s economy
is made up of agriculture, which needs to be in
surplus to combat poverty.
 Inadequate infrastructure: An area’s poor
position is determined by its insufficient
infrastructure, which fosters economic growth.
 Inadequate industrialization in some regions:
Industries create jobs for residents. While the
concentration of industries in one state or location
increases employment there, underprivileged
areas experience extreme poverty. Lack of
industrialization makes people poor because there
aren’t many job opportunities there. Industries
also offer opportunities with higher pay than parttime jobs do.
 Inadequate production of necessities: Poverty
spreads throughout the nation whenever
necessities are not produced in sufficient quantities.
Food and non-food essential production must
always be sufficient to prevent poverty.
 Uneven wealth and resource distribution:
Compared to a nation with a uniform distribution,
one with an uneven wealth and resource
distribution is more likely to be impoverished. An
extreme situation where everyone is either neorich or poor is the result of uneven concentration.
 Underutilised natural resources: It is necessary
to fully explore and utilise each location’s natural
resources to realise its full economic potential. To
ensure that no one experiences poverty due to
the underuse of natural resources anywhere, this
should be a government initiative.
 Deprivation of resources: Poverty may be brought
on by natural resource deprivation, imposed
deprivation, or situational deprivation. People are

62
z
forced into poverty as a result of being denied
access to their ideal way of life and employment
opportunities.
 Inflationary economics: Inflationary economics
affects not just the poor but also the middle class in
society. This indicates that more people are eking
out a living on the edge of poverty. Individuals
from every walk of life are impacted by economic
inflation, which is extremely damaging to a nation’s
economy. The economy of a nation might take
years to recover from economic inflation.
Social Factors:
 Untouchability: Untouchability is an unfair
social practice that denies members of the lower
castes their democratic rights in some of the most
underdeveloped areas of the nation. They are
impoverished and rejected by society. They are
required to work in low-paying jobs and are not
allowed to look for other types of employment.
 Unethical abuse of authority: When power is
misused, it has a skewed viewpoint and never
helps the underprivileged. A corrupt government
would constantly work to preserve the status quo
to exert more control over the populace. This is yet
another significant reason for poverty in corrupt
nations.
 Illiteracy and ignorance are widespread:
Another significant factor in poverty is illiteracy.
Those who lack education are unable to reach their
full potential, which limits their ability to earn
money. They remain poor because they are unable
to compete with their educated counterparts in a
competitive culture.
 Densely populated areas: These areas increase
labour market competition. As a result of increased
competition and diminished opportunities, poverty
develops in crowded areas.
 Caste-based classification: Depending on their
line of occupation, individuals are classified
according to their caste, which also prevents them
from looking for employment outside of their
caste. For instance, a member of a lower caste
won’t be allowed to work as a businessperson or
dealer. As a result of this system, the wealthy get
richer while the poor get poorer.
 High divorce rates and feminization of poverty:
High divorce rates and the feminization of poverty
should be eliminated by providing women in
society with equal employment opportunities.
Furthermore, due to gender inequality, women
who are unable to support themselves experience
poverty as a result of high divorce rates.
 Accessibility of opportunities: There are many
ways that social inequality can lead to poverty.
Indian Economy
z
z
z
In a society, everyone should have access to all of
the options. The weaker members of society are
denied equal opportunities as a result of inequality.
Political Factors:
 The process of granting concessions and eradicating
poverty is disrupted by Communal tensions and
conflict between two regional parties.
 Rural reforms typically either fail or become
permanently stalled. Even if the measures are
implemented, most of them are only short-term
solutions and half-measures, which are ineffective
for India’s long-term goals of reducing poverty.
 Vote bank politics are also blamed for the
poverty in India, where different political leaders
find it convenient to omit a sizable portion of
the population from the poverty census after
winning an election. Tribal groups, Dalits, and
other minorities are frequently left off the list of
recipients.
 The main reason for concern about India’s poverty
is that various development plans are being
driven by political interests. As a result, efforts
to combat unemployment and poverty have not
been successful.
Historical Factors:
 Colonial
exploitation: India’s traditional
handicrafts and textile industries were destroyed
by the British colonisation and rule over the
country for about two centuries, which led to
the deindustrialization of the country. India was
reduced by colonial policies to a mere producer of
raw materials for European industries.
Geographical Factors:
 Population density: The population density of an
area affects the poverty graph for that area as well.
Areas with a high population density turn bright
red when it comes to poverty.
 Selective soil fertility: The level of soil fertility
varies from location to location and is not uniform
across a nation. The infertile lands are inherently
forced into poverty while the fertile areas have an
abundance of agricultural produce.
 Uneven distribution of fertile land: The world’s
distribution of fertile land is a major contributor
to poverty in regions that aren’t naturally fertile.
Locals benefit from fertile land because they can
work in agriculture and avoid looking for work to
support their families. Unproductive lands deny
the locals access to the agricultural industry and
eliminate this popular source of employment
among the illiterate villagers.
 Varying farm output: Farm production varies
from year to year and from season to season. Lots
of fruit will be produced in a good year, but the
Poverty and Inequality
z
harvest could be hampered by droughts and other
natural disasters. This variation also contributes
to poverty during hard times.
 Differences between rural and urban poverty:
Rural and urban poverty differ in several ways. In
terms of poverty, the differences between rural
and urban lifestyles have a variety of effects. For
instance, in the latter case, poor people are more
likely to survive in rural areas than in cities due
to the high cost of living.
Environmental And Climatic Factors:
 Land flooding: Floods are one of many natural
disasters that can destroy farms and hurt
agricultural output. Unwanted poverty will result
from this, which a government will rarely be able
to address.
 Droughts: Another climatic calamity that causes
poverty is drought. A prolonged drought has
an adverse effect on farms and agricultural
productivity. In most nations, droughts are a
recurring cause of poverty.
 Inadequate seasonal rainfall: Any irregularities
in the seasonal rainfall could have serious negative
effects on poverty. A lack of anticipated rain causes
agricultural production to be disrupted, which
leads to poverty brought on by inflation.
PREVIOUS YEAR QUESTION (MAINS)
1. Critically examine whether the growing population is
the cause of poverty or poverty is the main cause of
population increase in India.
(2016)
6.16MULTIFACETED IMPACT OF
POVERTY
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Social consequences of poverty:
Family and poverty: Due to their financial
burdens and worries, the poor have more stressful
lives, which can spill over into their personal lives
and increase their chances of experiencing family
problems. Poorer households experience domestic
violence more frequently.

Poor
health
Lack of
access

Lack of
choices
Social and cultural lives and poverty: Due to
a lack of disposable income, poorer families and
63



individuals may lead less socially active lives and
may spend less time with their family and friends.
Poverty and Decision Making: When a group of
people is poor, they lack a voice in the community
and have to rely on other, more powerful groups
or individuals to express their rights and interests.
This threatens human rights in society and
frequently results in a dysfunctional political
system that stifles social advancement and peace.
Crime and victimisation and poverty: Criminal
activities such as robbery, murder, and burglary
are more prevalent among the poor. Nevertheless,
they have a higher chance of becoming victims of
street crime.
Exploitation of people in poverty: The living
conditions of the poor are deplorable, and some
z
Low
Economic
Growth
Low
Investment
Growth
Low
Level of
Savings
z
64
Low
Income
family members of these people face early death
from famine or hunger, slavery or prostitution.
 Terrorism and Poverty: It’s important to
remember that most terrorists do originate from
impoverished regions with high unemployment
and that terrorist organisations frequently
pay significantly higher wages than any other
employment opportunities if any are available at
all.
Consequences of poverty on health:
 Poor people are always third-world to experience
a variety of health issues, such as infant mortality,
mortality in their early 20s, and mental illness.
They are also more likely to experience sub-par
medical attention, prejudice, and unfair treatment.
Low Level
of Education
and Health
Development
Low Level
of Human
Capital
Low
Level of
Productivity
Fig: Vicious cycle of Poverty
 SDG 3: Assure that all people live healthy lives and
 Poverty and Child Development: Children raised
in poverty may become underdeveloped in terms
promote well-being at all ages.
of their physical, mental, and social abilities. As
 The 71st National Sample Survey (NSS)
previously
mentioned, a lack of nutritious, highestimates that in 2014, the total share of private
quality
food
can stunt a child’s development and
hospitalizations in rural and urban areas was 58%
lead
to
health
problems.
and 68%, respectively.
 Poverty and Child Marriage: Even though it
 According to the Health Profile of India report,
is prohibited by law, many Indian communities
75% of patients who go to private hospitals pay
still allow child marriages. When young women
their medical bills out of pocket (with their own
are still children, they become mothers. Before
money) or with life savings, while another 18%
reaching adulthood, many people pass away.
take out loans from private lenders, which results
 Poverty and Child Labor: Government statistics
in a significant amount of poverty.
indicate that 12.5 million children between the
 India is the country with the highest rate of
ages of 5 and 14 are employed in India, even
malnutrition, with over 200 million individuals
though child labour for those under the age of 14
afflicted with it, including 61 million children.
is illegal.
Consequences of poverty on Children:
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Economic consequences of poverty
 Poverty and Child Education: Since they
 Lack of social mobility and poverty: People
frequently lack access to the best educational
from low-income families are more likely to work
facilities, poor children typically perform less
in low-paid jobs because they have less access to
well academically than their more economically
quality education, influential contacts, and job
advantaged peers. Due to health problems, poor
opportunities. Poverty makes it difficult for people
to advance in their careers or social standing.
kids miss school more frequently.
Indian Economy
Housing and homelessness and poverty: The
poor have a greater chance of being homeless or
living in unfavourable conditions, which can be
harmful to their health. Housing expenses make up
a significant portion of the income of poor families.
 Segregation and poverty: Poor families frequently
reside in underdeveloped neighbourhoods that
are unsafe, where there are few employment
opportunities, quality educational institutions,
and recreational opportunities.
 Poor Purchasing Power: A nation where a poor
country’s or household’s per capita income and
purchasing power are below a particular minimum
standard, there are few medical facilities and
care providers, productivity is low, and there is
illiteracy.
 Decreased demand: Leading to lessen Economic
growth.
 Demographic “Bomb”: India’s large demographic
dividend could become a demographic liability
given the country’s severe poverty.
Ethical Consequences of Poverty:
 Indivisibility: Indivisibility is the concept that all
human rights, including civil, cultural, economic,
political, and social rights, are interlinked and
necessary for preserving human dignity. According
to the principle of indivisibility, efforts to combat
poverty should be multidimensional and involve
political, social, and economic measures.
 Equality and non-discrimination: Discrimination
and inequality can hinder economic expansion,
undermine the effectiveness of government
agencies, and weaken efforts to combat poverty.
Environmental Consequences of Poverty:
 It has been established that third-world debt and
poverty lead to resource theft in order to survive
or resolve debts.
 The use of forest resources by local populations,
agricultural businesses, and timber companies has
increased pressure on forests all over the world.

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6.17CONCEPT OF “FEMINIZATION OF
POVERTY”
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The term “feminization of poverty” is a concept that
originated in the 1970s and gained traction in certain
United Nations documents starting in the 1990s.
The idea gained attention as a result of a study by
Diane Pearce that examined gender trends in the
development of poverty rates in the United States
between the early 1950s and the middle of the
1970s.
Originally, it was used to refer to “an increase in
women among the poor” and “an increase in
Poverty and Inequality
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households headed by women among the poor
households.”
This approach was dropped because the measures of
feminization of poverty based on it are susceptible
to changes in the demographic makeup of the
population.
For instance, the impoverishment of female-headed
households can be countered by a decline in the
proportion of female-headed households in the
population.
Because of this, later studies took a different approach
and compared how poverty levels changed within
each gender group.
In contrast to the process of the feminization of income
poverty, the overrepresentation of women among the
income poor at any given time appears to be a much
more frequent phenomenon.
The assertion that income poverty is being
systematically feminised around the world has little
evidence to support that claim, despite the intense
political debate surrounding it.
According to data from the UK, there was no indication
that poverty was becoming more prevalent among
women between the late 1960s and the mid-1980s.
According to a study by Oxfam, the staggering
amount of unpaid work performed by women
worldwide totals $10 trillion annually, which is
43 times the annual revenue of Apple, the largest
company in the world.
With women performing 3.1% of the GDP’s unpaid
labour, inequality in India has a “female face”.
According to the study’s findings, women provide
unpaid care for others for 312 minutes per day in
urban areas and 291 minutes per day in rural areas. In
contrast, men only devote 29 minutes in urban areas
and 32 minutes in rural ones to unpaid caregiving.
Although India has many laws that address violence
against women, their implementation is still difficult,
in part because of a firmly patriarchal society.
Causes of Feminization of Poverty
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Family organisation: Gender roles regulating the
control over household resources and the division of
labour and consumption among the sexes.
Family composition: Higher male mortality, the
breakdown of marital unions, and the constitution of
families without these unions.
Inequality in the quality or access to public services:
barriers to girls’ education, sex-based educational
segregation, and a lack of focus on women’s health.
Inequality in social protection: Inequalities in benefit
concession or benefit values in targeted policies, lower
access to pensions and social assistance for women,
and contributory pension systems that reproduce
prior labour market inequalities.
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Labor market inequalities: Occupational segregation,
intra-career mobility, unequal levels of employment in
paid work, wage discrimination, and shift length.
Cultural, legal, and paralegal constraints on
public life: Property rights, judicial discrimination,
limitations on community and political life, etc.
Measures Needed
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Social:
 Health: Improving women’s health metrics can
have a big impact on the family’s and the newborns’
overall health. A significant reduction in household
expenses can be achieved by improving the health
of women and their newborns, as the third world
spends a large portion of their earnings on medical
care.
 Education: The major tool for eradicating poverty
is education. Women with more education are
more concerned with their children’s education
and make a greater contribution to their growth.
Economic:
 Equal Wages: Poverty is significantly impacted
by the wage gap between men and women. Equal
pay for women would guarantee higher household
income and productive spending on the family’s
overall health and nutrition.
 Skill Development: Women are heavily involved
in household-based industries and the collection
of minor forest produce. By improving their skills,
women can directly decrease their reliance on
their husbands for financial support, giving them
more autonomy over spending on their families
and businesses.
Political:
 Societies where women’s voices are sought after
and heard and where the ideals of equity (fairness)
and equality (opportunity) coexist are powerful
and more effective.
 Government programmes to reduce poverty
can be more effectively targeted by increasing the
proportion of women who participate in decisionmaking at the local level.
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India’s Social Sector Expenditure
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Education
Why Focus on the Social Sector?
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India is dedicated to achieving the SDGs by 2030, and
social sector development is crucial for doing so.
No nation has progressed without investing in its
social sector.
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Health
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From 2014–15 to 2019–20, the GDP
proportion of education remained
stable at 2.83–3%.
The total expenditure (combined
states and centres) on education
as a percentage of GDP has stayed
stagnant at 2.9% since 2019.
As a percentage of GDP increased
from 1.2% in 2014 to 2.1% in the
financial year 2023. This is near to
the required 2-3% of GDP.
The increase in health spending to
2.1% of GDP appears to have been
mentioned by the 15th Finance
Commission as well. State and federal
governments should both have a “fiveyear vision on the social sector.”
Key Issues in Social Sector
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6.18 SOCIAL SECTOR IN INDIA
Income, education, employment, community safety, and
social support can all have a significant impact on how
well and how long we live. These elements have an impact
on our capacity to make healthy decisions, pay for housing
and healthcare, handle stress, and more.
The advancement of this industry has intrinsic value
for its own sake and instrumental value for better
growth.
Even to build a $5 trillion economy more quickly, it
is necessary.
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The problem of undernutrition: According to the
NFHS-5 report, between 2015–16 and 2019–20, the
level of malnutrition decreased slightly in a few states
while it increased in a few others. A society in which
35% of children are underweight is unsustainable.
Social safety nets: It is well known that migrant
workers, who lack social safety nets, were the group
most negatively impacted by the pandemic. Due to
the reverse migration, MGNREGA allocations must be
increased in rural areas.
Programs for the vulnerable section need to
be continued: The government has done well in
introducing programmes like Swachh Bharat Abhiyan
and initiatives for housing, financial inclusion, and
providing loans to the self-employed.
 Cooking gas is provided through the Ujjwala Yojana
and electricity is provided through the Saubhagya
Yojana.
Quality education: The secret to advancing human
development is equal access to high-quality education.
According to several committees, the government
should spend 6% of the GDP on education.
6.19FINANCIAL INCLUSION AND
POVERTY ALLEVIATION
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Financial inclusion refers to the availability to
both individuals and businesses of useful and
affordable financial products and services that are
Indian Economy
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provided responsibly and sustainably and that meet
their needs. The ability to access financial services is
known as financial inclusion, and it requires equal
opportunity.
Its objective is to improve financial service access
for those who are underbanked and unbanked.
Financial inclusion’s primary goal is the accessibility
of financial services that cater to users’ unique needs
without discrimination.
Role of Financial Inclusion in Poverty
Reduction
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Less reliance on informal sources, such as
moneylenders, during times of need. Because of the
high rates charged, the poor are forced into a debt
cycle.
Empowering women to take on labour tasks that
would be unthinkable without financial assistance,
increasing consumption and investment to boost
revenues, and increasing spending on other social
factors like preventative health care.
Encourages the saving habit, which eventually aids
in capital investment
Financial inclusion gives the poor a sense of
mainstream acceptance, which boosts their
confidence. The capacity for taking risks also grows.
Overall, this encourages entrepreneurship.
Challenges in Financial Inclusion
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The need for enhancing financial literacy
Lack of Official Identification Documents
Protection of Consumers
Gender Inequality and the Rural Poor
Lack of banks and ATMs in rural areas is an example
of poor infrastructure.
Ways to Increase Financial Inclusion
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Financial literacy-based innovations.
Sensitization of bank employees when interacting
with the underprivileged.
Increasing the effectiveness of the banking
correspondent model.
Development of infrastructure, including banks and
ATMs in outlying and rural areas.
Creating goods that specifically address the needs
of the poor, like micro-pension.
6.20ROLE OF SELF-HELP GROUPS (SHG)
IN POVERTY ALLEVIATION
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With financial inclusion the credit facility to the poor
is increased. It also saves them from moneylenders.
Opportunities for self-employment through the
setting of micro-enterprise.
Poverty and Inequality
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Skill development program undertaken by SHGs
improves the employability of members involved.
As a result of increased jobs there is a rise in income
which enhances access to health services and
overall rise in living standards.
With more women participation and their enhanced
status address issues such as nutrition poverty and
low literacy rate
It is also observed that the percentage of the BPL
population is less in the states where there is a
large number of SHG.
6.21APPROACHES FOR POVERTY
ALLEVIATION
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Basic Income Programme:
Targeted income transfers should be a part of the
new strategy for reducing poverty.
 As part of a targeted basic income programme,
which is a top-up programme, the government
transfers the poverty gap (that is, the difference
between a household’s per capita consumption
and the poverty line it faces) into the bank
accounts of the poor.
 Significant leakages are one of the main criticisms
directed at programmes to reduce poverty. UBI is
thought to be a more effective substitute.
 Individual economic liberty is strengthened by UBI.
Instead of being forced to perform unproductive
work to meet their daily requirements, this would
enable them to choose the type of work they want
to do.
 UBI will aid in eradicating poverty and reducing
inequality as a form of social security. Thus, it
guarantees everyone’s safety and dignity.
 UBI might stimulate greater productivity. For
instance, agricultural labourers who previously
worked on other people’s farms for low pay but
now own a small plot of land can now start their
farms. Long-term, this will lower the proportion of
unused land and contribute to raising agricultural
productivity.
 In order to combat poverty in India, the economic
survey of 2016–17 has supported the idea of
universal basic income (UBI) as an alternative to
various welfare programmes.
 According to the survey, “the districts with the
greatest needs are precisely the ones where state
capacity is weakest, and thus a more effective way
to help the poor would be to provide them with
resources directly, through a UBI.” The concept of
UBI must be discussed in this context.

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Tax Reforms:
 The government needs to prioritise bringing more
people into the higher income tax brackets.
 To accomplish this, we advise that the highest
personal income tax rate and the corporate
income tax rate each be lowered to a flat rate
of 25%.
 Therefore, the government should concentrate
on improving compliance by lowering the highest
slabs of the tax rate to increase revenue realisation
from direct taxes.
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Investment Reforms:
 The Indian economy needs sufficient investments
in vital sectors like roads, railroads, and water.
 To ensure resource reallocation, the government
must rationalise its spending and tax rates.
PREVIOUS YEAR QUESTION (MAINS)
1. An essential condition to eradicate poverty is to
liberate the poor from deprivation. Substantiate this
statement with suitable examples.
(2016)
6.22 POLICIES AND PROGRAMMES TOWARDS POVERTY ALLEVIATION IN INDIA
The Integrated Rural
Development Programme
(IRDP)
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Jawahar Rozgar Yojana/
Jawahar Gram Samridhi Yojana
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Rural Housing - Indira Awaas
Yojana
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Food for Work Program
National Old Age Pension
Scheme (NOAPS)
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Annapurna Scheme
Sampoorna Gramin Rozgar
Yojana (SGRY)
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Mahatma Gandhi National
Rural Employment Guarantee
Act (MGNREGA) 2005
National Rural Livelihood
Mission Aajeevika (2011)
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National Urban Livelihood
Mission (NULM)
Kaushal, Pradhan Mantri Vikas
Yojana
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It was launched in 1978-79 and became universal on October 2, 1980, to
provide assistance to the rural poor in the form of subsidies and bank credit
for productive employment opportunities over successive plan periods.
The JRY was created to provide meaningful employment opportunities for
rural unemployed and underemployed people by constructing economic
infrastructure as well as community and social assets.
The Indira Awaas Yojana (LAY) programme aims to provide free housing to
Below Poverty Line (BPL) families in rural areas, with a primary focus on SC/
ST households.
Its goal is to increase food security by providing wage employment. Food grains
are provided to states at no cost; however, supply from the Food Corporation
of India (FCI) godowns has been slow.
This pension is provided by the federal government. Panchayats and
municipalities are in charge of implementing this scheme in states and union
territories.
The government launched the Annapurna Scheme in 1999-2000 to provide
food to senior citizens who are unable to care for themselves, are not covered
by the National Old Age Pension Scheme (NOAPS), and have no one in their
village to care for them.
The scheme’s main goal remains the creation of wage employment, the
development of durable economic infrastructure in rural areas, and the
provision of food and nutrition security to the poor.
Every rural household receives 100 days of guaranteed employment each year
under the Act. Women would be given one-third of the proposed employment.
In addition, the central government will establish National Employment
Guarantee Funds. Similarly, state governments will create State Employment
Guarantee Funds to carry out the scheme.
It is motivated by the need to diversify the needs of the rural poor and provide
them with consistent monthly income. Self-help groups are formed at the
village level to assist the needy.
The NULM focuses on forming Self-Help Groups among the urban poor,
providing opportunities for skill development leading to market-based
employment, and assisting them in establishing self-employment ventures
by providing easy access to credit.
It will target new entrants to the labour market, particularly class X and XII
dropouts.
Indian Economy
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National Urban Livelihood
Mission (NULM)
Pradhan Mantri Kaushal Vikas
Yojana
Pradhan Mantri Jan Dhan
Yojana
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The NULM organises the urban poor into Self-Help Groups, provides
opportunities for skill development leading to market-based employment,
and assists them in establishing self-employment ventures by providing easy
access to credit.
It will target new entrants into the labour market, particularly class X and
XII dropouts.
It aimed for direct benefit transfer of subsidies, pensions, insurance, etc., and
achieved its goal of opening 1.5 crore bank accounts. The scheme primarily
targets the unbanked poor.
6.23REASONS FOR NON-EFFECTIVITY
OF POVERTY ALLEVIATION
PROGRAMMES
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6.24STRATEGIES FOR POVERTY
REDUCTION IN RURAL AREAS
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There is a tacit understanding that targets will be
lowered following funding availability and that the
resources allocated to anti-poverty programmes
are insufficient. For instance, many states do not
guarantee 100 days of work under MGNREGA.
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Lack of awareness of these programmes among the
general public due to their illiteracy and ignorance.
After a strict screening process, it might be preferable
to implement these programmes through NGOs and
Civil Society Organizations.
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It is necessary to conduct an impartial “social audit”
of these programmes to stop leaks and enhance
delivery, not to fix accountability.
Lack of a monitoring system to determine the
effectiveness of such schemes or their outcome.
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There is no organised effort to identify those who
are poor, determine their needs, meet those needs,
and give them the tools they need to rise above the
poverty line.
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PREVIOUS YEAR QUESTION (MAINS)
OpinionMatters
1. Despite the implementation of various programmes
for eradication of poverty by the government in India,
poverty is still existing. Explain by giving reasons.
(2018)
v
Poverty and Inequality
Promote Agricultural Growth: While agricultural
growth has long been regarded as the primary factor in
reducing poverty, it is only one aspect of this strategy.
Accelerating the reduction of rural poverty: India’s
rural areas share many economic characteristics with
smaller urban areas, despite being predominantly
agrarian.
Capitalising connectivity between rural and
urban areas: Making use of the growing connectivity
between rural and urban areas, as well as between
the agricultural, industrial, and service sectors. This
strategy has proven successful in the past.
Creating more and better jobs: Future initiatives
must focus on improving job creation in more
productive industries, which has so far been lukewarm
and has produced few salaried positions that provide
stability and security.
Focusing on women and Scheduled Tribes: The
slow development of scheduled tribes and the low
participation of women in the labour force are the
two most concerning trends.
Enhancing human development outcomes: Better
health, sanitation, and education will not only increase
millions of people’s productivity but also give them
the means to realise their aspirations and give the
nation new sources of economic growth.
Do you think the COVID-19 pandemic halted the
reduction of poverty in India? Can India achieve
minimum poverty with global cooperation?
v
v
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7
Employment, Unemployment
and Skill Development
Economic history has shown that many countries have
experienced economic problems in the past. Unemployment
is one of the most difficult problems faced by society. Both
classical and Keynesian economists have explained how
employment and income are related.
7.1
EMPLOYMENT
The term “full employment” refers to a situation
in which everyone who is able and willing to
work is hired at the going rate. In other words, full
employment requires that everyone able and willing
to work must have a job.
Full employment, according to John Maynard
Keynes, is the absence of involuntary
unemployment.
The maximum amount of both skilled and unskilled
labour that can be employed in an economy at any
given time is full employment.
Employment increases the economy’s general
growth, provides income for households with low
incomes, and restores domestic demand for goods
and services.
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Terminologies Related to Employment
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Employment Rate: Ratio of employed person to
population (15 to 59 years)
Employment Elasticity: Percentage changes in
employment induced by changes in GDP, which
captures the responsiveness of the labour market.
Employment Intensity: The extent to which
growth creates employment.
J. M. Keynes’ Theory of Employment and
Income
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Concept of Effective Demand
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J.B. Say was a French economist and industrialist
who lived from 1776 to 1832. Say’s law of markets
underpins the classical theory of employment.
The idea put forth by J.B. The Saying is that “Supply
creates its demand.” As a result, neither general
overproduction nor the issue of unemployment in
the economy is possible.
Effective demand is the underlying tenet of Keynes’
employment and income theory. Effective demand
refers to the amount of money that consumers spend
on industrial goods.
Rent, wages, interest, and profit are all ways that
entrepreneurs make money. Therefore, effective
demand equals national income.
The level of employment would rise in response to an
increase in aggregate effective demand. Unemployment
would increase if total effective demand dropped.
Consequently, a country’s total demand can be used
to calculate its total employment.
Concept of Aggregate Demand
Function (ADF)
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J. B. Say’s Law of Market
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Keynes’ book, “The General Theory of Employment,
Interest, and Money,” published in 1936, is a seminal
work that marked a watershed moment in the
evolution of modern economic theory.
Keynes’ theory challenged classical economists’ belief
that market forces in a capitalist system self-adjust to
achieve equilibrium.
In the Keynesian model, aggregate demand plays
a major role in determining output. The amount of
money entrepreneurs anticipates making when selling
the goods made possible by the number of workers
employed is known as the aggregate demand.
The four components of aggregate demand are as
follows:
1. Consumption demand
2. Investment demand
3. Government expenditure and
4. Net Export (export–import)
Concept of Aggregate Supply
Function (ASF):
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The aggregate supply function rises as the employment
level rises. The total value of all goods and services
produced in an economy over a year is referred to as
aggregate supply.
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In other words, aggregate supply is equal to the value of the national product. i.e., national income.
The aggregate supply price is the total amount of money that all entrepreneurs in a given economy expect to make
from the sale of goods manufactured by a specific workforce.
The components of aggregate supply are
 Consumption expenditure (C) aggregated (desired)
 Private savings (S) aggregated (desired)
 Net tax payments (T) (Total tax payment to the government minus transfer payments, subsidies, and interest
payments to the government)
 Transfer payments to foreigners (Rf) for personal reasons (e.g., donations to international relief efforts)
7.2KEY EMPLOYMENT AND UNEMPLOYMENT INDICATORS
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Labour force
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Workforce
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Labour Force Participation
Rate (LFPR)
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Worker Population Ratio
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Unemployment Rate
Activity status
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Usual Status
Activity Status - Current
Weekly Status (CWS)
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The number of people who can and want to work is referred to as the labour force
or labour supply. Dependents such as children and the elderly are not considered
labour because the entire population is incapable of engaging in economically
productive activities.
The labour force also excludes those who are unable to work but would like to.
The term “workforce” refers to people between the ages of 15 and 59 who are
actively engaged in economically productive activities.
The difference between workforce and labour force is unemployed, i.e.,
Unemployment = Labour Force – Work Force.
The labour force participation rate is calculated as the labour force divided by the
total working-age population. The working age population refers to people aged 15
to 64. This indicator is broken down by age group and measured as a percentage
of each age group.
For example, if the population is 1000 and 500 people are employed while 100 are
unemployed, the LFPR is 600. LBPR can also be expressed as a percentage, so the
above figure becomes 60%.
The worker population ratio (WPR) is the number of employed people per thousand
people.
It reveals the employment situation in the country. A high ratio indicates that a
larger proportion of the population is actively involved in the production of goods
and services in the country.
The unemployment rate is the percentage of people of working age (15 and older)
who are looking for work but are unable to find it.
In other words, rather than a percentage of the total population, unemployment
rates are expressed as a percentage of the labour force.
Determined based on the activities pursued by the person during the specified
reference period.
It is known as the person’s usual activity status when the activity status is
determined based on the reference period of the last 365 days preceding the date
of the survey.
The activity status determined based on a reference period of the last 7 days
preceding the date of the survey is known as the current weekly status (CWS) of
the person.
Employment, Unemployment and Skill Development
71
7.3 UNEMPLOYMENT
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According to the OECD (Organisation for Economic
Co-operation and Development), unemployment is
defined as people over a certain age (usually 15) who
are not in paid employment or self-employment but
are currently available for work during the reference
period.
Expansion
Peak
Prosperity
Steady Growth Line
Recession
Depression
Line of Cycle
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Prosperity
Recovery
Trough
Fig: Representation of Phases of a Business Cycle
The number of unemployed people as a percentage of
the labour force serves as a measure of unemployment,
which is expressed as the Unemployment Rate.
Unemployment can have many sources, such as
the following:
 New inventions and technologies;
 The state of the economy, as influenced by a
recession;
 Globalisation
and international trade have
increased competition.
 The government’s policies;
 Market corrections and regulation.
The following are the types of unemployment:
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Cyclical
Unemployment
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Seasonal
Unemployment
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Frictional
Unemployment
(Temporary
Unemployment)
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Expansion
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Data and Facts Related to Unemployment in India
According to Economic Survey (2022-23):
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Urban unemployment rate: Quarterly urban
employment data shows progress beyond prepandemic levels as the unemployment rate declined
from 8.3 per cent in July-September 2019 to 7.2 per
cent in July-September 2022.
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Unemployment Rate: Labour markets have recovered
beyond pre-Covid levels, in both urban and rural
areas, with unemployment rates falling from 5.8
per cent in 2018-19 to 4.2 per cent in 2020-21,
and a noticeable rise in rural FLFPR from 19.7 per
cent in 2018-19 to 27.7 per cent in 2020-21.
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Labour Force Participation Rate (LFPR): The
population’s participation in the labour force—those
who are employed, actively looking for work, or
otherwise available for employment.
 The labour participation rate increased to 47.9 per
cent in July-September 2022 from 46.9 per cent a
year ago.
 During the same time period, the workerpopulation ratio increased from 42.3 to 44.5 per
cent.
 The significant increase in the rural female labour
force participation rate (FLFPR) from 19.7%
in 2018-19 to 27.7% in 2020-21 is a positive
development.
Types of Unemployment
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The nature of unemployment differs between
developing nations like India and developed nations.
In developed countries, unemployment is only
temporary, cyclical, or frictional. However, structural
unemployment, which results from a low rate of capital
accumulation, predominates in developing nations.
This unemployment exists during the downturn phase of the economy’s trade cycle.
In a business cycle during a period of recession and depression, income and output fall
leading to widespread unemployment.
It is caused by a deficiency of effective demand. Cyclical unemployment can be addressed
by public investment or expansionary monetary policy.
Many macroeconomic theories describe full employment as a goal that, if realized,
frequently leads to an inflationary phase in terms of cyclical unemployment.
This type of unemployment occurs only during certain seasons of the year.
Agriculture and agro-based industries such as sugar can only be produced during specific
seasons. These industries only employ people during that time of year.
As a result, people may be unemployed during the off-season.
Seasonal unemployment occurs on the demand side as well, for example, in the ice cream
industry, vacation resorts, and so on.
Frictional unemployment occurs when there is a mismatch between the supply of labour
and the demand for labour.
This is due to labour immobility, a lack of necessary skills, machinery breakdown, a lack
of raw materials, and other factors.
The persons who lose jobs are and in search of jobs are also included under frictional
unemployment.
Indian Economy
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Educated
Unemployment
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z
Technical
Unemployment
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Structural
Unemployment
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Disguised
Unemployment
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When an educated person’s qualifications do not match the job, they may be underemployed
or unemployed.
A flawed education system, a lack of employable skills, high student turnout, and a
preference for white-collar jobs are all major contributors to educated unemployment
in India.
Because modern technology is capital intensive, it necessitates fewer workers and
contributes to technological unemployment.
Inventions and innovations nowadays lead to existing workers adopting new techniques.
Technological unemployment is the result of labour-saving devices.
Structural unemployment results from a significant shift in the social structure.
Lack of demand for the product or shift in demand to other products cause this type of
unemployment. For example, the rise in demand for mobile phones has adversely affected
the demand for cameras, tape recorders etc.
This type of unemployment is caused by massive and deep structural changes in the
economy.
Disguised unemployment occurs when more people are there than what is required.
Even if some employees are absent, production does not suffer. Agriculture has this type
of unemployment.
If a person’s contribution to output is less than what he can produce by working normal
hours per day, he is said to be disguisedly unemployed. In this case, the marginal
productivity of labour is zero, less than zero, or negative.
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. Disguised unemployment generally means ____________
z
(2013)
(a) a Large number of people remain unemployed
(b) Alternative employment is not available
Reason for India’s Low FLFPR:
(c) Marginal productivity of labour is zero
z
(d) Productivity of workers is low
Phillips Curve
z
z
z
W. Phillips introduced the Phillips curve, an economic
theory that claims there is a stable, inverse
relationship between unemployment and inflation.
According to the hypothesis, inflation follows
economic growth and should result in more jobs
and lower unemployment.
However, the occurrence of stagflation in the 1970s,
when there were high levels of both inflation and
unemployment, has somewhat empirically refuted the
original premise of the theory.
Inflation Rate %
Phillips Curve
Unemployment Rate Rate %
z
One of the main reasons for India’s low LFPR is the
abysmally low level of female LFPR. According to
the most recent CMIE data, the male LFPR was 67.4%
in December 2021, while the female LFPR was as low
as 9.4%.
The causes of low women: Law and order, efficient
public transportation, violence against women,
societal norms, and other areas are examples of
LFPR. Furthermore, women who live far from work
have a difficult time finding work.
Furthermore, many women in India work solely for
their households (caring for their families).
7.4NATURE OF UNEMPLOYMENT IN
INDIA
z
z
z
The current unemployment issues in India are mostly
structural in nature.
In India, rural regions see a higher rate of
unemployment.
Seasonal
and
disguised
unemployment are prevalent in rural areas.
Two aspects of Urban unemployment:
1. Industrial Unemployment:
 People have moved in great numbers from rural
to urban industrial districts in search of work.
 These expanding urban populations could not
be given enough employment opportunities due
to the sluggish rate of industrialisation in the
nation. This has caused a significant industrial
unemployment rate in the nation.
Employment, Unemployment and Skill Development
73
2. Educated or middle-class unemployment:
 Almost all of the nation’s urban regions
experience
this
particular
type
of
unemployment, which is unique from the
others.
 A substantial amount of staff is unnecessarily
directed into general education as a result of the
delayed expansion of technical and vocational
educational facilities.
Causes of Unemployment
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Over-Reliance on agriculture: India’s agricultural
sector is undeveloped. It offers seasonal employment.
The populace is heavily dependent on agriculture.
However, due to agriculture’s seasonality, there are a
few months of employment.
Infrastructural bottlenecks: Low manufacturing
sector investments and inadequate infrastructural
expansion limit the secondary industry’s ability to
create jobs.
Regressive labour laws: Strict employment protection
laws have compelled employers to use more capital to
produce goods and services than is necessary given
the current labour cost-to-capital ratios.
Outdated curriculum: The academic content taught
in schools and universities fails to meet the demands
of the market. This is the primary reason for structural
unemployment.
Prevalence of informal economy: Due to a large
workforce working in the unofficial sector because
they lack the necessary education or skills, this is not
reflected in any employment data.
Social issues: Regressive societal standards that
prevent women from starting or keeping jobs. Other
factors include ethnicity, race, age, etc., in the job.
Poor Governance: Low infrastructure, financial,
and market links, insufficient government backing,
and legal implications all contribute to the viability
of small firms, cottage industries, and other related
ventures.
Higher taxation: Income, wealth, excise, custom, and
other taxes are all heavily levied by the government.
Due to high taxes, even citizens are unable to create
their private firms, and manufacturers only employ a
small number of workers.
7.5
GAINFUL EMPLOYMENT AND ITS
NEED
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74
Gainful employment is a situation in which an
employee receives consistent work and compensation
from his or her employer.
Need of Gainful Employment
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Sustainable development and inclusive Growth:
To guarantee equitable growth and preserve the
momentum of a sound economic trajectory by adding
a significant number of employment to the formal
economy.
Decent living standard: Achieving a decent quality
of life is facilitated by ensuring gainful work, which
raises the indicator’s total value.
De-radicalization: Youth radicalization has been
linked to unemployment, especially in minority
populations. A decent employment generation might
reduce such and help in de-radicalization.
Internal Security: One of the causes of left-wing
extremism in India is the economy’s poor job creation
and unequal growth.
Demographic Unrest: India’s demographic dividend
will become a source of demographic unrest in the
absence of education, vocational training, and gainful
work.
Maintaining Social Fabric: Unless high-quality jobs
are given to the youths there would be a high chance
of disturbing the social stability which could also turn
communal.
Poverty and inequality: The main driver in ending
multidimensional poverty and inequality will be job
creation since, in the absence of employment, there
would be no way to escape this predicament.
PREVIOUS YEAR QUESTIONS (MAINS)
1. “While we flaunt India’s demographic dividend, we
ignore the dropping rates of employability.” What are
we missing while doing so? Where will the jobs that
India desperately needs come from? Explain.(2014)
Challenges for Creating Employment
Opportunities
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z
z
z
Entrepreneurship potential: High aspirations for
stable employment and a lack of entrepreneurship
skills among the younger generation.
Lack of Credible Data: There are many individuals
working in the unorganised field, but there is not
enough information about jobs in new areas like Ola
drivers, amazon delivery personnel, etc.
Structural challenges: The fact that more than 90%
of India’s labour force lacks any formal education
conflicts with the fact that manufacturing requires
a lot of capital and the services industry needs
competent workers.
Competition from abroad: The New Economic Policy
of 1991 and continued economic liberalisation in India
resulted in intense competition with international
enterprises like those in the USA. For instance, Capital
Indian Economy
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z
z
z
z
intensive industries like that of the USA, and labourintensive industries like Bangladesh.
Labour legislations: Indian labour laws encourage
unorganised, small, and fragmented businesses.
Poor Skill Levels: The major causes of low skill levels
in India’s workforce are a lack of formal vocational
education, insufficient skill training capacity, a negative
attitude toward skilling, and a lack of industry-ready
skills even in professional courses.
Low Purchasing Power: Despite being large, the
Indian domestic market is not sustainable for the
manufacturing sector due to a low purchasing
power.
Employee – Employer linkage: The lack of a
connection between the worker and their boss leads
to an imbalance in the supply and demand of labour
throughout India.
Volatile Global Market: India’s labour force is
impacted by the boom-bust cycle that occurs
periodically in wealthy nations. This volatility
component was made worse with Covid-19.
7.6
z
INFORMAL EMPLOYMENT
The term “informal economy” refers to unregistered
businesses where employers do not offer social
protection to employees.
Differences Between Formal & Informal
Economy
Formal Economy
z
z
z
z
z
z
It has a formal contract
with the employer.
It provides predefined
work conditions and
job responsibilities.
Assured and decent
fixed salary with perks
and incentives.
Fixed duration of work
time.
Provide social security
for health and life
risks.
It is part of a wellorganized team of
individuals engaged in
similar activities and
is socially and legally
conscious of its rights.
Informal Economy
z
z
z
z
z
z
It does not have a
formal contract with
its employer.
There
are
no
standardised or fixed
working conditions.
Irregularly
and
unevenly paid.
No platform to express
his grievances.
No fixed hours of
work and mostly earns
hand-to-mouth.
Lacks
any
form
of social security
coverage and has little
understanding of the
value of protecting
one’s
social
and
financial well-being.
Importance of Informal Employment for
India
z
z
z
z
z
z
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Key Source of Employment in Developing Economy:
In many developing nations, the informal sector is a
crucial part of the economic system. In both rural
and urban areas, informal sector enterprises play
a crucial role in the organisation of production and
are a significant source of employment and income
prospects.
Majority of Workforce: India has an estimated 450
million informal employees who make up ninety
percent of its workforce. There are an estimated 5-10
million workers added annually.
Employment generation: According to NITI Aayog’s
Strategy for New India at 75, India’s informal sector
employs approximately 85% of all workers. Also,
as per the Labour Force Survey, over 90 per cent of
Indian workers are informal workers.
Increased share in overall employment: The
proportion of jobs in the unorganised sector rose by
3.6% in 2017–18. However, the percentage of formal
employment during the same period only climbed by
0.9%.
Dominance over contribution: Although the informal
sector may not make a significant contribution to the
national income, its dominance in employment is
expected to last for some time.
Inter-linkages: In India, the informal sector is getting
more integrated with the formal one, achieving
the gaps in the supply chain and providing vital
services to the economy.
Rural development: A key part of the informal sector,
which accounts for 75% of the rural economy and
includes low-end services and agriculture, is found in
rural areas.
Facilitating Factors for the Growth of
Informal Economy
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z
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Education and skill gap: The country adds 12
million people to its workforce each year, but
only about 4% have received any formal training.
India’s workforce readiness is one of the lowest in the
world.
“Missing Middle Syndrome”: Encouragement of small
businesses to expand results in a market dominated
by big and small businesses. Due to the unusually low
proportion of medium-sized businesses, the economy
experienced a “missing middle” condition.
Encouragement from the regulation: Most state and
central labour laws are applied to larger enterprises.
Formal enterprises became more technology-intensive
to stay competitive against informal enterprises. It
also discourages informal businesses from moving
into the formal sector.
Employment, Unemployment and Skill Development
75
z
z
z
Economic inequality as one factor: Economic
disparity and ongoing unemployment are long-term
effects of this issue, which favours a future of jobless
economic growth.
Poor incentive structure: Small businesses are
discouraged from growing, which prevents the formal
workforce from growing.
Post-Independence policies: India chose a stateled industrialization strategy after gaining its
independence; however this approach was unable to
accommodate the nation’s enormous labour force.
z
z
Policy Measures to Deal With
Unemployment
z
Issues Faced by Informal Workers
z
z
z
z
z
z
z
z
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76
Inclination towards formal economy: According to
SBI Eco wrap, over the past few years, a minimum of
Rs 13 crore has entered the formal economy through a
variety of channels, including the most recent e-Shram
website.
Gig economies are emerging: Since 2016, a number
of policies have facilitated higher legalisation rates
at a much faster rate than in many other countries.
Impact on Women: Compared to men, women are
more exposed to informality and frequently find
themselves in precarious circumstances.
Grey Market: Contrary to the formal economy, the
informal economy frequently does not contribute
to a nation’s Gross National Product (GNP) or Gross
Domestic Product (GDP). Thus, the informal sector
can be described as a grey market in labour.
Lack of Credible Data: Because there are no official
statistics that accurately reflect the state of the
economy, it is difficult for the government to formulate
policies involving the informal sector in particular and
the entire economy in general.
Labour-Related Challenges: Despite the fact that
a major section of the workforce is employed in the
rural sector, the informal labour force in cities faces
more challenges.
Low Productivity: The informal sector is made up of
small businesses and micro, small, and medium-sized
enterprises (MSMEs). These businesses are not as big
as companies like Reliance. The company is not able
to use economies of scale to its advantage.
Inability to Raise Tax Revenue: Since the informal
economy’s companies are not directly regulated, they
typically avoid taxes through the concealment of their
earnings and outgoings from the legal system. The
government faces a dilemma because a sizable portion
of the economy is still untaxed.
Under Utilization of Human Resources: Despite
the fact that a large number of the Indian population
are engaged in the informal sector, very little value
is added by each person. In light of this, a significant
amount of our human resources is being underutilised.
Migration crisis: The economy is directly impacted
by both the migrant problem and the rising
unemployment rate.
Job Loss due to Pandemic: The most recent
worldwide report from Oxfam estimates that 75% of
the 122 million jobs that were lost in 2020 were in
the informal sector.
z
z
z
z
z
z
z
E-Shram Portal: In order to maximise the
employability of unorganised workers and provide
them with the advantages of social security
programmes, the Ministry of Labour & Employment
has developed the eSHRAM portal for creating
National Database of Unorganized Workers (NDUW).
Labour Reform: The three labour codes on industrial
relations, occupational safety, health, working
conditions, and social security were passed by
Parliament with the goal of streamlining the nation’s
outdated labour laws and fostering economic growth
without jeopardising workers’ rights.
Pradhan Mantri Shram Yogi Maan-dhan: It is a
Central Sector Scheme run by the Ministry of Labour
and Employment overseas and is carried out by the
Life Insurance Corporation of India and Community
Service Centers (CSCs). This programme aims to assist
the nation’s 42 crore unorganised sector workers.
MGNREGA: It is one of the largest work guarantee
programmes in the world and its primary aim is to
guarantee 100 days of employment every financial
year to adult members of any rural household willing
to do public work-related unskilled manual work.
National Commission for Entrepreneurship in the
Informed Sector: In order to examine the issues and
difficulties the informal economy faces; India is likely
the first country to have established the National
Commission for Enterprises in the Unorganized Sector
(NCEUS) in 2004.
PM SANNidhi: Pradhan Mantri Street Vendor’s Atma
Nirbhar Nidhi (PM SANNidhi), a programme to offer
street vendors cheap loans, has been introduced by the
Ministry of Housing and Urban Affairs (MoHUA). The
programme would help vendors, hawkers, and other
individuals in various regions who deal in goods and
services relating to textiles, clothes, artisanal goods,
barbershops, laundry services, etc.
Self-employment and Talent Utilisation (SETU):
It was established in 2015 by NITI Aayog to foster
a sense of self-employment and to maximise the
potential inherent in talent.
Skill Strengthening for Industrial Value
Enhancement (STRIVE): It seeks to enhance the
efficacy and commercial relevance of skill development
Indian Economy
training programmes in long-term vocational
education and training, as well as institutional reforms.
Pradhan Mantri Kaushal Vikas Yojana (PMKVY):
By 2022, it hopes to have trained over 40 crore
people in various disciplines in India. It aims to
provide vocational training and certification to Indian
youth in order to improve their standard of living and
social standing.
z
(c) Reserving some skilled jobs to rural and urban poor
in some public sector undertakings.
(d) Certifying the skills acquired by trainees under the
National Skill Development Programme.
Unorganised Workers’ Social
Security Act, 2008
z
PREVIOUS YEAR QUESTION (PRELIMS)
Q. With reference to Pradhan Mantri Kaushal Vikas
Yojana, consider the following statements: (2018)
1. It is the flagship scheme of the Ministry of Labour
and Employment.
2. It, among other things, will also impart training
in soft skills, entrepreneurship, and financial and
digital literacy.
3. It aims to align the competencies of the unregulated
workforce of the country to the National Skill
Qualification Framework.
Which of the statements given above is/are correct?
(a) 1 and 3 only
(b) 2 only
(c) 2 and 3 only
(d) 1, 2 and 3
Recognition of Prior Learning (RPL)
z
z
It was first introduced as a part of PMKVY and
mostly refers to an evaluation process for a person’s
current skill set, knowledge, and experience
acquired through formal, non-formal, or informal
learning and not as part of the National Skill
Development Program.
Objectives:
 To conform the nation’s unregulated workforce’s
skills to the uniform National Skills Qualification
Framework (NSQF).
 To increase a person’s employment prospects
and to offer alternative paths to higher
education.
 To present chances for eliminating disparities
caused by favouring some types of knowledge
over others.
PREVIOUS YEAR QUESTION (PRELIMS)
1. ‘Recognition of Prior Learning Scheme’ is sometimes
mentioned in the news with reference to __________
(2017)
(a) Certifying the skills acquired by construction
workers through traditional channels.
(b) Enrolling the persons in Universities for distance
learning programmes.
7.7
z
z
z
It gives the Central Government the authority to
create suitable welfare programmes on issues
relating to life and disability cover, health and
maternity benefits, old age protection, and any
other benefit as may be decided by the Central
Government in order to provide Social Security
benefits to unorganised sector workers.
FIXED TERM EMPLOYMENT (FTE)
In a fixed-term employment contract, an employer
engages an employee for a predetermined period
of time. In most cases, it is for a year, but depending
on the circumstance, it may be extended after that.
To make it simpler for companies planning to hire
employees to carry out certain projects, tasks, or
orders, the government has expanded the option
of hiring workers on fixed-term employment to all
sectors.
As per the estimate based on PLFS 2018-19, out
of the 24% of workers in the normal salary group
with salaried jobs, only 2.2% have access to all social
security benefits.
Benefits of FTE
z
z
z
z
z
z
z
Employees will be eligible for benefits offered to
permanent employees under FTE.
If converted to FTE employees, contract workers
would benefit from the statutory benefits.
They might be guaranteed a stronger sense of
accountability from the main employer.
Poor working conditions have been a key cause
of dissatisfaction in industrial centres among the
contract labour. Hence, it is in the industry’s best
interest to enhance working conditions.
The cost of capital has stayed so cheap as to discourage
the utilisation of labour.
The industries will profit if the FTE category of the
workforce offers them much-needed flexibility.
FTEs are especially helpful when carrying out
particular projects, like those in the infra sector. They
are common in apparel, shoes, and several media
outlets.
Key Point of Provision:
z
New definition of Fix term Employee: A worker who
is hired on a contract basis for a set amount of time
Employment, Unemployment and Skill Development
77
is referred to as having fixed-term employment. As a
result of the contract between the employer and the
relevant worker not being renewed, the workman’s
services will end automatically.
Tenure and remuneration: The idea of fixed-term
employment establishes the length of the job as
well as any additional service requirements and
compensation that regular employees are entitled to
under various labour regulations.
Parity with permanent workman: The fixed
worker would be entitled to the same advantages as
permanent workers, including salaries, hours of work,
allowances, and other statutory benefits.
Ease of hire and fire: The revised Order states that
bad and temporary employees do not require a notice
of termination of employment.
Better conditions for work: In comparison to
contract workers, those hired for a little time will have
better working and service conditions.
z
z
z
z
z
Features of Self-employment
z
z
z
z
z
Impacts of FTE:
Over time, there has been a decrease in the transition
rate from FTE to permanent employment.
Global Example: The length of FTE contracts is
decreasing; in Spain, 25% of new contracts are for
less than a week and 40% are for less than a month.
Due to FTE, the labour market now has a low
transition rate and a wide wage gap (between FTE
and permanent workers).
The majority of FTE hiring will likely be low-wage
workers who fall into the lowest income range.
FTE reduces job security and raises wage volatility.
z
z
z
z
z
z
z
7.8
z
78
The Supreme Court overturned two Gujarat
government notifications that exempted all factories
from overtime pay and working standards.
The Supreme Court (SC) cited Article 21 in its
argument that denial of humane working conditions
and overtime pay mandated by law “is an affront to
the workers’ Right to life and right against forced
labour that is granted by Art. 21 and 23 of the
Constitution.”
z
z
z
z
SELF-EMPLOYMENT
A self-employed person earns his or her living by
taking contracts with businesses rather than working
for a specific employer. Simply put, it is the state of
working for oneself as a freelancer or business owner
rather than for an employer.
Self-employment entails doing something on one’s
own to earn a living.
It entails a person owning and managing activities,
though he or she may enlist the assistance of one
or two others. Thus, self-employment may provide
employment to other persons as well.
The earnings from self-employment are not
guaranteed. It is determined by the amount of money
one can make by producing, purchasing, and selling
goods, or providing services to others for a fee.
In self-employment, the owner is solely responsible
for profit and bears the risk of loss. So, we find a direct
link between effort and reward in self-employment.
In self-employment, a person is free to make decisions
about how to run his business profitably and to take
advantage of any opportunities for business expansion
that may arise.
It gives complete freedom to work as per one’s own
will and within the parameters of the prevailing laws.
Significance of Self-employment
Supreme Court Judgement
on FTE
z
According to the Periodic Labour Force Survey
(PLFS), 2020-21, 55.6% of India’s workers were selfemployed.
z
Developing an entrepreneurial spirit: Selfemployment involves either no risk or very little risk.
However, when a self-employed person begins to be
innovative and takes steps to expand his business, he
becomes an entrepreneur.
Advantage of small business: There are a number of
advantages for small businesses over large ones. It is
simple to get started and doesn’t take much capital.
Small-scale self-employment is a good substitute for
large-scale enterprise, which has led to a number
of negative effects like environmental pollution, the
growth of slums, labour exploitation, and so on.
Indigenization of manufacturing: It plays an
important role in the Indigenization of manufacturing
activities providing a boost to technology and various
sectors in the economy.
Preference over wage employment: In contrast to
wage employment, there is no income ceiling for selfemployment. One can use their talent for themselves
when one works for themselves. The choices can be
made easily and swiftly. These all serve as powerful
motivators for choosing self-employment versus paid
work.
Scope for creativity: It gives people the chance to
develop their creative and artistic abilities, which
helps to preserve India’s rich cultural legacy. We
can see creative ideas in handicrafts, UI and UX,
advertisements, handloom products, and so on.
Indian Economy
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z
Women empowerment: It helps in women
empowerment, as women’s gender group is a major
part of self-employment.
Multiplier effect: It acts as a strategic multiplier
effect in job creation in the Indian economy by
creating various jobs from the software industry to
the farming sector.
Issues Related to Self-employment in India
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z
z
z
z
z
Low Job creation: According to some data, just 4%
of India’s self-employed actually recruit people from
outside. This indicates that a very small percentage
creates jobs.
Low earnings: The average monthly income for all
self-employed people, according to the PLFS data, has
been around 8,000 per month, which is significantly
less than the average monthly income for regular
employees.
High participation in the Agri sector: Almost 60%
of self-employed people work in the agriculture
industry, which is plagued by low productivity.
Prevalence of non-formality: The majority of selfemployed are only classified as “formal” if they have
registered with a government agency and/or paid
taxes.
Gender pays gap: On average, male workers make
almost three times as much as female workers in the
group of self-employed people.
NSSO Report: According to the NSSO data, there are
63 million unregistered enterprises in India, 96%
of which are operated by individuals. Most of these
businesses do not pay GST since their annual sales
are less than Rs 20 lakh.
Occupational Safety and Health (OSH) in the Informal
Sector through targeted programmes and capacity
building.
z
Skill development: Using government schemes like
the Pradhan Mantri Kaushal Vikas Yojana, India can
improve the skills of its young people to meet the
needs of the modern manufacturing industry.
To conclude, The rise in unemployment rates in recent
times is due to the Covid-19 pandemic. This has caused a
lot of people to lose jobs nationwide. India needs to focus
on improving its skills and reskilling its labour force so
that it can benefit from its demographic dividend before it
becomes too late and the demographic dividend becomes
a liability.
7.9
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z
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z
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Quality Education: The level of education must
match the demands of the market at the time. The
demands of the workplace must be analysed by future
generations.
Liberalisation and Neutralizing impact of it:
Antidumping and countervailing taxes on products
that hurt regional industrial sectors.
Short-term economic reform: strengthening the
government’s attempts to boost formalisation,
including the GST, Demonetization, EPF reforms, Skill
India initiatives, Fixed Term Contract Reform, Tax law
rationalisation, and Maternity Benefit Reform.
Improve data collection on employment: Collect
and disseminate data on a regular basis. Increase
the use of administrative data, such as EPFO, ESIC, and
the NPS, to track the state of employment on a regular
basis while adjusting for workforce formalisation.
Social protection coverage: Enact a thorough
Occupational Health and Safety Act, and improve
The definition of skill development is expertise gained
or developed via instruction or experience. It improves
people’s capacity for adjusting to shifting consumer
needs and assisting in gaining from innovative and
entrepreneurial endeavours.
Present Status
z
z
z
z
Way Forward
z
SKILL DEVELOPMENT
z
Unemployment Rate: The unemployment rate fell to
4.8% in 2019-20. In 2018-19, it stood at 5.8% and
6.1% in 2017-18.
Worker Population Rate: It improved to 38.2% in
2019-20 from 35.3% in 2018-19 and 34.7% in 201718.
Labour Force Participation Ratio: It increased to
40.1% in 2019-20 compared to 37.5% and 36.9% in
the last two years. The higher the LFPR, the better.
Gender-Based Unemployment Rate: The data
showed the jobless rate for both males and females
fell to 5.1% and 4.2%, respectively, in 2019-20 from
6% and 5.2% in 2018-19.
Periodic Labour Force Survey (PLFS) 2020–21:
From 4.8% in 2019–20 to 4.2% in 2020–21, the
unemployment rate decreased by 0.6%.
Need for Skill Development
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Demographic Dividend: India is predicted to have
the largest workforce in the world by 2025. If we want
to fully take advantage of the demographic dividend,
skill development must be prioritised in the overall
strategy.
Knowledge-based economy: Since India wants to
create a knowledge-based economy, it is crucial to
cultivate highly trained human capital in order to
boost the level of innovation within the labour force.
Unemployment rates: Low wages and high
unemployment rates are directly related, so in order to
solve the unemployment problem, skill development
must also be addressed.
Employment, Unemployment and Skill Development
79
Inclusive economic growth: India has the secondlargest labour force and one of the fastest-expanding
economies in the world. Of the overall population,
women make up 49%, therefore, Women’s skill
development is crucial to the country’s economic
success.
Automation: Even individuals working in low-skilled,
low-paying jobs are likely to lose their jobs as a result
of the advancement of technology, digitization, and
automation. Therefore, it is important to instill the
necessary abilities to prepare them for future changes
in the industrial landscape.
Sectoral mobilization: As production increases,
fewer people will need to work in agriculture. As a
result, the labour would be mobilised across sectors,
moving from agricultural to secondary and tertiary
pursuits.
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Issues with Skill Development in India
Lack of Basic Education: According to a 2020 NSO
survey, one in every eight students enrolled in a
school or college drops out before completing their
education, with 63% of them at the elementary level.
Lack of Attention to Upskilling/Reskilling:
According to the PLFS 2019-20, 86.1% of those aged
15 to 59 have received no vocational training. Only
13.9% of people were trained through formal and
informal channels.
Inadequate Training Facilities: According to the
NSSO survey, there is a lack of training facilities
in as many as 20 high-growth industries in India,
including logistics, healthcare, construction,
hospitality, and automobiles.
Covid-19 Pandemic: It has resulted in the cancellation
of both short-term and long-term training programmes,
affecting millions of students.
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India Skills Report, 2022
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Employability: Overall youth employability in
India has increased to 48.7% compared to last year.
Male-Female
Employability:
Among
the
employable youth population, 51.44% of females
were found highly employable while 45.97% of
males were found highly employable.
State-wise Employability: Youth from the states
of Maharashtra, Uttar Pradesh, Kerala, and West
Bengal were considered the most employable in
terms of demographic talent availability.
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Way Forward
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Policy Initiatives by Government
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Grameen Kaushal Yojana Deen Dayal Upadhyaya:
This initiative aims to address the vision of a skilling
ecosystem that meets the needs of industry partners
while also ensuring long-term placements for rural
poor youth.
Pradhan Mantri Kaushal Vikas Yojana: The flagship
scheme was launched in 2015 to provide short-term
training, and skilling through ITIs and under the
apprenticeship scheme. Under this programme, the
government has trained nearly 10 million young
people since 2015.
TEJAS Initiative for Skilling: Recently, the Dubai
Expo 2020 hosted the inaugural event for TEJAS
(Training for Emirates Jobs and Skills), a Skill India
International Project to train Indians living abroad.
Mandatory CSR Expenditure in Skilling: Since the
Companies Act of 2013 mandatory CSR spending,
Indian firms have contributed over 100,000 crores to
a range of social causes.
Atmanirbhar Skilled Employee Employer Mapping
(ASEEM): It is a platform that was introduced in
2020 by the Ministry of Skill Development and
Entrepreneurship (MSDE) to assist skilled individuals
in locating opportunities for sustainable livelihood.
USTTAD (Upgrading Skills and Training in
Traditional Arts/Crafts for Development): to
conserve traditional arts/crafts and build the capacity
of traditional artisans and craftsmen belonging to
minority communities;
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Accessibility: ITIs should be further expanded,
primarily in the country’s rural regions, and basic
gender-specific infrastructure should be built to
increase accessibility, especially for women.
Private sector role: Make the private sector liable for
the nation’s skill development as well. By promoting
their participation in the creation of curricula, the
delivery of training and internships, and the evaluation
and accreditation of training programmes.
Removing societal biases: To eradicate the prejudices
that women in the nation currently experience when
looking for work, it is crucial to recognise and make
efforts to modify fundamental and subtle sociocultural
attitudes.
Employment opportunities: To eliminate the
prejudices that women in the country still encounter
when looking for work, it is crucial to recognise and
work to change fundamental and subtle socio-cultural
attitudes.
Initiatives like Skills on Wheel might be utilised to
address transportation and infrastructure issues. In
Brazil, there are exemplary Skill Trucks that deliver
skills instruction to the outlying, rural areas of the
nation.
Vertical Mobility: Establishing a vertical mobility
system for courses in vocational education from
Indian Economy
certificates to diplomas to degrees. offering possibilities
ranging from school level to PG.
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Recognition of Prior Learning: It is important to
restructure the informal training so that it certifies the
skills level of workers who have inherited their skills
from their ancestors. This will help them to get jobs,
get financial services, and provide livelihood security.
To conclude, A life of liberty is possible with the aid of
education, but prosperity is only made possible by the
use of one’s abilities. The population pyramid of India is
anticipated to bulge over the 15-59 age range over the
following ten years. It is anticipated that this demographic
advantage will only exist until 2040. India has a very
limited amount of time to capitalise on its demographic
dividend and address its talent gap. Therefore, it is
essential to make concerted efforts to skill its population
and make India the world’s skill capital.
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7.10 GIG WORKERS
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According to NITI Aayog’s research, “India’s Booming
Gig and Platform Economy,” 23.5 million gig workers
may exist in India by FY30.
Key Drivers of the GIG Sector
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About GIG Worker
A gig economy is a form of a free market where
businesses hire independent workers on a
temporary basis and temporary positions are
common.
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According to the Code on Social Security, a 2020
gig worker is a person who performs labour or
participates in work arrangements and earns from
such activities outside of the conventional employeremployee relationship.
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Workers in the gig economy can be classified into
platform and non-platform-based workers.:
1. Platform workers: These workers are those
whose livelihoods rely on digital platforms or
online software apps, such as food aggregation
platforms Zomato, Swiggy, Ola, and others.
2. Non-platform workers: These employees
typically work regular industries either part-time
or full-time, earning a casual wage and using their
accounts.
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India Staffing Federation 2019: India is the world’s
fifth-largest flexible staffing market, trailing only the
United States, China, Brazil, and Japan.
‘India’s Booming Gig and Platform Economy’ Report
(NITI Aayog):
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Workforce: India’s gig economy is expected to grow
to 2.35 million by 2029-30. It also states that the gig
economy will employ 77 lakhs (7.7 million) people
in 2020-21. They accounted for 1.5% of the total
workforce in India or 2.6% of the non-agricultural
workforce.
Platformization of Work: As platformization of nongig work into gig work occurs, gig workers’ higher
employment elasticity demonstrates their expanding
demand. More than 75% of businesses currently use
fewer than 10% of gig workers, but this number will
increase as more MNCs use flexible employment
practices.
High potential industries for Gig Workers:
Construction,
Manufacturing,
Retail,
and
Transportation and Logistics
Skill Level of Gig Workforce: Currently, mediumskilled occupations make up around 47% of gig work,
high-skilled jobs about 22%, and low-skilled jobs
about 31%.
Skill Polarisation: The report emphasises the
polarization of skills because the trend shows a gradual
drop in the proportion of workers with medium skills
while the proportion of low-skilled and high-skilled
workers is rising.
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The Development of a Start-up Culture: India’s
start-up ecosystem has been expanding quickly and
due to the high fixed costs associated with recruiting
full-time staff for start-up businesses, contractual
freelancers are used for non-core tasks.
Business Models: Many gig workers are compensated
in a variety of ways, including fixed fee, time & effort,
and actual unit of work delivered and quality of the
outcome. The model with a fixed fee is the most
common, while the time and effort model is a close
second.
Remote Work Flexibility: In the digital age,
employees are no longer required to work from a fixed
location; instead, they can complete their tasks from
any location, allowing businesses to choose the best
personnel without regard to location.
Changing Work Culture: The millennial generation
appears to approach careers with a very different
mindset. Instead of pursuing occupations that might
not satisfy their inner desires, they try to pursue the
work they want to do.
Technological Advancements: Due to technological
advancements, contracting has become much simpler,
enabling both people to find employment and
businesses to interact more intimately with those who
are independent contractors rather than employees.
Demand for Contractual Work: An increase in
contract employment has caused large multinational
corporations (MNCs) to embrace flexible hiring
practices, particularly for specialised projects, in
an effort to save operating costs in the wake of the
epidemic.
Employment, Unemployment and Skill Development
81
Issues and Challenges
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Accessibility: Access to internet services and digital
technologies can be a limiting factor, even though
the gig economy is open to everyone who is ready to
engage in such employment due to the large range of
employment opportunities it offers.
Job and Income Insecurity: Gig Workers are not
covered by labour laws governing salaries, hours,
conditions of employment, and the ability to engage
in collective bargaining.
Occupational Safety and Health Concerns: People
who work for digital platforms, particularly women
who work in the delivery and taxi services offered
through apps, are subject to a number of occupational
safety and health risks.
Mismatch of Skill: Vertical and horizontal skill
mismatches of varying degrees can be seen in online
web-based platforms. According to International
Labour Organisation (ILO) research, workers with
higher educational attainments may not always find
employment that matches their skills.
Challenges faced due to Terms of Contract: The
terms of service agreements govern most aspects of
working conditions on digital platforms. They often
describe the contractual arrangement as something
other than an employment one between the worker
and platform owner.
RECOMMENDATIONS OF NITI AAYOG:
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Proper Estimation of Gig Workers: To determine the
scale of the gig economy and the traits of gig workers,
conduct independent enumeration procedures.
Catalyse Platformization: Launch the Platform India
initiative (similar to Start-up India), which is based
on the pillars of Accelerating Platformization through
Simplification and Handholding, Funding Support and
Incentives, Skill Development, and Social Financial
Inclusion.
Accelerate Financial Inclusion: Improve access to
institutional financing by offering financial solutions
created just for platform users and those looking to
launch their own platforms.
Skill Development for Platform Jobs: In order to
increase youth and the workforce’s employability,
pursue platform-led, ends- or outcome-based skilling
and job creation strategies.
Improving Social Inclusion: Improving social
inclusion in the modern digital economy through the
implementation of programmes that promote gender
sensitization and accessibility awareness.
Universal Social Security Coverage: Learn from
global examples and suggestions on how to improve
social security measures in partnership mode on the
lines of the Social Security Code 2020, including
paid sick leave, Occupational Disease and Work
Accident Insurance, pension and retirement plans,
and additional contingency Benefits for gig workers
and their families.
Way Forward
Ensuring Social Security Benefits: Platforms may
adopt measures for paid sick leave, health access,
and insurance as part of their workplace or work
engagement policies for all the employees they
engage, year-round, in a manner similar to the ones
firms developed to address the issues created by the
Covid-19 pandemic. This offering of social security
cover to platform workers engaged by these firms will
create a positive impact.
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Insurance for occupational diseases and accidents
at work: In India, platforms can use methods to
provide accident insurance to all delivery and driver
partners as well as to other platform employees. As
envisioned by the Code on Social Security, 2020, these
may be provided in collaboration with the private
sector or the government.
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Retirement/Pension Plans and Other Benefits:
Adopting policies that provide retirement and old
age benefits as well as other insurance protections for
situations like workplace injuries that could result in
loss of income and employment is necessary.
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Contingency Coverage from a Corpus Fund: A
mobility platform established the “Drive the Driver
Fund” with a corpus of INR 20 Cr. to assist autorickshaw, cab, and taxi drivers in order to support
them and help minimise the effects of the lockdown
on their income. These measures can support gig and
platform workers and other self-employed individuals
associated with the sector in case of contingencies.
To conclude, In a gig economy, workers are employed
through freelancing and contract work. This way, there is
no need for a large, centralized workforce. It is important
to be active in this sector and help it grow. We need
policies and processes that make it easier for the sector
to function as it should.
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PREVIOUS YEAR QUESTIONS (MAINS)
1. Examine the role of the ‘Gig Economy’ in the process
of empowerment of women in India.
(2021)
7.11 SOCIAL SECURITY CODE 2020
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The Social Security Code 2020 subsumes nine
regulations relating to social security, retirement and
employee benefits.
Major Provisions:
 Enhanced Coverage: The unorganised sector,
fixed-term employees, gig workers, platform
workers, interstate migrant workers, etc. are
now included in the Code’s expanded scope of
application.
Indian Economy
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National Database and Registration: All of these
workers would be registered on an internet portal
using a straightforward process based on selfcertification with the goal of creating a national
database for unorganised sector workers.
Uniform Definitions: For social security benefit
purposes, salaries are calculated consistently.
It has also given a comprehensive definition of
wages.
Consultative Approach: This led to a facilitating
approach on the part of the authorities. This
new role of inspector-cum-facilitator will allow
employers to look for help and advice to improve
compliance.
Social Security Fund: It will be created on
the financial end to carry out social security
programmes.
Career Centre: Career centres will be set up to
help meet the need for human resources and keep
track of employment data.
Stringent Penalties: Any failure to deposit
employee contributions is subject to an Rs.
1,00,000 fine as well as a one- to three-year
sentence in prison. There is no compounding
allowed for repeat offences, and the penalties and
prosecution are severe.
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Do You Know?
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Blue-Collar Worker: A person who works in the
working class and is paid hourly for their labour.
White-Collar Worker: A salaried professional,
usually referring to those who work in offices and
in management.
Grey-Collar Worker: Even though the term “greycollar” is often used to refer to people who work
past retirement age. It also refers to the remaining
group of workers who are not categorised as whiteor blue-collar.
Gold-Collar Worker: Refer to highly qualified
individuals who are of great value to the business.
Green-Collar Worker: A worker who is employed
in the environmental sectors of the economy.
Pink-Collar Worker: A position that is typically
regarded as women’s employment.
Red-Collar Worker: Government workers of all
types.
Open-Collar Worker: A worker who works from
home, especially via the Internet.
OpinionMatters
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Do you think in India “what was once known as the
demographic dividend may now become a demographic
disaster?”
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Employment, Unemployment and Skill Development
83
8
Inclusive Growth
INTRODUCTION
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Inclusive growth entails equitable resource
distribution, with benefits accruing to all segments
of society. However, resource allocation must be
centred on the intended short and long-term benefits
of society, such as consumer goods availability, people
access, employment, and living standards, among
other things.
Productive
Employment
Poverty
Reduction
Economic
Growth
INCLUSIVE
GROWTH
Socio-Economic
Development
Good & Ethical
Governance
Inequality
Reduction
Human
Development
Gender
Equality
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8.2NEED FOR INCLUSIVE
GROWTH z
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Schematic: Virtuous cycle of inclusive growth
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World Bank: “Inclusive Growth” describes the rate
and structure of growth, which are interconnected
and must be addressed jointly.”
UNDP: UNDP defines inclusive growth as “the
procedure and consequence in which all groups of
people participate in the growth and gain equally
from it.”
OECD: Economic growth that fosters opportunity for
all facets of the population and equally distributes the
benefits of growing prosperity, both monetary and
non-material, is known as inclusive growth.
11th Five-Year Plan (2007-12): Laid special
emphasis on Inclusive Growth for the first time. It
was later carried forward by the 12th Five-Year Plan.
The Twelfth Five Year Plan focuses on Growth:
Growth which is: Faster, Inclusive and Sustainable.
8.1
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FEATURE OF INCLUSIVE GROWTH
Considered to be the constraints of the excluded and
marginalised.
Participation of all segments of society.
Reduction of gaps in per capita earnings between
different economic sectors.
Non-Discriminatory in nature.
Has the greater poverty-reduction potential
Ensure that individuals have access to fundamental
facilities and services/capabilities, such as basic
health and education.
This access should cover both the number and quality
of these fundamental services.
Include poor people, lagging socioeconomic groups,
and trailing areas as participants in this growth.
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Economic Prosperity: To reduce poverty quickly and
sustainably, inclusive growth that allows individuals
to both contribute to and benefit from economic
prosperity is required.
Sustainable Growth: For inclusive growth is required
in order to eradicate poverty. To be sustainable, it
must be broad-based across industries and include a
big portion of the country’s labour force.
The Pattern of Growth: Many academics describe
inclusive growth as the growth rate and pattern,
which are believed to be interconnected and hence
must be tackled together.
Women’s Empowerment: Not all women have
equal access to education and health care. Females
are viewed as submissive to males and completely
dependent on their families in every way. As a result,
inclusive growth is critical to women’s empowerment.
Regional disparities: They are the root cause of
the increase in intra-state and interstate distress
migration. Distress migration exacerbates housing,
lodging, safety, hygiene, and sanitation issues.
Economic Transition: The key to transitioning the
informal sector into the formal economy is financial
inclusion.
Long-Term Growth: The significance of inclusive
growth for long-term growth cannot be overstated.
Employment: Inclusive growth refers to economic
growth that generates job opportunities and aids in
poverty reduction.
Health And Education: It entails the underprivileged
having access to basic health and education services.
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It entails ensuring equal chances and giving people
power via education and skill development.
Environmental sustainability: It also includes an
environmentally sustainable growth process, strives
for good governance, and aids in the formation of a
gender-conscious society.
8.3
ELEMENTS OF INCLUSIVE GROWTH
Social sector
development
Employment
generation
PILLARS OF
INCLUSIVE
GROWTH
Environmental
protection
Poverty &
Inequality
reduction
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Undustrial and
infrastructure
development
Reduction
in regional
disparities
Agricultural
development
Skill Development:
 The use of the demographic dividend will depend
on the employability of the working-age population,
as well as their health, education, occupational
training, and skills.
Financial Inclusion:
 Financial inclusion refers to the method of
providing disadvantaged people with inexpensive
access to financial services.
 Financial inclusion is required for inclusive growth
because it fosters a saving culture, which kicks off
a virtuous cycle of economic progress.
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Technological Progress:
 The world is approaching the Industrial Revolution
4.0 era.
 Technological advancements have the potential to
reduce or worsen inequality depending on how
they are applied.
Economic Development:
 India has one of the fastest-growing major
economies in the world. The Indian economy, on
the other hand, is currently slowing due to both
cyclical and structural issues.
 However, the goal of establishing a $5 trillion
economy by 2024-25 can help India reduce
inequality, improve social spending, and create
jobs for everybody.
Social development:
 It entails empowering all marginalised populations,
including SC/ST/OBC/Minorities, women, and
transgender people.
 Empowerment can be achieved through the
improvement of social institutions such as
hospitals, particularly primary care in rural areas,
schools, and universities.
 Investment in social structures will not only
benefit the economy (via fiscal stimulus), but will
also result in a healthy and capable workforce in
the future.
OpinionMatters
As per the IMF, “India’s digital payment volume has
climbed at an average annual rate of about 50% over
the past 5 years.” Do you think rising digital payments
are acting as a divide in the path of inclusive growth?
8.4INCLUSIVE GROWTH: CONSTITUTIONAL MANDATE
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Article- 38(1)
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Article- 38(2)
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Article- 39
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The State shall strive to promote the welfare of the people by securing and protecting
as effectively as it may a social order in which justice, social, economic and political,
shall inform all the institutions of national life.
The State shall, in particular, strive to minimize the inequalities in income, and
endeavour to eliminate inequalities in status, facilities and opportunities, not only
amongst individuals but also amongst groups of people residing in different areas
or engaged in different vocations.
The State shall, in particular, direct its policy towards securing—
that the citizens, men and women equally, have the right to an adequate means
of livelihood;
that the ownership and control of the material resources of the community are
so distributed as best to subserve the common good;
that the operation of the economic system does not result in the concentration of
wealth and means of production to the common detriment;
that there is equal pay for equal work for both men and women;
Inclusive Growth
85
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Article-39A
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Article- 41
Article- 42
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Article- 46
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Article- 47
Article- 48A
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The State shall ensure that the operation of the legal system promotes justice,
on a basis of equal opportunity, and shall, in particular, provide free legal aid, by
suitable legislation or schemes or in any other way, to ensure that opportunities
for securing justice are not denied to any citizen because of economic or other
disabilities.
The State shall, within the limits of its economic capacity and development, make
effective provision for securing the right to work, education and public assistance
in cases of unemployment, old age, sickness and disablement, and in other cases of
undeserved want.
The State shall make provisions for securing just and humane conditions of work
and for maternity relief.
The State shall promote with special care the educational and economic interests
of the weaker sections of the people, and, in particular, of the Scheduled Castes
and the Scheduled Tribes, and shall protect them from social injustice and all
forms of exploitation.
The State shall regard the raising of the level of nutrition and the standard of
living of its people and the improvement of public health as among its primary
duties and, in particular, the State shall endeavour to bring about prohibition
of the consumption except for medicinal purposes of intoxicating drinks and of
drugs which are injurious to health.
The State shall endeavour to protect and improve the environment and to safeguard
the forests and wildlife of the country.
in ensuring that priorities are shared by all parties,
especially at the many levels of government, and that
roles are delineated and understood.
8.5APPROACHES TO INCLUSIVE
GROWTH
1. Trickle-Down Approach: This approach argues that
the benefits of growth as enjoyed by the wealthy,
will automatically trickle down to the bottom of
the pyramid. It asserts that tax breaks and perks
for businesses and the wealthy will trickle down to
everyone else.
2. Welfare Approach: The welfare approach focuses on
how resources and goods are best divided and how
the allocation of these resources affects overall social
welfare.
3. Bottom-Up Approach: This is the opposite of the topdown policy followed by the ‘trickle-down’ approach.
It encourages people to participate in large numbers
in the development process.
4. Public Relations Approach: This talks about prodding
the public to engage themselves in the development
process. It includes the use of socio-psychological
factors to incentivize people to participate in the
inclusive growth process.
5. Co-Ordinated Approach: Numerous inclusive growth
projects require a coordinated strategy for their
conception, funding, and execution. The difficulty is
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6. Strategic Approach: Using a Strategic approach
in inclusive growth is The “one” or “best” method
to promote inclusion does not exist. Programs that
integrate workers into the labour force, deal with
gender prejudice, foster social innovation, support
initiatives that assist low-income families, and
encourage digitalisation in rural and distant regions
may all contribute to inclusive growth.
8.6SUSTAINABLE DEVELOPMENT
GOALS AND INCLUSIVE GROWTH
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The 2030 Agenda for Sustainable Development, which
was adopted by all United Nations Member States in
2015, provides peace and prosperity for people and
the planet now and in the future. The 17 SDGs, which
are an urgent call to action for all nations—developed
and developing—in a global partnership, are at the
centre of it.
Sustainable Development Goals 8: Economic
Growth
Indian Economy
8
DECENT WORK AND
ECONOMIC GROWTH
8.7DIMENSIONS OF INCLUSIVE
GROWTH
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Equality:
 Equality: The goal of equality is to provide
everyone with the same access to resources,
markets, and a fair regulatory environment.
 Inclusive Growth: Equality is the most important
requirement for achieving equitable development
in its most ideal form. Equality and inclusive
growth have mutual effects.
A Good Government:
 Good
Government: Effective and efficient
government supports justice, the rule of law, and
accountability while promoting public engagement,
consensus, and equality.
 Administration & Accountability: Inclusive
Growth, public administration, and accountability
are all included through good governance; for
instance, issues with inadequate health facilities
may impede Inclusive Growth and are frequently
linked to the Ministry of Health and Family
Welfare’s bad governance.
Decentralization:
 Self-governance: One of the delivery methods for
inclusive growth is strengthening local institutions
of self-governance.
 Amendment: The constitution’s 73rd and 74th
amendments represent innovation in Indian
politics.
 Power: To make the PRIs a facilitator of inclusive
growth, the federal and state governments must
give them more power.
Transparency and Accountability
 Accountability: It is being held responsible for
the effectiveness of service delivery. It establishes
accountability for the completed tasks in terms of
output and results.
 Check and balance: The former refers to
the departmental hierarchy of a government
institution, while the latter refers to independent
agencies that serve as a check and balance on
governmental actions, such as the CAG, PMO, and
others.
Sustainability:
 Environment: Long-term results of the Indian
Economic Planning for Inclusive Growth are
significantly out of sync with environmental goals.
Inclusive Growth



Standard of Living: The environment and level
of living for the poor have declined despite the
enormous rise of the Indian economy.
LPG: It has been explained in the challenges
surrounding inclusive growth that Liberalization,
Privatization, and Globalization (LPG) have
severely harmed the environment and widened
the gap between rural and urban areas.
Inclusive Growth: It is impossible to accomplish
sustainability and inclusive growth separately, and
they complement one another.
8.8INDIA @75 BY NITI AAYOG AND
INCLUSIVE GROWTH
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Strategy for New India @75:
New India: NITI Aayog’s “Strategy for New India @
75” is an effort to integrate innovation, technology,
enterprise, and effective management at the centre
of policy formulation and execution.
 Policy Course: It will promote debate and solicit
comments for further adjusting our policy course.
 Jan Andolan: Without the involvement of the
general people, economic transformation, in
our opinion, cannot occur. The Jan Andolan of
development must be adopted.
The Inclusive Growth Goals Of The New India @75
Vision Are As Follows:
 A quick, clean, consistent, structured growth that
is inclusive, reaching 9–10% by 2022–2023
 By 2022–2033, use technology to promote inclusive,
sustainable, and participatory development.
 Ensuring that urban poor and slum inhabitants,
especially new migrants, can access city services,
via inclusive city development.
 To remove obstacles from the physical environment
(such as accessible restrooms), admissions
processes, and curriculum design to make schools
more inclusive.
 To increase accessibility to higher education for
the most vulnerable communities.
 To provide high-quality ambulatory services close
to the public for a comprehensive package of
diagnostic, curative, rehabilitative, and palliative
care.
 To develop a broad-based policy framework with
citizens at its core.

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8.9
POLICY INTERVENTIONS TO ACHIEVE INCLUSIVE GROWTH
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Rural Economy
Based Growth
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Sustainable
and Inclusive
Agricultural Growth
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Holistic Approach to
Combat Poverty in
India
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Social Sector
Development
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Role of Public and
Private Partnership
In This Regard
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Balanced Regional
Growth
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Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) 2005
Mission Antyodaya
The National Rurban Mission
Pradhan Mantri Awas Yojana- Gramin
Pradhan Mantri Adarsh Gram Yojana (PMAGY)
Pradhan Mantri Gram Sadak Yojana (PMGSY)
Pm Kisan Sampada Yojana
Pm Fasal Bima Yojana
Pradhan Mantri Krishi Sinchayee Yojana
National Agriculture Market
Paramparagat Krishi Vikas Yojana
National Livestock Mission (NLM)
Integrated Rural Development Programme (IRDP)
Jawahar Rojgar Yojana/Jawahar Gram Samriddhi Yojana
Food for Work Programme
National Old Age Pension Scheme (NOAPS)
Annapurna Scheme
Sampoorna Gramin Rojgar Yojana (SGRY)
National Rural Livelihood Mission
National Urban Livelihood Mission
Pradhan Mantri Kaushal Vikas Yojana
Scheme for Rehabilitation Of Manual Scavengers (SRMS)
Pradhan Mantri Jan Dhan Yojana
Pradhan Mantri Mudra Yojana (PMMY)
Pradhan Mantri Surakshit Matritva Abhiyan (PMSMA)
Ayushman Bharat Scheme
Mission Indradhanush
The Pradhan Mantri Swasthya Suraksha Yojana (PMSSY)
Midday Meal Scheme
The Swachhta Udyami Yojana
Redevelopment Of Railway Stations Through Public-Private Partnership
Eco-Tourism Facilities Through Public-Private Partnerships
Setting Up Integrated Schools For Sports And Academics At Sports Authority Of India
Enhancement in Viability Gap Funding For the Social Sector
Structuring Of Bharatnet On PPP Mode
‘Transformation Of Aspirational Districts’ Initiative
Pradhan Mantri Khanij Kshetra Kalyan Yojana
One District One Product Scheme
The Backward Region Grant Fund (BRGF)
North East Industrial And Investment Promotion Policy (NEIIPP 2007)
Indian Economy
8.10ENVIRONMENT VS DEVELOPMENT
DEBATE
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Environmental Importance:
 Economic
Importance: The diversity of
ecosystem services provided by the environment
demonstrates the environment’s economic
importance. Provisioning services are among
them (food, irrigation, drinking water).
 Ecological Service: These ecological services are
used for production and consumption by millions
of families and development initiatives.
 There Is No Cost To The Environment: Natural
resource access is completely open, and no
one user suffers the full cost of environmental
deterioration, resulting in resource misuse.
Environmental Impact on Development:
 Unavoidable:
Rapid industrialization and
urbanisation are necessary if the desired economic
growth rates are to be achieved.
 Boost: This is also thought to be necessary to
significantly boost per capita income.
 Negative Impact: These revenue-generating
activities, however, are almost certain to have
negative environmental impacts, such as pollution.
 Environment: Notably, environmental quality
is being sacrificed to achieve the aims of mass
employment and poverty alleviation.
 Income Level: Environmental quality is thought
to be restorable with progressive increases in
income levels as well as improvements in financial
and technical capacities.
Environmental Sustainability and Developmental
Factors:
 Environmental Compliance: Failure to follow
environmental standards is a major reason
why natural disasters result in much avoidable
mortality. Any activity to objectively assess the
danger of natural disasters to a place is rarely
carried out in the proper spirit.
Subsidies’ Negative Effects:
 Subsidies:
The government has supplied
the majority of subsidies to offer welfare to
disadvantaged segments of society.
 Environment: The subsidised character of
services such as energy and electricity also
contributes to misuse and weakens environmental
sustainability.
 Paradox: Subsidies can reduce the government’s
ability to invest in emerging technology by
undermining its income base.
Inclusive Growth
Population Dynamics’ Complexity:
 Population: The relationship between under­
development and environmental deterioration is
exacerbated by the rising population.
 Incentives:
Furthermore, poverty creates
strong incentives to have big families and
encourages migration, making metropolitan areas
environmentally unsustainable.
 Strain: Both effects put more strain on assets,
deteriorating the environment, decreasing
efficiency, and reinforcing poverty.
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Amartya Sen - Environmental Impact
on Development
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Correlation: According to Amartya Sen, economic
riches should be examined with other characteristics
such as public health, medical aid, the prevalence
of economic and social inequities, the quality of
education, crime, and environmental quality.
Complement: As a result, it is vital to complement
the measurement of economic riches with an
assessment of these other components of wellbeing.
Integration: Environmental and development
policies must be integrated and strengthened one
after the other.
8.11CHALLENGES IN ACHIEVING
INCLUSIVE GROWTH
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Poverty:
 Multidimensional Poverty Index: According to
the Multidimensional Poverty Index (MPI) 2018,
India moved 271 million people out of poverty
between 2005-06 and 2015-16, with the poorest
areas, groups, and children benefiting the most.
At the subnational level, India has the most
pronounced pro-poor trend.
 Deprivation: Nonetheless, despite monumental
achievements, 373 million Indians face extreme
deprivation. Furthermore, 8.8% of the population
is living in severe multidimensional poverty, and
19.3% are prone to multidimensional poverty.
Unemployment:
 Labour Force Survey: According to the NSSO’s
Periodic Labour Force Survey (PLFS), the urban
unemployment rate was 7.8%, while the rural
unemployment rate was 5.3%, bringing the overall
unemployment rate to 6.1%.
 Reasons:
Because of illiteracy and overdependence on agriculture, India’s employment
quality and quantity are low.
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Informal economy: More than 80% of individuals
are unprotected in the informal economy, posing a
concern with employment quality.
Agriculture Regression:
 Employment: Agriculture employs over 44% of
Indians, although it contributes just 16.5% to the
Indian GDP, resulting in widespread poverty.
 Agriculture issues include the following:
 Land availability per capita is decreasing.
 A gradual decrease in the employment share
 Labour productivity is low. Etc
Social Development Issues:
 Social Development: One of the primary
considerations for inclusive growth is social
development. However, it has several issues, such
as
 Regional, socioeconomic, and gender differences
are significant.
 Public spending is modest and growing slowly,
notably in health and education.
 The subpar delivery system
 OBC, SC, ST, and Muslim social indices are
significantly lower.

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Regional Disparities:


Challenge: Regional differences are a key source
of worry in India. Factors like the caste system,
wealth differences, and so on contribute to regional
disparities, resulting in a society in which certain
groups have greater advantages than others.
Examples: The following are some examples of
geographic disparities:
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Kerala is the most literate state, with a literacy
rate of 93.1%, while Bihar has a literacy rate of
only 63.82%.
In 2018, Goa’s per capita income was Rs
4,67,998, whereas Bihar’s per capita income
was only one-tenth of that, at Rs 43,822.
Social Enterprises: They can play an important role
in India’s inclusive development agenda. However,
they are not officially or legally recognised as a sector
in India, as they are in many other countries, despite
playing an important role in the fight against poverty.
Land Reform: Failing Land Reform is one of the
primary reasons for India’s failure to attain inclusive
development and distributive justice.
8.12MEASURING (INDICES AND REPORTS) INCLUSIVE GROWTH
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Index of Inclusive
Development
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Index of Social
Progress (SPI)
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Global Slavery Index
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8.13 WAY FORWARD
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It is a composite index of social and environmental factors that include:
Human necessity
The foundation of happiness
Opportunity
Limitations of Index:
Non-market activities are not included in GDP.
Factors like the environment, equality, and so on are not included.
Only income disparities are considered; other inequalities such as social inequality,
equality of opportunity, and so on are excluded.
Publisher: The Walk Free Foundation of Australia has released it.
Definition: Modern slavery refers to a scenario in which a single individual denies
another person’s freedom to control their body and exploit them.
Education:

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Least Inclusive: India ranked 62nd out of 74 emerging countries in the World Economic
Forum’s (WEF) Inclusive Development Index (IDI), making it one of the least inclusive
countries in the Group of 20 (G-20).
Parameters: The IDI has been founded on the premise that most individuals base their
country’s growth on their level of life rather than GDP.
Factors: It calculates inequality based on growth, development, and poverty.
Research: Several empirical studies have been
conducted in industrialised nations regarding
sources of growth or factors such as physical
capital and labour hours, education, and so on.


Education: According to research, particularly in
the United States, education and physical capital
are important sources of economic growth.
Institutions: As a result, numerous training
institutes should be built to give skill-based
education and improved job prospects to the
populace to boost skill sets and human resource
development.
Indian Economy
Private institutions: They can integrate concepts
from these programmes to increase revenues.
Elimination Of Disparities:
 Distribution: Because of the very uneven
distribution of money, there is a significant social
gap among various classes in society.
 Linkage: Indeed, economic progress and social
disparities are inextricably linked. In such a case,
government action is critical.
 Reasons: The government must discover numerous
causes of why such disparity exists and what the
consequences of such inequality will be. This
assists the government in taking proper action.
Institutional Framework:
 Attitude: People’s socio-economic attitudes must
be altered.
 Structure: The restrictive institutional structure
is a good impediment to LDC growth.
 Advancement: A country’s people must desire
advancement, and its political, economic, legal,
and social institutions must be conducive to it; but,
in LDCs, these circumstances are mostly lacking,
and a social and Cultural Revolution is desperately
needed.
 Size: This entails raising the size of businesses
and coordinating the labour market. Because the
private sector cannot pursue such projects, the
government should create transportation and
communication infrastructure.
Family Planning And Public Health:
 Health: A healthy population returns the state’s
power in the form of an efficient workforce.
 Duties: As a result, among the major duties that
the government must do are the establishment
and preservation of public health services.
 Key Steps: The key steps implemented by the
government to enhance the health situation
include enhancing environmental cleanliness,
removing stagnant and dirty water, improving
sewage disposal, and developing the population’s
immune system to limit the spread of infectious
illness.
Agricultural growth:
 Agriculture: It employs 34 per cent of the Indian
population. It is the key sector on which most
other sectors rely, as numerous businesses rely
only on it for raw resources.
 GDP: It is worth noting that this sector accounts
for 25% of India’s national GDP and is the primary
source of livelihood in the country.
 Agricultural Growth: The government should
play an active role in agricultural growth.

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Inclusive Growth
8.14WORLD ECONOMIC FORUM AND
INCLUSIVE GROWTH z
Strategies: The World Economic Forum has proposed
three practical strategies for nations to increase both
social inclusion and economic growth:
1. Public and Private: Nations should enhance
public and private investment in their citizens’
capacities since this is the most significant method
for them to raise their rate of productivity growth
in the long run.
2. Labour: Governments, in collaboration with
employers’ and workers’ groups, should improve
national labour laws and institutions. These have
an impact on the number and distribution of
employment possibilities and salary, as well as
the amount of purchasing power and aggregate
demand in the economy.
3. Investment: Governments should boost public
and private investment in labour-intensive
economic sectors that benefit society as a whole.
Infrastructure for the sustainable water, energy,
digital, and transportation care sectors, the rural
economy, and education and training are among
them.
8.15 CONCLUSION
To enhance the lives of Indians, the Indian government,
state governments, and local governments should continue
to work on eliminating poverty and attaining sustainable
development. Inclusive and equitable growth can be
targeted through creative collaborations with international
organisations, civic society, and private firms.
OpinionMatters
Do you agree we need policies that recognise we live
in an interconnected world where collaboration is
essential, and that maintaining this needs fairness and
justice in order to achieve inclusive growth?
PREVIOUS YEAR QUESTION (PRELIMS)
1. The main objective of the 12th Five-Year Plan is _________
(a) inclusive growth and poverty reduction.
(b) inclusive and sustainable growth
(2014)
(c) sustainable and inclusive growth to reduce
unemployment
(d) faster, sustainable and more inclusive growth.
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2. 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.
Select the correct answer using the codes given below:
(a)
(b)
(c)
(d)
2. What are the salient features of ‘inclusive growth’?
Has India been experiencing such a growth process?
Analyze and suggest measures for inclusive growth.
(2017)
3. Comment on the challenges for inclusive growth which
include careless and useless manpower in the Indian
context. Suggest measures to be taken for facing these
challenges.(2016)
4. Pradhan Mantri Jan-Dhan Yojana (PMJDY) is necessary
for bringing the unbanked to the institutional finance
fold. Do you agree with this for the financial inclusion
of the poorer section of Indian society? Give arguments
to justify your opinion.
(2016)
1 and 2 only
3 and 4 only
2, 3 and 4 only
1, 2, 3 and 4
PREVIOUS YEAR QUESTION (MAINS)
1. Explain intra-generational and intergenerational
issues of equity from the perspective of inclusive
growth and sustainable development.
(2020)
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5. Capitalism has guided the world economy to
unprecedented prosperity. However, it often
encourages short-sightedness and contributes to
wide disparities between the rich and the poor. In
this light, would it be correct to believe and adopt
capitalism driving inclusive growth in India? Discuss.
(2014)
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Indian Economy
9
Money and Currency System
9.1 MEANING OF MONEY
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Money, a commonly accepted medium of exchange, is
the payment of goods and services or settlement of
debts.
Money is nothing in and of itself, and its value is
derived from its function as a medium of exchange, a
unit of measurement, and a storehouse of value.
Money is the most liquid form of an asset, as it can be
easily traded and is universally accepted.
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9.2 FUNCTION OF MONEY
9.2.2 Secondary Functions:
9.2.1 Primary Functions:
Medium of Exchange: It facilitates the exchange of
commodities or transactions. It has the following
properties:
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Primary Functions
FUNCTIONS
OF MONEY
Medium of Exchange
Measure of Value
Secondary Functions
Standard of Deferred Payment
Store of Value




Transfer of Value
Universal acceptance as legal tender.
Durable for a long period of time.
Recognition of authority and people.
Hard to counterfeit.
Advantages
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Simplest form of exchange.
No concentration of wealth.
No influence of foreign exchange
regime.
Measure of value: Also regarded as a unit of account,
a common measure of goods and services being
exchanged. Relative comparison between the value
of goods and services is possible because of the
divisibility and fungibility of money.
Divisible: Even if divided into tiny pieces it can match
commodity value more precisely. For instance, 5 notes
of hundred and 1 note of 500, amounts same i.e. `.500.
Fungible: The ability of an asset to be interchanged
with other individuals of asset of the same type. For
example, 2 `.100 notes can buy the same amount of
goods and services.
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Standard of deferred payments: RTemporary
postponement of loan payments that are able to be
made at a later date using money.
Transfer of values: The value of money remains the
same throughout the country and is transferable. For
instance, `. 500 cash can be deposited and transferred
to any corner of the country, while its value remains
the same.
Money can be saved and invested to be used as
a store of value in the future. For instance, saving
accounts in banks and post offices or buying any
property as an investment.
9.3 EVOLUTION OF MONEY
9.3.1 BARTER SYSTEM
Exchange of one set of commodities for another without
the mediation of money. For instance, exchange of wheat
flour with a kg of rice.
Disadvantages
Suffers from ‘Double coincidence of wants, where both parties in exchange
have complementary demands of each other’s product or surplus. For
instance, a wheat farmer wants to buy bread and a baker who wants wheat,
here both can exchange commodities for their required wants.
Does not provide for the direct purchase of goods because of the absence
of a common medium of exchange.
No capital saving.
Exchange of perishable goods, at times leads to wastage.
Impossibility of divisibility.
Money Vs Barter System:
Parameters
Perishable
Double coincidence of want
Divisibility
Storage cost
Universal acceptability
Deferred payment
Liquidity
Fungibility
Barter System
Yes, for commodities
vegetables and fruits.
Essential condition.
Money
such
as No, it can be kept intact for a long time. For example,
Paper currency and coins.
Difficult
High, given the perishable nature of
commodities
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Yes
Low
High
Not possible
Possible temporary postponements of payments
Low
High
Cowries
(used by India)
Cigarettes
(Currency of Jails)
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Disadvantages:
 Bulky to carry.
 High cost of storage and transport.
 Smuggling for intrinsic value.
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Do You Know?
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Whale Teeth
(used in Fiji)
For example, coffee beans, cowries, whale teeth, etc.
Disadvantages:
 Bulky to store and transfer.
 Face value may differ across the regions.
 Divisibility and fungibility is difficult for commodity
money.
 Generally, they are perishable in nature.
9.3.3 Metallic Money
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Comparatively low.
Value of money is derived from the underlying
commodity.
They may have intrinsic value, use in themselves or
their value in buying goods
Coffee Beans
(used by Aztecs)
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High divisibility
No
9.3.2 Commodity Money
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Not necessary.
It is composed of pure and valuable metals such as
gold and silver.
It may have a higher intrinsic value than face value.
For instance, silver metallic coins of 10 paise may have
a high intrinsic value when melted.
Gold coins were first issued by Indo-Greeks and
Kushanas, however, Gupta gold coins were spectacular
– motifs of the king playing the veena.
Advantages:
 High intrinsic value.
 Non-perishable
 To some extent, divisibility and fungibility is
possible.
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Face value: A legally defined value of the coin
relative to other units of currency. It cannot be
derived from selling constituent metal. For instance,
` 10 paper currency has a face value of 10.
Intrinsic value:
9.3.4 Paper (FIAT) Money
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Paper money that is not backed by any physical
commodity and instead derives its value from
government orders.
Because fiat money is legally recognised, it is used to
settle all debts and payments within the jurisdiction.
Intrinsic value of fiat money is less than its face value.
When fiat money is backed by gold or silver standards,
it is referred to as representative money.
When fiat money is backed by the central bank and
promises to “pay the bearer the sum of this many
rupees,” anonymous bearer bonds with zero interest
are issued.
For example, Indian Rupee, Euro, Pound, US Dollar, etc.
Fiat money in India is issued by two entities:
 Coins and `. 1 note – By the Government of India
under the Coinage Act, 1906.
 Bank notes – By the Reserve Bank of India under
the RBI Act, 1934.
Indian Economy
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RBI Act, 1934 empowers the central bank to make
recommendations to the government of India to
withdraw any notes from circulation. The process
of withdrawal of notes from circulation is known as
Demonetization.
India has carried out demonetization exercises three
times since independence.
Problems with fiat money:
 Over printing of currency due to a reduction in its
value may result in hyperinflation.
 Bulky to store and transport.
 Prone to counterfeit, so the issue of circulation of
fake currency
 Cannot be easily divided into small increments,
causing rounding issues. For instance, 60 paise
change is not returned to customers due to a
change problem on the grocery bill.
Fiat money does not include
Paper money
Virtual/Crypto
without legal
currenty
backing
G-Sec
T-Bills
Fiat Money does
not Include
Share, Bonds &
Debentures
Cheques
9.3.5 Bank Money
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Demand
Draft
Money backed by the Central Bank of the country is
termed as Bank Money.
Bank money includes – cheques, demand drafts, debit
& credit cards, NEFT & RTGS.
Advantages:
 Instant and easy transaction settlements.
 Option of deferred payment.
 Hard to counterfeit.
 No issue of change, the exact amount can be paid.
 Can be frozen if the card is lost.
 Legally recognized for high-value payment.
Unregulated digital currency that is only available in
electronic form.
It is stored on a blockchain network that is not
governed by a central bank.
It can only be stored and transferred using specially
designed software, mobile, or computer applications.
Virtual currencies are all digital currencies, but
not vice versa, because digital currency is a simple
currency issued in digital form by a bank.
For example, Bitcoins, Ethereum, Litecoin, etc.
Money and Currency System
Legal tender: Money issued by the government or the
central bank that can’t be refused by anyone.
Fiduciary money: Money which is backed up by trust
between the payee and payer. It is not declared as legal
tender therefore; people are not required to accept it.
The issuer of fiduciary money promises to exchange
it with commodity or fiat money if requested by the
bearer. Example – cheques.
Commercial bank money: Claims against financial
institutions which can be used to purchase goods
and services. It is created through fractional reserve
banking.
 Fractional reserve banking: A process in which a
commercial bank gives out loans worth more than
the value of the actual currency a person holds.
 It is debt generated by the commercial bank that is
exchanged for real money or for goods or services.
Credit money: In which monetary value is more than
the commodity value.
PREVIOUS YEAR QUESTION (PRELIMS)
1. Which one of the following statements correctly
describes the meaning of legal tender money?(2018)
(a) The money which is tendered in a court of law to
defray the fee of legal cases.
(b) The money which a creditor is under compulsion
to accept in settlement of his claim.
(c) The bank money in the forms of cheques, drafts, bills
of exchange, etc.
(d) The metallic money in circulation in a country.
Debit &
Credit Cards
9.3.6 Virtual/Cryptocurrency
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9.4 TYPES OF MONEY
9.5 CREATION OF MONEY
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Money supply: The total amount of currency held
by the people and deposits with banks in a country’s
economy on the date measured.
 Money supply changes with changes in the values
of Consumer Unit (CU) and Demand Draft (DD) or
Time Deposits.
 Money Supply (M1) = CU + DD
 Various actions of the RBI (monetary authority)
and commercial banks, even public preference to
hold cash and deposits in banks affect the money
supply.
 These influences on the money supply can be
understood using the key ratios  Currency Deposit Ratio (cdr): The ratio
of currency held by the public to their bank
deposits. It is purely a behaviour parameter that
indicates how individuals feel about liquidity or
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












cash. CDR increases, for instance, during festive
seasons for meeting extra expenditure.
Reserve Deposit Ratio (rdr): The percentage
of all deposits that commercial banks keep as
a reserve.
Reserve money can either be kept as vault cash
in the bank or deposited with the RBI.
A portion of a person’s bank deposit is held
in reserve, while the remainder is loaned to
various investment projects. This reserve is
used to meet the demand for cash by account
holders.
Various instruments used by RBI for healthy
RDR, such asCash Reserve Ratio (CRR): a fraction of
deposits that banks must keep with the RBI.
Statutory Liquidity Ratio (SLR): a fraction of
demand deposit and time deposit that banks
must keep with themselves in specified liquid
assets – cash, gold, etc.
Bank rate: an interest rate used by RBI to
control the value of RDR, when a commercial
bank runs short of reserves, it can borrow
money from RBI at the bank rate.
Commercial banks accept deposits from the
public and lend the money to borrowers at
a profit.
Borrowing rate: the interest rate offered by
banks to depositors.
Lending rate: the interest rate charged by
banks to investors for a loan.
Spread: the difference between the borrowing
rate and lending rate is known as the spread,
which is appropriated by banks as their profit.
Demand is of two types:
Demand deposit: which is payable by the
banks on the demand from the account holder.
Example: Saving and current accounts.
Time deposit: deposits that have a fixed period
of maturity. Example: Fixed deposit.
Money Creation
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The process by which the banks create checkable
deposits (the money) by lending excess reserves.
The total amount of money created by banks is
determined by the number of excess reserves
available as well as the reserve requirement ratio
set by the central bank to back up deposits.
Liquidity is the ease with which an asset can be
converted into ready cash without affecting its market
value. Money is the most liquid among all assets.
Order of liquidity: Money / Currency > Demand
deposits > Saving Deposits > Time Deposit.
More
Cash current account
shares, bonds
Liquidity
Less
High interest deposit account
Certification of deposit Loans
Physicsl assets & capital - property
& Macbhinery etc.
PREVIOUS YEAR QUESTION (PRELIMS)
1. Consider the following liquid assets:
(2013)
1. Demand deposits with the banks.
2. Time deposits with the banks.
3. Saving deposits with the banks.
4. Currency
The current sequence of these assets in 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
Value Money
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Value of money is defined as the purchasing
power of money which is the number of goods
and services that can be purchased with a unit of
currency.
Value of money i.e., purchasing power is inverse
of the general price level. That is, when the value
of money rises, the general price level falls, and vice
versa.
For example, at a given point of time, ` 10 was able
to buy 2 Cadbury chocolates, but with an increase
in the general price level, now `. 10 can buy only
one Cadbury. This is because of the erosion of
purchasing power of money.
9.6 DEMAND OF MONEY
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Money is the most liquid asset, is widely accepted, and
can be exchanged for any commodity.
However, there is an opportunity cost to holding cash.
Interest can be earned on money placed in a bank’s
fixed deposit.
Demand of money balance, also known as liquidity
preference, is composed of transaction demand and
speculative demand.
The quantity of money demanded is based on the
quantum of transactions, which in turn depends on
the income of an individual.
Increased income = increased demand for money
High interest rate → Demand of money decreases
Indian Economy
People desire to hold money balance for the
following motives:
 Transaction motive – primary motive for holding
money is to carry out day-to-day life transactions.
For instance, money is held for buying groceries,
utensils, bus or train tickets, veggies or fruits, etc.
 The transaction demand for money in the
economy is defined as the amount of money
required for current transactions of
companies and individuals.
 According to Keynes, the income level
determines the transaction demand of
money. The higher the income level, the larger
the size of money holdings for transactions.
 Aside from income, transaction demand for
money is determined by:
Interest rate – it has an inverse relation.
Increase in interest rate → cost of holding
money increases → people’s holding
decreases.
Decrease in interest rate → cost of holding
money decreases → people hold a higher
level of money.
Price level – direct relation.
Increase in price → higher money holding to meet
payment transactions.
Decrease in price → lower amount of money is
held.
 The total value of an economy’s annual
transactions, which includes all intermediate
goods and services, is greater than the nominal
GDP.
 An increase in nominal GDP implies an increase
in the total value of transactions.
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(c) A decrease in the rate of interest
(d) An increase in the level of income and employment
Speculative motive: when people prefer to hold
money instead of investing it in shares, bonds, or any
risky investment.
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


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Stock: It is a measure of quantity present at a
specific time that may have accumulated in the
past. For example, the stock of money people are
holding at a given point in time.
Flow: It is measured over an interval of time,
measured as per unit time. For instance, the value
of transactions a person may undertake in a given
time - month, quarter, or year.
PREVIOUS YEAR QUESTION (PRELIMS)
1. Supply of money remains the same when there is
an increase in demand of money, there will be____
(2013)
(a) A fall in the levels of price.
(b) An increase in the rate of interest
Money and Currency System
According to Keynes, the higher the rate of
interest, the lower the speculative demand for
money.
People expect interest rates to fall in the near
future when interest rates rise. Bond prices will
rise as interest rates fall, so investors will hold
bonds until the interest rate is realised.
Similarly, when interest rates fall, people expect
them to rise in the near future. With the increase
in the interest rate, the bond price will fall,
therefore investors will hold the money until
the fall in the bond price is realized.
Speculative Demand and Liquidity Trap
Liquidity trap: A situation of very low-interest
rate in the economy where people expect the rise
of interest rate in the future and subsequent fall of
the bond price. But instead, it causes capital loss.
Therefore, due to low-interest rates, people prefer
to hold money instead of invest.
Bonds: A paper bearing a promise for future
monetary returns over a specified period of time.
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Precautionary motive - when people save money
for use in unforeseen or contingency situations.

Do You Know?
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Based on different interpretations of market
movement, people speculate future returns.


According to Keynes, to cover precautionary
demand, people keep saving accounts, as well as
some stocks and commodities.
To minimize the potential loss arising from
the situation of contingency, people hold a
precautionary balance.
It depends on the size of income, the availability
of credit, and the rate of interest.
DETERMINANTS OF MONEY DEMAND:
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Prevalent price level: A high price level or interest
rate reduces money demand (and vice versa).
Inflation level: High inflation level > reduced
demand for money; as people prefer to save instead
of expenditure.
Disposable income: High disposable income > higher
tendency to spend > high demand for money.
Innovation level in an economy.
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Reserve Money = Currency in circulation +
Bankers’ Deposits with the RBI + ‘Other’ deposits
with the RBI.
Opportunity Cost
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The term “opportunity cost” refers to a benefit
that a person forgoes when making a decision;
a benefit that a person could have received but
instead chose another course of action.
It is the difference between the returns of the
most profitable option and the chosen option, also
known as the economic cost.
The opportunity cost of free goods like air and
water is nil.
Public goods do not have a zero opportunity
cost. In the case of public goods, opportunity cost
is transferred from the product’s consumer to the
taxpayer.
PREVIOUS YEAR QUESTION (PRELIMS)
1. If a commodity is provided free to the public by the
government, then:
(2018)
(a) The opportunity cost is zero.
(b) The opportunity cost is ignored.
(c) The opportunity cost is transferred from the
consumers of the product to the taxpaying
public.
(d) The opportunity cost is transferred from the
consumers of the product to the government.
9.7 MONEY SUPPLY – MONETARY
AGGREGATES
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Money supply, also known as Monetary Aggregate
is a total stock of money in circulation at a particular
point in time.
Money supply is also known as “money stock,” “stock
of money,” “money supply,” and “quantity of money.”.
The classification of money supply, as published by
RBI, viz. M1, M2, M3, and M4 along with M0.
Money supply is the product of the Money Multiplier
(m) and the reserve money.
9.7.1 Reserve Money (M0)
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Reserve Money (M0) is the monetary base of the
economy consisting of currency in circulation, the
Banker’s deposit with the RBI, and Other Deposits
with the RBI.
It is also known as High-Powered Money, Monetary
Base, Base Money, and so on.
‘Other’ Deposits with the RBI comprise of
 Deposits of quasi-judicial and financial institutions.
 Balance in the account of the Foreign Central
Banks and Government.
 Balance in the accounts of international agencies
such as the IMF.
9.7.2 Narrow Money (M1 & M2)
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M1 and M2 are regarded as Narrow Money, it includes
currency notes, coins, and demand deposits held by
the public in commercial banks.
Highly liquid money and banks cannot run their
lending programmes with this money.
M1 = Currency with the Public + Demand Deposits
with the Banking System + ‘Other’ deposits with
the RBI.
M2 = M1 + Savings Deposits of Post-office Savings
Banks.
9.7.3 Broad Money (M3 & M4)
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M3 and M4 are regarded as Broad Money.
M3 = M1 + Net Time Deposits with the Banking
System.
M3 is also known as an Aggregate monetary
resource, it is broad money without time deposits of
post office saving banks and is commonly used as a
measure of the money supply.
‘Net’ in M3 implies that only deposits of the public
held by the bank are to be included in the money
supply, interbank deposits are not regarded as a part
of the money supply.
M4 = M3 + All deposits with Post Office Savings
Banks (excluding National Savings Certificates).
Liquidity:
M1 > M2 > M3 > M4
PREVIOUS YEAR QUESTION (PRELIMS)
1. Consider the following:(2016)
1. Currency with the public
2. Demand deposits with banks
3. Time deposits with banks
Which of these are included in Broad Money (M3)?
(a) 1 and 2
(b) 1 and 3
(c) 2 and 3
(d) 1, 2 and 3
2. Following are some components of money supply
in India:
1. Currency with the public
2. Aggregate demand deposits with banks
3. Aggregate time deposits with banks
4. ‘Other’ deposits with the Reserve Bank of India
Which of the aforesaid items are components of
narrow money (M1) in India?
(a) 1, 2 and3
(b) 2 and 4 only
(c) 1, 2 and 4
(d) 1 and 4 only
Indian Economy
9.7.4 High Power Money
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High power money is a total liability of the monetary
authority of the country, RBI.
Liabilities of the RBI:
 Notes and coins in circulation with the public.
 Vault cash of the commercial banks with the RBI.
 Deposits of the Government of India and
commercial banks held by the RBI.
RBI must pay a person an equal value of the figure
printed on the note when produced currency
is produced by a person. Similarly, deposits are
refundable by the RBI on demand from the deposit
holders.
These liabilities of the RBI must be backed by assets
consisting of gold and foreign reserves.
Thus,
Money supply = currency + deposits
M = CU + DD = (1 + cdr) DD
Where,
CU = Currency
DD = Net Demand Deposits
cdr = CU/ DD
The currency issued by the central bank is known
as ‘High Power Money’, as it is generally backed by
supporting ‘reserves’ and its value is guaranteed by
the government.
Sources of High Power Money in India are:
 RBI – issues currencies with denominations of 2,
5, 10, 20, 50, 100, 200, 500, and 2000, which RBI
calls the ‘Reserve Money’.
 Government of India – mint coins of all
denominations and one rupee note.
9.7.5 Factors Affecting the Money Supply
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Monetary Base: The amount of currency that is in
circulation and as commercial bank deposits held
in the central bank. The more reserve money in the
system, the more the money supply would be.
Person's
Reserve
Preference
Ratio
Bank Reserves
Interest
Rate
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Fiscal
Policy
DETERMINATS OF
MONEY SUPPLY
Money Multiplier
Monetary
Policy
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Which of the following measures would result in an
increase in the money supply in the economy?(2012)
1. Purchase of G-Sec 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 codes:
(a) 1 only
(b) 2 and 4 only
(c) 1 and 3
(d) 2, 3 and 4
9.8 MONEY MULTIPLIER
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Monetary Base
Monetary policy – expensive or tight monetary policy
reduces the money supply in the market whereas, the
cheap monetary policy increases the money supply.
Person’s preference – the higher the portion of
their income deposits in the bank, the less the money
supply.
Money and Currency System
Fiscal policy – taxation and expenditure overhead
changes lead to a change in the money supply.
 Higher taxation reduces the money supply.
 Deficit financing increases the money supply.
 Increase in the sale of G-sec will reduce the money
supply.
Business – cycle – money supply increases in the
boom cycle whereas, in the depression cycle, the
money supply decreases.
Money multiplier: the act of creating money in the
economy through the creation of credit, which is
based on the fractional reserve banking system.
Interest rate – higher the interest rate, the less the
money supply as it discourages borrowings by the
people.
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Money multiplier is defined as the maximum amount
of broad money that commercial banks could create
for a fixed amount of base money and reserve ratio.
It is also referred to as a Monetary multiplier,
the maximum extent to which the money supply is
affected by any changes in the amount of deposit.
It is a ratio of the total money supply to the stock of
high-powered money.
Money multiplier = Money Supply ÷ Monetary Base
M
1 + cdr
Money Multiplier
=
=
> 1 rdr < 1
H cdr + rdr
M – stock of money; H – stock of high-powered money.
cdr – Currency Deposit Ratio; rdr – Reserve Deposit
Ratio.
Money Multiplier is greater than 1.
cdr – C/DD ratio of the total deposit kept by a
commercial bank, and rdr are important determinants
of the money multiplier.
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The money multiplier effect is caused by the credit
creation phenomenon, which is as follows:
 When a bank receives a deposit of amount A, its
total reserve increases.
 The financial institution must keep a sum equal to
r × A in hand to meet the withdrawal demands of
deposit holders. (r = required reserve ratio).
 It is allowed to extend the excess reserves as a
loan, equal to A – (r × A).
 When the borrower keeps the whole loan amount
in the bank (assumed), it increases its total reserve
by an amount equal to A – (r × A).
 Again, from this reserve, the bank is required to
keep a fraction of this second round of deposits
with the central bank, and the rest can be extended
as loans.
 This cycle continues and ultimately increases the
amount of cash in the economy because of a rise
in deposits. Contrary, the money supply decreases
with a decrease in deposits.
 Thus, money multiplier = 1/ Required Reserve
Ratio (R).
Required Reserve Ratio (R) is the fraction of
deposits that the bank is required to hold in hand.
High Required Reserve Ratio > Less the excess
reserve > Less the bank can lend as loans > Low
the money multiplier
PREVIOUS YEAR QUESTION (PRELIMS)
1. The money multiplier in an economy increases with
which one of the following?
(2019)
(a) Increase in the cash reserve ratio
(b) Increase in the banking habit of the population
(c) Increase in the statutory liquidity ratio
(d) Increase in the population of the country
9.9THE VELOCITY OF MONEY
CIRCULATION
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Velocity of circulation of money is a measure of the
number of times that the average unit of currency
is circulated in an economy to purchase goods and
services within a given period.
The average number of times money passes from one
hand to another in a given period of time.
For example, if you bought a pen worth `.10 from a
shopkeeper, he uses the same 10 rupee note to buy
Chocolate, then the same currency note performs a
function of 20 `.
Factors affecting the velocity of money:




Income distribution: Poor people tend to use
their money immediately, thus money in their
hands has high velocity.
Business cycle: In a boom phase of the business
cycle, which has high demand and supply that leads
to higher economic transactions. Thus, the boom
phase has a high velocity of money circulation.
EMI preference: Use of EMI loans for purchase
will result in a higher velocity of money.
Developed countries: Higher spending patterns
and trust in government social security result
in a higher velocity of money circulation.
9.10 CREDIT CREATION IN INDIA
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A bank can create credit either by advancing loans or
by purchasing securities.
Banks maintain some part of deposits as liquid
cash, termed as a cash reserve. This is a minimum
requirement as specified by RBI.
The excess or surplus can be given out as loans and
advances by banks.
Secondary or derivative deposit – Bank opens
a deposit account in the borrower’s name when
they authorise the loan, this deposit is known as a
secondary or derivative deposit.
The deposit left after giving out loans is known as
the credit multiplier. Thus, credit is created from
secondary deposits.
Credit multiplier is the inverse of CRR and indicates
the number of times primary deposits multiply.
The need for credit comes from:
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Demand side: consumers require credit to acquire
simple assets, such as consumer durables.
Supply side: The demand for credit from
corporates for long-term investments.
Types of loans:





Commercial loan: given to the supply side for
the purposes such as acquiring fixed assets and
for maintaining the business.
Individual loan: given to the demand side,
generally for consumption and acquiring durables.
Installment credit: credit amount is decided in
advance and paid out in either stages or all at once.
But it is repaid in instalments.
Operating credit: given to meet daily credit
requirements for operations. The credit limit is
set by the bank and provides a current account
from which money can be withdrawn.
Receivable finance: given in the form of bills of
finance.
Indian Economy
9.11 VARIANTS OF CURRENCY
Various terminologies are used to indicate the nature of currency in the market.
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Hard Currency
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Soft Currency
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Hot Currency
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Heated
Currency
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Cheap Currency
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Dear Currency
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Helicopter
Money
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Every economy requires the international currency in which the greatest faith is shown.
It is the world’s strongest currency and has a high level of liquidity in the international market.
It is always scarce.
The economy with the highest and most diverse exports, which creates compulsive imports
for other countries, creates high demand for its currency, which becomes the hard currency.
Examples: US Dollar (USD), Euro, British Pound sterling, etc.
In the forex market, the currency is widely available in any economy.
The Indian rupee, for example, is a soft currency in the Indian forex market.
It is a temporary name of any hard currency.
If a hard currency is exiting an economy at a fast pace for the time, it is termed a hot currency.
For instance, during the South East Asian crisis, the US dollar had become hot.
The domestic currency is under enough depreciation pressure (heat) as a hard currency’s
high tendency to exit the economy.
Also known as ‘currency under heat’ or ‘under hammering’.
According to economist John Maynard Keynes, when a government begins repurchasing its
bonds before they mature, the money that flows into the economy is referred to as cheap
currency or cheap money.
In the banking industry, it is regarded as a period of comparatively lower/softer interest rate
regime.
Opposite to cheap currency, when a government issues bonds, that money that flows from
the public to the government or the money in the economy in general, is termed as dear
currency or dear money.
It is considered a period of comparatively higher/ costlier interest rates regime in the banking
industry.
A hypothetical concept put forward by the economist, Milton Friedman.
This involves the central bank of the country printing currency notes and distributing it to
the people free of cost.
It is aimed to promote demand in the economy during the recession.
9.12 CURRENCY IN INDIA
During the British East India Company rule, paper
currency was first issued in India.
The first paper currency was the `.1 note.
Private banks such as the Bank of Hindustan and the
presidency banks issued the first paper notes in the
late 18th century.
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Currency Circle
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After the 1861 act, the Government of India had
the monopoly to issue paper notes in India. Lack of
mobility, lack of development, and lack of education
resulted in a major issue in the redemption of
these notes. Thus, these paper notes of the Indian
government were legal tender in a few major
cities and nearby areas. These areas were termed
‘Currency Circles’.
Money and Currency System
9.12.1 Currency Controller in India
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As per Section 22 of the RBI Act 1934, RBI has the
sole right to issue Bank notes of all denominations.
The currency function was transferred from the
Controller of Currency to the RBI on April 1, 1935.
Currently, the Reserve Bank is in charge of designing,
producing, and managing the nation’s currency, with
the goal of ensuring an adequate supply of clean and
genuine notes.
9.12.2 Decimalization of Coinage
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At the time of independence, the basic unit of Indian
currency was 1 Rupee which could be divided into 16
Annas or 64 Pice.
This 16 Anna or 64 Pice structure remained till 1957
when decimalization of the coinage was done.
With the Decimalization of Coinage in 1957, the
spelling of “piece” was changed to “Paise” and 1 Rupee
was divided into 100 Paise.
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The 100th part of the Rupee was called Naya Paisa.
The term “naya” was dropped in 1964.
9.12.3 Currency Chests
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Currency Chests are storage facilities where banknotes
and rupee coins are kept on behalf of the Reserve
Bank.
The State Bank of India, six associate banks,
nationalised banks, private sector banks, a foreign
bank, a state cooperative bank, and a regional rural
bank have all established currency chests.
Deposits in the currency chest are considered RBI
reserves and are included in the CRR.
9.12.4 Languages and Signature on a
Currency Note
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Languages
on currency
note
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Signature
on currency
note
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The value of a currency note is
written in 17 languages on the front
panel, 15 languages on the back
panel, and Hindi and English.
15 languages that are included in
the backside panel are Assamese,
Bengali, Gujarati, Kannada, Kashmiri,
Konkani, Malayalam, Marathi, Nepali,
Oriya, Punjabi, Sanskrit, Tamil,
Telugu, and Urdu.
Signature on all currency notes,
except one rupee note, is of the
incumbent RBI Governor.
Whereas, as the one-rupee note is
issued by the Ministry of Finance, it
bears the signature of the Finance
Secretary.
The printing of `. 1 and `. 2 notes has been discontinued
in accordance with the Coinage Act of 2011.
According to the RBI Act, the RBI may issue any note
of any denomination up to `. 10,000.
The government notifies the denomination of notes,
and the RBI Act follows suit.
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9.12.7 Issue and Currency Departments of
the RBI
Issue department is a separate department whose
assets and liabilities are kept separate from the
Banking Department.
Department of Currency Management, a separate
department of the RBI responsible for currency
management is located at the Central Office, Mumbai.
There are 19 issue offices in India.
The RBI grants permission to selected bank branches
to open Currency Chests and Coin Deposits.
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9.12.8 Proportional Reserve System
Initially, the assets of the Issue department should
include at least 2/5ths of gold or sterling securities,
provided the gold is worth at least `. 40 crores and
the remaining 3/5ths of assets could be rupee coins.
This was called the “Proportional Reserve System”
which was changed in 1956.
Currently, the RBI is required to keep `. 200 crores
in gold and foreign exchange reserves, with at least
`. 115 crore in gold.
Under the Minimum Reserve System, since 1957, the
RBI is empowered to issue currency to any extent
against the minimum reserve.
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9.12.5 Role of RBI w.r.t. Coins
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The Government of India mints coins, and the Reserve
Bank of India distributes them on its behalf.
The Reserve Bank of India is the sole source of legal
tender in India, as it distributes one-rupee notes,
coins, and small coins throughout the country as an
agent of the government.
9.12.6 Paper Currency in Circulation
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In India, paper currency notes are currently issued
in denominations of `.5, `.10, `.20, `.50, `.100, `.200,
`.500, and `.2,000.
9.12.9 Printing Press
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Minimum reserve is the asset that RBI has to keep
to back its liabilities.
RBI is required to maintain a reserve equivalent to
` 200 crores in gold and foreign currency, Of which
` 115 crores should be in gold.
This system has been followed since 1957, and the
RBI is empowered to issue currency to any extent
against this Minimum reserve.
The first printing press for banknotes in India was established in 1928 at Note Press (CNP), Nasik (Maharashtra).
No. of press
Four printing presses print and supply banknotes
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Location
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Minimum Reserve
Dewas in Madhya Pradesh,
Nasik in Maharashtra,
Mysore in Karnataka, and
Salboni in West Bengal
Indian Economy
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Owned by Govt.
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Owned by RBI
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Coins
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9.13 PLASTIC MONEY
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The presses in Madhya Pradesh and Maharashtra are owned by the Security
Printing and Minting Corporation of India (SPMCIL), a wholly owned company of
the Government of India.
SPMCIL is the only PSU under the Department of Economic Affairs (MoF)
Thr presses in Karnataka and West Bengal are owned by Bharatiya Reserve Bank
Note Mudran Private Limited (BRBNMPL), a wholly owned subsidiary of the Reserve
Bank.
The Government of India is the issuing authority of coins and supplies coins to the
Reserve Bank on demand.
The Reserve Bank puts the coins into circulation on behalf of the Central Government.
Plastic money refers to the hard plastic cards which are used in place of actual bank notes to carry out day-to-day
transactions.
For example, debit cards, credit cards, charge cards, and ATM cards.
9.13.1 Card Types Based on Payment Modality
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Credit card
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Debit card
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Hybrid card/
Duo card
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Prepaid card
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Credit card allows the holder to make a purchase on credit (loan), even if s/he may / may not
have sufficient balance in her/his bank account at the time of purchase.
Bank transfers the concerned amount to a merchant from the bank’s own funds and later the
bank recovers the same amount from the customer.
Customers have the option to pay the entire due amount at once or convert it into Equated
Monthly Installments (EMI).
Interest rates are charged depending on the billing cycle, grace period, and other terms and
conditions.
Credit cards can be used for withdrawing money from ATMs, then it’s a type of ‘borrowing’,
so, banks levy interest rates.
A debit card allows a cardholder to make purchases up to the amount in their own bank
account.
A bank transfers the concerned amount from the customer’s own bank account when a
payment is made through a debit card.
A holder is not able to purchase if he/she has insufficient balance.
E-commerce sites nowadays have allowed debit-card-based EMI.
Withdrawing money from an ATM using a debit card is not considered as borrowing as it is
withdrawn from your own bank account.
A single plastic card has two chips for credit and debit cards.
Example: Indus Bank Hybrid card.
It’s a subtype of a debit card; a person can buy a prepaid card even without having an account
in the given bank; unlike a debit card which requires a bank account.
For example, the IRCTC’s UBI prepaid card can be used to purchase rail tickets, meals, and
so on.
9.14 LEGAL TENDER MONEY
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The money which is legally recognized by the law
of the land for payment of transactions and debts is
termed as ‘legal tender’.
It is also known as lawful money that must be accepted
as a medium of exchange and payment for a money
debt and cannot be denied.
While usually, all denominations of the circulating
paper money are legal tenders, the amount of each
Money and Currency System
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denomination in coins acceptable as legal tender
varies from country to country.
According to the RBI Act, 1934, the Central Bank has
the sole right to issue bank notes, it states that “Every
bank note shall be legal tender at any place in India in
payment for the amount expressed therein”.
The value of paper money is determined by the
government’s recognition; thus, recognition or
cancellation of legal tender status.
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Two types of legal tender money:
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Limited Legal Tender Money
Unlimited Legal Tender Money
Which can be paid for the payment of a debt up to a This can be paid for the payment of a debt of any amount.
certain limit, and beyond this limit.
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Legal action can be taken against a person who refuses
Someone can say no to the payment and no legal
to accept this money.
action can be taken against them.
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For example, paper notes are unlimited legal tender
For example, coins are limited legal tender in India
in India.
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PREVIOUS YEAR QUESTION (PRELIMS)
1. 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 forms of cheques, drafts, bills
of exchange, etc.
(d) The metallic money in circulation in a country.
9.15BLOCKCHAIN AND DISTRIBUTED
LEDGER TECHNOLOGY (DLT)
Blockchain, which is also known as Distributed
Ledger Technology (D uses decentralization and
cryptographic hashing and makes the history of any
digital asset unalterable and transparent.
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9.16 CRYPTO CURRENCIES
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Block
Nodes Miners
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Blockchain Technology was invented by Satoshi
Nakamoto in 2008, as a public transaction ledger for
the cryptocurrency, bitcoin.
Blockchain is decentralized which allows users to
control their own money so that no third party, not
even the government, would be able to access or
monitor it.
Blockchain consists of three important concepts:
 Blocks - Files, where data pertaining to the Bitcoin
network are permanently recorded, are termed
blocks. A block is analogous to a page of a ledger
or record book.
 Nodes - Any kind of electronic device that keeps
copies of the blockchain and operates the network.
 Miners - create new blocks on the chain through
a process called mining.
Decentralised in nature: They have no central data
store or administration functionality.
Reduce duplication: While the committee has taken
a strong stance against cryptocurrencies, it has
recommended blockchain-based systems for building
a low-cost KYC system that reduces the need for
duplication of KYC requirements for individuals.
Increase transparency in the finance sector: DLTbased systems can be used by banks and other financial
firms for loan tracking, collateral management, fraud
detection, claims management in insurance etc.
Maintaining land records: Beneficial for removing
errors and frauds in land markets through the
preservation of land records.
A cryptocurrency is an internet-based medium
of exchange based on blockchain technology that
conducts financial transactions using cryptographic
functions.
Decentralised
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Digital records: Blockchain records the transaction
of digitally stored assets and their information is
stored in several places at the same time.
Cryptocurrency
Electronic
Transparent
It uses blockchain technology to achieve
decentralisation, transparency, and immutability
over traditional methods of government control and
interference.
The fact that a cryptocurrency is not controlled by any
central authority is its most important feature.
Evolution of cryptocurrency:


9.15.1 Advantages
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Non-reputiable

Bitcoin, the first decentralised cryptocurrency,
was created in 2009 by a presumably anonymous
developer named Satoshi Nakamoto.
Quantitative easing, the post-subprime crisis, and
the recession in 2008-09, of the dollar in the US
increased the dollar supply and led to erosion of
purchasing power dollar.
Banks charged fees on online transfers, credit
cards, and ATMs.
Indian Economy
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Bitcoins:
 Satoshi Nakamoto proposed it as an electronic
decentralised currency that works on a peer-topeer basis.
 Bitcoins can be digitally sent to anyone with a
Bitcoin address anywhere in the world.
 One person may have multiple addresses for
various purposes, such as personal, business, and
so on.
 Bitcoin is not a printed currency but non-reputable
as there is a record of every transaction it has been
through. All this forms a part of a huge ledger
called the blockchain.
 It maintains a foolproof system of the record of
every transaction as well as tracking issuance of
the currency sent without the identities of the
parties being disclosed.
 They are mined by computing power in a
distributed network.
Libra:
 Cryptocurrency which was rolled out by Facebook
in 2020 with an aim to create a global currency

that can be used to transfer money anywhere in
the world without any transaction fees.
Asset-backed cryptocurrency, Libra is meant to
revolutionize international money.
 Asset-backed cryptocurrencies are crypto coins
that are linked to an object with economic value.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to ‘Bitcoins’ sometimes seen in the
news, which of the following statements is/are correct?
(2019)
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) 3 only
(c) 2 and 3 only
(d) 1, 2 and 3
9.16.1 Crypto-Currencies Vs Digital Currencies
Cryptocurrency
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Digital Currency
Decentralized
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Transparent
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Encrypted form of digital currency.
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Regulations within the network are governed by the
community majority.
Anyone and everyone is able to see transactions made
and received by any user, as all revenue streams are
placed in the blockchain
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9.16.2 Concerns with Cryptocurrency
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Highly speculative
Promote illegal online marketing such as drug dealers
and child pornography.
Consumers have been defrauded.
Safe havens for black money.
9.16.3 RBI and Stand of Supreme Court on
Cryptocurrency
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RBI banned cryptocurrency in 2018. According to the
RBI, cryptocurrency is:
 Poor unit of account due to frequent and high
fluctuation in value.
 Pose several risks such as money laundering,
terror financing, operational risks for the users,
hacking, phishing, etc.
 Paucity of information.
Money and Currency System
Centralized
Transaction within the network is regulated by a
centralized entity, such as a bank.
Non-transparent
Information about transactions and wallet addresses
is kept confidential and private.
Unified electronic cash form.
May seriously disrupt the business model of
commercial banks.
 Legal status is unclear.
The Supreme Court has overturned the RBI’s circular
prohibiting financial institutions from facilitating
cryptocurrency transactions.
 The Internet & Mobile Association of India (IMAI)
has pleaded against the ban, stating, dealing
and trading in cryptocurrency was a legitimate
business activity and that the RBI did not have
jurisdiction over it as these assets could be
classified as commodities rather than currency.
 The Supreme Court noted:
 The prohibition is excessive as it cuts off the
lifeline of otherwise legitimate trade.
 An outright ban would be a disproportionate
government response, as there are numerous
less intrusive options.
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105

Ban is unconstitutional as it violates the
fundamental right guaranteed under Article
19(1)(g) – freedom to carry out trade.
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Subhash Chandra Garg Committee
The Subhash Chandra Garg Committee was
established to investigate the legality of
cryptocurrencies and blockchain technology. It has
given the following recommendations:
Private cryptocurrency, with the exception of stateissued cryptocurrency, is prohibited in India.
It is advisable to “have an open mind” regarding
the introduction of an official, government-backed
cryptocurrency in India.
It has drafted a law which mandates a fine and
imprisonment of up to 10 years for offences, such
as mining, holding, selling, issuing, dealing in, and
transferring cryptocurrencies.
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9.16.4 way forward
Rather than imposing bans, awareness campaigns
should be organised to alert investors to specific risks
and to monitor trades for fraud and scams.
The RBI should develop a detailed regulatory
framework to licence virtual currency intermediaries
such as exchanges, and they should follow the same
KYC standards as stock exchanges.
A flourishing blockchain technology could benefit
India’s financial sector and governance. Hence, in
the face of growing technological innovation in the
financial sector, it is critical to devise and strengthen
the supporting regulatory frameworks that operate
regardless of the nature of an instrument.
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PREVIOUS YEAR QUESTION (PRELIMS)
1. 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
2. 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
9.18 DIGITAL PAYMENTS
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PREVIOUS YEAR QUESTION (MAINS)
1. What is Cryptocurrency? How does it affect global
society? Has it been affecting Indian society also?
(2022)
9.17NATIONAL PAYMENT CORPORATION
OF INDIA (NPCI)
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106
Under the provisions of the Payment and Settlement
Systems Act, 2007, NPCI is an umbrella organisation
for operating retail payments and settlement systems
in India. It is a joint initiative of the RBI and the Indian
Banks’ Association (IBA).
Under the provisions of Section 25 of the Companies
Act 1956 (now Section 8 of the Companies Act 2013), it
has been incorporated as a “Not for Profit” Company.
National Financial Switch (NFS), the largest network
of shared automated teller machines (ATMs) in India.
State Bank of India, Punjab National Bank, Canara
Bank, Bank of Baroda, Union Bank of India, Bank of
India, ICICI Bank, HDFC Bank, Citibank, and HSBC are
the ten core promoter banks.
NPCI’s National Automated Clearing House (NACH)
aims to facilitate high volume, low-value interbank
debit/credit transactions that are repetitive and
electronic in nature.
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The government and the RBI are taking pragmatic
steps to promote digital financing or digital payment.
Steps were taken by the RBI:
 It has eliminated fees for NEFT and RTGS
payments and asked banks to pass on the savings
to customers in order to promote digital payments.
 The Merchant Discount Rate (MDR) charges for
RuPay and UPI payments have been eliminated.
 All businesses with an annual revenue of 50 crores
or more are required to accept RuPay and UPI
payments from customers.
RuPay and UPI are products of the National Payments
Corporation of India (NPCI).
RuPay is the first of its kind domestic Debit and Credit
Card payment network of India.
RuPay cards can also be used internationally in a few
countries for transactions – Singapore, Bhutan, UAE,
Bahrain and Saudi Arabia.
According to a comprehensive survey:
 Digital payment in India has increased from 38%
in 2021 to 53% in 2022, as merchants seek to
expand their digital payment options in response
to rising consumer demand.
 31% of consumers consider BNPL (Buy Now Pay
Later)as a feasible option over credit cards.
 By 2025, the number of unique digital wallet users
will exceed 4.4 billion globally.
Indian Economy
The digital payments space has seen massive
growth over the past few years, growing at a
compound annual growth rate (CAGR) of30 per
cent. By the year 2026, digital payments in India
are set to reach $10 trillion in value from the
current value of $3 trillion.

9.18.2 Platforms for Digital Payments
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Payment And Settlement Systems In
India: VISION-2018 by RBI
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It is aimed at building the best payment and
settlement systems for a cashless India. Its vision
revolves around the 5Cs – Coverage, Convenience,
Confidence, Convergence and Cost. To achieve
these visions, it focuses on four strategic initiatives
– Responsive Regulation, Robust Infrastructure,
Customer Centricity and Effective Supervision.
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UPI & UPI
2.0
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9.18.1 Digital Modes of Payment Settlement
FEATURES
Introduced
by
Settlement
type
Minimum
transfer limit
Maximum
transfer
limit
Fund
transfer
speed
Service
timing
Mode
NEFT
RBI
RTGS
IMPS
RBI
NPCI
`. 2 lakhs
`. 1
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Half hourly One on one One on one
batches
settlement settlement
—
No limit (`. No limit
50,000 per
transaction)
2 hours
Immediate
24/7
Available
24/7
on certain
days of
week
between
stipulated
time period
(till 6PM)
Online/
offline
Online/
offline
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`. 2 lakhs
Immediate
Online
Committees on Digital Payment in India
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Ratan Watal Committee to recommend appropriate
measures for encouraging digital payments in India
in 2016.
Nandan Nilekani Committee to further deepen
digital payments and enhance financial inclusion
through Fintech in 2019.
Money and Currency System
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BHIM AND
BHIM 2.0
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BHARAT
QR
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UPI is a payment system that allows
money transfers between any two
bank accounts by using a smartphone.
Launched in April 2016 by NPCI.
It enables customers to pay directly
from their bank accounts to various
merchants, both online and offline,
without having to type credit card
numbers, IFSC codes, or net banking/
wallet passwords.
It facilitates ‘Peer to peer’ (P2P)
collection requests which can be
scheduled and paid as per requirement
and convenience.
UPI 2.0:
UPI can be linked to the overdraft
account along with the savings and
current accounts.
Allow pre-authorize of a transaction
and pay at a later date.
Added authentication of merchant QR
code through notification to the users.
Increased transaction limit to 2 lakhs/
day
BHIM – Bharat Interface for Money
is a mobile payment application based
on UPI.
It was developed by NPCI and was
launched in 2016.
BHIM 2.0 has been launched under the
Ministry of Electronics and Information
Technology. It has increased the
existing cap of `. 20,000 to `. 1,00,000,
from verified merchants.
It provides an easy and secure mode
of transaction.
Bharat QR is a mobile payment solution
for Person to Merchant (P2M).
Payment networks NPCI, Visa, and
Mastercard are mutually derived.
Once the BAR codes are deployed on
Merchant locations, users can pay the
utility bills using BQR-enabled mobile
banking apps without sharing any
user credentials with the merchant.
Bharat QR transactions are different
from POS transactions. In POS
transactions, a POS terminal is required
whereas in Bharat QR transactions, QR
Code is required.
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Aadhar
Enabled
Payment
System
(AEPS)
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EMV
CARDS
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Mobile
Money
Identifier
(MMID)
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A bank-led model which allows online
interoperable transactions at the
Point of Sale through the business
correspondent of any bank using
Aadhaar authentication.
It promotes financial inclusion.
EMV stands for Europay – Mastercard
and Visa.
It is a debit card security standard
in which a microprocessor chip is
embedded in the card.
It prevents card skimming and cloning
which was earlier possible in magnetic
stripe cards.
It is a 7-digit number issued by the
bank against a bank account which
facilitates fund transfer.
Every bank account has only one
MMID.
Different MMID can be linked to the
same Mobile Number.
Combination of Mobile number & MMID
is uniquely linked with an Account
number and helps in identifying the
beneficiary details.
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9.18.4 Solution and Way Forward
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PREVIOUS YEAR QUESTION (PRELIMS)
1. 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 physical
currency in about two decades.
(c) FDI inflows will drastically increase.
(d) Direct transfer of subsidies to poor people will
become very effective.
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9.18.3 Issues and Challenges with Digital
Payments
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Time-consuming: The costs associated with online
payment through RTGS and NEFT systems have also
created a hindrance and consume more time.
Structural challenges: India is far from creating a
strong digital payment system because of structural
obstacles such as digital financial illiteracy, cybersecurity, etc
Poor digital penetration: Still rural parts remain
aloof from the benefits of digital technology. Digital
payment remains a distant dream still in a few pockets
of the country.
Digital inequality: Marginalised sections such as
women, and old age is disproportionately devoid of
access to the digital mode of payment.
Fraud and Security: Security breaches and risks
for data security are the biggest concern among
consumers. Common fraud techniques employed
are – phishing, vishing, remote access, and account
takeover.
Awareness and Adoption: India is a cash-dominant
society. Even though there is a rapid increase in digital
payment modes, there is still a lack of awareness
among people concerning security, data privacy, etc.
Merchant Support: Due to the complexity of EMV
standards and contactless payment, many merchants
are still resisting the transition.
Compatibility: Mobile wallets need to be compatible
with all mobile models and their operating systems.
Rise of UPI: Developed by NPCI can be considered the
biggest competitor for mobile wallets.
 According to NPCI data, the total number of
transactions conducted on the BHIM-UPI exceeded
2 billion in a month in October 2020.
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Improving digital literacy: This will help to increase
digital transactions as well as the coefficient of a safety
factor. This will help to check the presently occurring
banking frauds.
Strengthening cyber infrastructure: Strengthening
the cyber infrastructure and cyber security in India is
crucial to reduce hacking and banking theft incidents.
Boost Mobile infrastructure: Most of the digital
payments are now handled by mobile devices, so the
operating systems and android versions should be
made compatible to increase the confidence in digital
payments.
Bridging the digital divide: Among the masses by
incentivizing people in urban and more importantly in
the rural areas and among the marginalized sections
of society.
Easing settlement process: Ease the complexities
and enable end-of-day settlement process for the
merchants.
Reduce the transaction charges on digital
payment: Transaction charges over digital payments
and discourage cash transactions by charging cash
handling costs.
Integrated digital payments system: An integrated
system of digital payments should be placed to reduce
existing challenges and support quality outcomes. For
instance, by ensuring more stringent laws etc.
Indian Economy
Digital Bank Unit
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The NITI Aayog discussion paper titled ‘Digital
Banks: A Proposal for Licencing and Regulatory
Regime for India’ emphasised the need for Digital
Bank Units.
As per the RBI, DBU is a specialized fixed point
business unit/hub housing certain minimum
digital infrastructure for delivering digital banking
products and services as well as maintaining
current financial goods & services digitally, in both
self-service and assisted mode.
The Finance Minister announced the establishment
of 75 DBUs in 75 districts to commemorate our
country’s 75th anniversary of independence (Azadi
ka Amrit Mahotsav) in his Union Budget Speech for
2022-23.
Commercial banks, except regional rural banks,
payment banks, and local area banks, with past
digital banking experience, are permitted to open
DBUs in tier I to tier VI centers, unless otherwise
specifically restricted, without having the need to
take permission from the RBI in each case.
9.19FUNDS AND INDICES RELATED TO
DIGITAL PAYMENTS
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Digital Payment Index (DPI): Published by RBI. RBI
has announced the construction of a composite DPI
to record the extent of digitalization effectively with
March 2018 as the base year.
 The Index for March 2022 stands at 349.30 as
against 304.06 for September 2021.
 It
has demonstrated significant growth
representing the rapid adoption and deepening
of digital payments across the country.
Digital Competitive Index: Released by IMD – World
Competitiveness Centre.
 It began in 2017 and assesses 63 economies’
capacity and readiness to adopt and explore
digital technologies as a key driver of economic
transformation in business, government, and
society at large.
 It evaluates an economy based on 3 factors:
 Knowledge - capacity to understand and learn
new technologies;
 Technology competence to develop new
digital innovations;
 Future readiness- preparedness for coming
developments.
 As of 2021, the US ranked as the most digitally
competitive country in the world with a score of
100. Whereas, India scored at 55.13
Money and Currency System
Acceptance Development Fund: Formed by RBI
to improve the last mile payment network in rural
areas to transact digitally. Operationalized as a bank
sponsored development fund to improve payment
infrastructure in Tier III and Tier IV centers.
Payment Infrastructure Development Fund
(PIDF): On the recommendation of Nandan Nilekani
Committee on deepening digital payment, RBI has
created 500 crores PIDF. It aims to motivate sellers
to deploy Points of Sale (PoS) infrastructure for both
physical and digital modes.
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9.20DIGITAL TRANSACTIONS
OMBUDSMAN (2019)
RBI designates senior RBI officials as Digital
Transactions Ombudsman (DTO) at 21 places across
India.
They can hear customer complaints up to ₹ 20 lakh
against prepaid payment instruments, Mobile wallets,
Apps, NEFT/RTGS, and other digital transactions.
They can order the company/ bank to revert /settle
the transaction and pay up to an additional ₹ 1 lakh
for the mental agony of the customer.
Higher Appeal lies to the Deputy Governor of RBI.
For amounts more than ₹ 20 lakh, in that case, the
victim has to approach ordinary courts/consumer
courts depending on the case matter.
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Recommendations of Nandan
Nilekani Committee
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Digital Financial Inclusion Index: RBI should
prepare area-wise ‘Digital Financial Inclusion
Index’ to monitor progress & take remedial steps.
Improve accessibility to banks: Ensure no user
is within five kilometres of an access point for
banking.
Banking correspondents: Local vendors should
be made Banking Correspondent (BC).
Acceptance Development Fund (ADF): To develop
digital payment infrastructure in poorly served
areas (e.g. subsidy on PoS devices). RBI and Banks
should co-contribute a fiscal amount to this fund.
Reduce the MDR / card payment fees: Allow
customers to do “n” number of digital payment
transactions per month with no charges.
Regarding NEFT: RBI should make NEFT available
24/7 and review charges on its usage. (June 2019:
RBI removed charges on both NEFT and RTGS
and asked the banks to pass on the benefits to
customers.)
Promote international coverage: NPCI should
offer RuPay and BHIM UPI in other countries to
facilitate remittance to India.
Use of local language: Encourage local language
apps/ software for digital payments for deepening.
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9.21NEW UMBRELLA ENTITY (NUE) FOR
THE PAYMENT SYSTEM
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New Umbrella Entities will provide various payment
services similar to those currently provided by the
NPCI.
Need for NUE:
 Promote competition: To reduce the cost of
transactions and also this will provide a variety
of product offerings in the payment system.
 Manage new payment systems: New payment
systems including wallet transactions, Aadhaarbased payments, remittance services, UPI
transactions, ATMs, white-label PoS, etc could be
managed.
 Restrict the monopoly of NPCI: Presently,
the NPCI is the only entity managing all retail
payments systems in India. Thus, the NUEs will
boost competition and enhance the delivery of
services in the retail digital payment ecosystem.
 Increased number of digital transactions: The
country’s retail transfers grew dramatically. For
instance, in 2020-21 alone `.165 lakh crores of
money transferred in 27 billion transactions. Thus
it requires a regulator to oversee the transactions
and ensure proper service delivery.
RBI Framework:
 Capital requirements: The pan-India NUEs will
focus on retail payment systems with a minimum
paid-up capital of ` 500 crore. However, the RBI
will not permit any single promoter or group to
hold more than 40% of investment in the NUE.
Also, the NUE should maintain a minimum net
worth of `. 300 crores at all times.
 Ownership: The NUE’s promoter or promoter
group should be “owned and controlled by
residents” with at least three years of experience
in the payment ecosystem.
 Governance: The entity has to follow corporate
governance norms set by the RBI. The Reserve
Bank of India will be given the right to approve the
appointment of directors and nominate a member
of the NUE’s board.
 Foreign Investment: As long as the NUEs meet
the additional requirements, foreign investment
is allowed.
9.22 MERCHANT DISCOUNT RATE (MDR)
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Merchant Discount Rate (MDR), also known as the
Transaction Discount Rate (TDR), is the cost paid by
a merchant to a bank for accepting payment by digital
means from consumers. This cost is usually recovered
from the customer.
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MDR is a user fee charged as a percentage of the
transaction amount, by the banks to merchants for
facilitating card-based or digital transactions.
Recently the government has done away with MDR
for large-retails, clearing the way for the adoption
of low-cost digital payments like BHIM UPI, UPI-QR
Code, Aadhaar Pay etc.
PREVIOUS YEAR QUESTION (PRELIMS)
1. Which of the following best describes the term
“Merchant Discount Rate” sometimes seen in the news?
(2019)
(a) The incentive is given by a bank to a merchant for
accepting payments through debit cards pertaining
to that bank.
(b) The amount paid back by banks to their customers
when they use debit cards for financial transactions
for purchasing goods or services.
(c) The charge to a merchant by a bank for accepting
payments from his customers through the bank’s
debit cards.
(d) The incentive is given by the Government to
merchants for promoting digital payments by their
customers through Point of Sale (PoS) machines and
debit cards.
9.23INITIATIVES TO PROMOTE
A CASHLESS OR LESS-CASH
ECONOMY
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Committee to strengthen the digital payment
ecosystem was set up by the Finance Ministry under
the chairmanship of Ratan Watal.
Chandrababu Naidu Chief ministers’ Committee
to PM to promote and enhance the digital payment
ecosystem in India.
Indian Economy
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Vittiya Saksharta Abhiyan by the Education Ministry,
wherein college students explain to people about
digital transactions.
Joint initiative of NITI Aayog and NPCI: lottery/
cash back schemes for customers (Lucky Grahak)
and merchants (Digi Dhan Vyapar). The government
itself has launched further referral bonuses, and
cashback schemes for using UPI-BHIM.
Digidhan Mission (2017) by the Ministry of
Electronics and Information Technology (MeitY) to
create awareness about digital payments.
DIGIDHAN DASHBOARD: Web portal launched by
MeitY to monitor digital transactions in India.
Budget-2019: Imposed Tax Deduction at Source
(TDS) on withdrawal of ₹1 cr or more from a single
user account.
Digital Payment Abhiyan (2019- Sept): Launched
by MEITY along with Google India and Data Security
Council of India (DSCI, a not-for-profit organization
by NASSCOM).
9.24 LABELS OF ATM IN INDIA
Label
Features
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Bank’s own
ATM
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Brown
Label ATMs
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White
Label ATMs
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Owned and operated by the concerned
bank and it carries the bank’s ‘logo’.
They are the costliest way to provide
such service to a bank’s customers.
‘Owned’ and ‘operated’ by a third
party, a non-banking firm.
The concerned banks only handle
part of the process which is ‘cash
handling’ and ‘backend server’
connectivity. ‘
They do not bear the ‘logo’ of the
banks they serve.
They are interconnected with the
entire ATM network in the country.
The Tata Communications Payment
Solutions – Indicash, first to get
permission from the RBI for setting
white labelled ATM “.
9.25 CONCEPT OF DEMONETIZATION
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Demonetization is the act of stripping off the status of
the legal tender of currency.
It has been used to stabilise a currency and fight
inflation, as well as to push informal economic activity
into greater transparency and away from black and
grey markets.
The First demonetization was carried out in 1946, RBI
demonetized ` 1,000 and ` 10,000 notes.
Money and Currency System
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The Second demonetization was carried out by the
Moraji Desai government in 1978.
The Third demonetization was implemented by the
NDA government in 2016, `. 500 and `. 1000 notes
were demonetized.
The positive impact of demonetization:
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Increase in tax collection: The number of registered
Income Tax Returns (IT`) has increased by 24.7%.
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Tackled Black Money: For instance, the government
was able to identify more than 37000 shell companies
that were engaged in hiding black money and hawala
transactions.
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Checked organized crimes: Due to demonetization,
terrorist and Naxalite financing has stopped almost
entirely. Also, it had led to a huge fall in sex trafficking.
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Checked the circulation of fake currency: Since
demonetization, no high-quality fake currency notes
were found/seized by intelligence operations.
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Rise in digital transactions: Digital transactions
have increased by around 50-55% points since
demonetization. RBI has to print fewer notes which
reduces the government’s printing expenses.
The negative impact of demonetization:
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Poor Planning: The high-value notes constitute
87.5% of the currency value, and the sudden rollout of
demonetization has disrupted the lives of the common
man.
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Economic slowdown: As people run out of money,
they may not be able to pay, which results in an
economic slowed-down & supply-chain of the informal
sector getting affected.
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Decline in the GDP: The country’s growth rate, which
was 7.5% in September 2016 declined to 5.7% in June
2017.
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Corruption persists: It is still apparent that corruption
has not yet been suppressed since demonetisation.
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Cash holding revived: The cash-GDP ratio has reached
levels similar to the period before demonetisation.
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Agriculture sector suffered disproportionately:
Stress in agriculture has started showing up due to
demonetization pertaining to cash as the dominant
mode of transaction in the agriculture sector.
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Worsening the banking system: As banks were
not in a position to significantly boost lending, their
total interest income has decreased. Worsening their
capital situation and their NPA situation got worse.
9.26 BLACK MONEY
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Black money is defined as income that is not declared
by a person or group of people in a country and thus
goes unrecognised for tax purposes.
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There is no universal definition of black money. In
layman’s terms, money that has been acquired through
illegitimate means or money which is unaccounted for,
that is, for which the government fails to pay taxes,
and which is hidden from government authorities and
is not reflected in the GDP of India, national income is
termed as ‘black money’.
White money, against black money, is money that is
earned through legitimate means and is accounted for,
for which income or other tax is paid.
Generation of black money:
 Illegal activities – corruption, money laundering,
smuggling, etc.
 Tax evasion by corporations.
 Tax avoidance by exploiting existing loopholes in
the system, though it is not illegal.
 Investment in billions of jewellery and in real
estate to hide actual income.
 Setting up companies in tax havens.
 Setting up shell companies to redirect their profits
and tax liabilities.
 Investment through derivative instruments such
as P-notes.
Effect of black money:
 It affects the financial ecosystem of the country.
 High inflation: The central bank is unable to
control the economy’s money supply, resulting
in higher inflation. This will cause the currency’s
value to fall.
 Erode country’s credibility: Black money affects
the credibility of a country negatively.
 Encourage illegal activities: As it is most
frequently utilised for illicit activities like narcotics
and drug dealing, terrorism, etc.
v
112
Tax loss for government: The government suffers
a big loss in the form of taxes because of black
money.
 Parallel economy: Black money creates a parallel
economy in the nation that is entirely underground.
Government’s initiatives to curb black money:
 Tax reforms such as incorporating tax deduction
at the source itself.
 Demonetization of `. 500 and 1000 notes.
 Encouraging and promoting cashless and digital
transactions.
 Electoral reforms such as the implementation of
electoral bonds.
 Legislative reforms:
 Prevention of Corruption Act, 1988
 Benami Transactions Prohibition Act, 1988
 Prevention of Money Laundering Act, 2002
 The Undisclosed Foreign Income and Assets
(Imposition of Tax) Bill, 2015
 Lokpal and Lokayukta Act, 2013
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Which one of the following effects of the creation
of black money in India has been the main cause of
worry to the Government of India?
(2021)
(a) Diversion of resources to the purchase of real estate
and investment in luxury housing
(b) Investment in unproductive activities and purchase
of precious stones, jewellery, gold, etc.
(c) Large donations to political parties and growth of
regionalism
(d) Loss of revenue to the State Exchequer due to
tax evasion
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v
Indian Economy
10
The Banking System In India
“The banks are the lifelines of the economy and play
a catalytic role in activating and sustaining economic
growth, especially, in developing countries and India is
no exception,” - S S Mundra, Deputy Governor of the RBI.
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The banking system is regarded as the backbone of a
country’s economy.
It is the most important component of the nation’s
financial system because it accounts for more than
70% of the money that moves through it.
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10.1HISTORY AND EVOLUTION OF
BANKING IN INDIA
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10.2 EVOLUTION OF BANKING
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The Pre-Independence
Phase of Banking i.e.
before 1947
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Second Phase from
1947 to 1991: (PostIndependence Phase)
With public sector banks, commercial banks,
and international banks, Indian banking is a true
representation of a diversified economy.
Presently there are 12 public sector banks (as of
April 2023) in India comprising of State Bank of India
which plays an important role in the overall growth
of an economy
The evolution of the Indian Banking System can be
classified into 3 distinct Phases:
1. The Pre-Independence Phase, i.e. before 1947
2. Second Phase from 1947 to 1991
3. Third Phase 1991 and Beyond
India’s banking system began with the establishment of a few banks, such as the Bank
of Hindustan in Calcutta (now Kolkata) in 1770, which shut down in 1832.
Following that, other banks entered the market but failed, including the General Bank
of India (1786-1791) and Oudh Commercial Bank (1881-1958), the country’s first
commercial bank.
The Imperial Bank of India was created in 1921 after the merger of the Bank of Bengal,
the Bank of Bombay, and the Bank of Madras.
The State Bank of India replaced the Imperial Bank of India later in 1955.
The Reserve Bank of India was established in April 1935 in accordance with the
recommendations made by the Hilton Young Commission.
In general, the nationalisation of the bank is this phase’s key distinguishing attribute.
Nationalization was seen as an effective measure from the perspective of economic
planning.
Reasons for Nationalisation:
 Large industries and large business houses were primarily served by banks.
 Agriculture, small-scale industries, and exports were among the sectors that
lagged.
 The moneylenders continued to exploit the poor people.
 Following this, the Reserve Bank of India was nationalised on January 1st, 1949.
 On July 19, 1969, fourteen commercial banks were nationalised.
 April 1980 saw the nationalisation of six additional commercial banks.
 On October 2, 1975, Regional Rural Banks (RRBs) were created in response to the
Narasimham Committee’s recommendations.
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Third Phase of Banking
1991: LPG Era
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There was a major shift in the Indian economy starting in 1991.
Considering this, in 1991, the Narasimham committee recommended, private investors
be welcomed to invest in India by the government.
The RBI approved ten private banks.
Several well-known banks that benefited from this deregulation still exist today,
including HDFC, Axis Bank, ICICI, DCB, and IndusInd Bank.
The Narsimham committee once more advocated for the participation of more private
players in 1998.
The RBI also suggested the establishment of two new categories of banks, namely
Payment Banks and Small Banks, in order to promote financial inclusion.
Do You Know?
Under Section 22(1) of the Banking Regulation Act,
1949, the RBI granted the bank a licence to operate as a
Small Finance Bank (SFB) and Payments Bank of India.
10.3 CORE BANKING SOLUTION (CBS)
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Regardless of where they open and keep their account,
it allows consumers to manage their accounts and
access banking services from any bank branch on the
CBS network.
Core Banking Solution (CBS) is a network of bank
branches that enables users to access numerous
banking services and manage their accounts from any
part of the world.
It is a centralized back-end system that successfully
handles banking transactions across several bank
locations.
Core Banking Solution (CBS) facilitates quicker banking
transactions and improves financial accessibility in
rural and remote areas.
10.4 SCHEDULED COMMERCIAL BANKS
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PREVIOUS YEAR QUESTION (PRELIMS)
1. 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 a network 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
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The scheduled commercial banks are those financial
institutions that are listed in the second schedule of
the RBI Act of 1934 and conduct banking activities like
accepting deposits, extending loans, and providing
other banking services.
The Reserve Bank of India will lend money to
Scheduled Banks at bank rates.
The RBI must receive CRR deposits from Scheduled
Banks.
Scheduled banks include all commercial banks,
including nationalised, global, cooperative, and
regional rural banks.
Any public or private sector bank having paid up
capital and reserve of a minimum of 5 lakh rupees
and is not conducting business against the interest of
depositors.
Certain privileges and benefits of these banks are:
 A central bank’s ability to provide a refinancing
facility.
 Access to currency storage facilities.
 Membership in the clearinghouse is automatic.
Commercial and cooperative banks make up the
two categories of scheduled banks.
Commercial banks account for the largest portion of
credit provided to agribusiness and related activities
in India.
Commercial banks disburse around 60% of credit
followed by cooperative banks around 30% and RRB
and others.
PREVIOUS YEAR QUESTION (PRELIMS)
1. In India, which of the following has 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
Indian Economy
Schedule commercial banks can be further divided
into four groups
1. Public sector banks:
 The banks in which the government owns more
than 50% of the stock include SBI and its
associates, nationalised banks, and other public
sector banks.
 Banks Board Bureau recommends for selection
of heads in Public Sector Banks and Financial
Institutions and helps banks in developing
strategies and capital raising plans.
 In order to hasten the expansion of banking
services in rural areas, the State Bank of
India was founded in 1955 by converting the
previous Imperial Bank of India.
 Nationalised banks: the Banking Companies
(acquisition and transfer of undertakings) Act
1970 nationalised 14 major commercial banks in
India
 Advantages of public sector banks:
 Offer a high interest on deposits.
 One can access loans with low interest and
provide service to a large customer base.
 They also provide service in rural areas of the
country.
 They have multiple branches to provide
Financial Services.
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Recent Steps to Strengthen PSBs:
Enhanced Access and Service Excellence (EASE):
Based on a unique Reforms
Index is a part of the Reform Agenda to further the
agenda of customer-centric digital transformation
and data into PSBs’ working system.
Empowerment of bank Boards: Now the bank’s
Chief Risk Officer is recruited from the market.
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10.5 PRIVATE SECTOR BANK
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Advantages and Disadvantages of Private
Sector Bank:
Advantages
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Bank Board Bureau
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It was established as an independent organisation
in February 2016 based on the suggestions of the
RBI-appointed Nayak Committee.
It was part of the Indradhanush Plan.
It suggested the selection of full-time directors
and non-executive chairs for Public Sector Banks
(PSBs) and state-owned financial institutions.
PREVIOUS YEAR QUESTION (PRELIMS)
1. 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
The Banking System In India
Private sector banks are those in which the majority of
shares or equity are owned and maintained by private
individuals.
The Indian banking industry was initially controlled
by public sector banks, but after the 1990s, private
sector banks appeared and expanded rapidly.
Their usage of cutting-edge ideas, new financial tools,
and technology contributed to their rapid growth.
In India, there are two categories of private sector
banks:
1. Earlier than 1968, Private Sector Old Banks
2. New Private Sector Banks (emerged after the
1990s)
Old private sector banks are ones that were in
operation before nationalisation.
In 1993, the Reserve Bank of India published guidelines
and rules for the opening of new private-sector banks
in India.
A bank’s share capital is primarily held by private
individuals. These banks have limited liability
company structures.
Currently, there are 21 private-sector banks in India.
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Private sector banks
provide speedy
service to their
clients.
Additionally,
some banks offer
specialised services
based on the needs
of the customer’s
finances.
The management
structure of private
sector banks is
efficient.
Private sector banks
can make quick and
smooth financial
decisions.
Disadvantages
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All financial services
are subject to additional
costs at private sector
banks.
These banks are
inaccessible to the rural
populace because they
exclusively serve urban
areas.
Employees in private
sector banks have less
job security.
10.6 FOREIGN BANK
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These banks have branches in our nation even though
their headquarters and registration are in another
country.
Less than 1% of the country’s overall branch network
is made up of foreign banks. However, they do
contribute roughly 7% of the overall assets and 11%
of the profits of the banking industry.
115
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The RBI’s approach to foreign banks operating in
India is based on two guiding principles:
1. Reciprocity: It refers to the fact that foreign banks
only receive close to national treatment in India if
their home nation permits Indian banks to build
branches without restriction.
2. Single mode of presence: The RBI defines a single
mode of presence as being allowed in India as
either a branch or a completely owned subsidiary
(WOS) mode.
The following are some additional policy directives
that the RBI has provided to foreign banks:
 Banks must follow the Basel Standard’s mandated
Capital Adequacy requirements.
 They must meet the INR 500 crore minimum
capital requirement.
 They ought to maintain the CRAR at 10% or less.
 Foreign banks’ priority sector targets in India are
40%.
 Foreign banks must also follow additional
regulations set forth by the Reserve Bank of India.
It’s possible for foreign banks to open offices in India.
Comparatively speaking to branches or agencies,
representative offices have less power.
As a first step in establishing a presence in a country,
foreign banks frequently open representative offices.
Although they cannot do banking operations on their
own, they can develop relationships with potential
customers.
Additionally, foreign bank branches are more likely
to operate in regions with lower regulatory hurdles
to entry.
Currently, there are 34 foreign banks functioning as
representative offices and 45 foreign banks operating
as foreign bank branches.
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In accordance with the terms of the Ordinance
promulgated on September 26, 1975, along with the
Regional Rural Banks Act, 1976, the Regional Rural
Banks (RRBs) were created in 1975.
Recommended by: the Narasimham Committee
under the Regional Rural Bank Act of 1976.
These banks were established in accordance with a
1975 ordinance and the RRB act in order to provide
credit for rural and agricultural industries.
The ownership of RRB is jointly held by the state
government (15%), the Government of India (50%)
and the sponsor Bank (35%) respectively.
The first RRB was established on October 2, 1975,
under the name Prathama Grameen Bank.
The Reserve Bank of India controls RRBs, while
NABARD is in charge of their supervision.
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10.7 REGIONAL RURAL BANKS (RRB)
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Note: RRB operates similar to commercial banks but
within a smaller geographical reach for each of them.
Currently, there are 43 RRB in India serving 525
districts across the country.
National Bank for Agriculture and Rural
Development (NABARD)
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It was established in 1982 as a statutory body in
accordance with the National Bank for Agriculture
and Rural Development Act of 1981.
It was established as a result of the B. Sivaraman
Committee’s recommendations.
Objective: Its main goals are to support rural and
agricultural development and to offer refinancing
options to commercial banks, state-owned
cooperative banks, central cooperative banks,
regional rural banks, and land development banks.
It oversees RRBs, State Cooperative Banks, and
District Central Cooperative Banks.
It suggested the selection of full-time directors
and non-executive chairs for Public Sector Banks
(PSBs) and state-owned financial institutions.
PREVIOUS YEAR QUESTION (PRELIMS)
1. 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 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Significance of Regional Rural Banks
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They give loans for agriculture-allied activities and
retail trade as small rural industries.
The RRB has a priority sector lending target of
75% where loans went to agriculture activities and
vulnerable sectors.
Important role in inclusive development.
Helps the most marginalised section.
10.8 LOCAL AREA BANK
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Local area banks are described as little private
institutions with affordable organisational models that
offer financial services with geographic restrictions.
These banks typically operate in three major
contiguous regions, as well as rural and semi-urban
areas.
Indian Economy
The local area banks’ primary goal is to mobilise rural
savings through local institutions.
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Additionally, they are designed to create new
investment opportunities in the same local
communities.
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Local area banks were first introduced in the Union
Budget in 1996 to offer financial services locally in
their neighbouring districts.
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These banks function as non-scheduled banks, and
the Reserve Bank of India oversees and controls their
operations.
According to the most recent data India has four local
area banks (LABs):
1. Coastal Local Area Bank Ltd
2. Krishna Bhima Samruddhi Local Area Bank Ltd
3. Capital Local Area Bank Ltd
4. Subhadra Local Area Bank Ltd. Kolhapur
Difference between Regional Rural Bank and Local Area Bank
Regional Rural Banks
They are based on M Narsimham committee on
financial inclusion in 1970s
These banks are set up under the provision of RRB act
1976 and its amendment in 2015
They are subjected to CRR and SLR norms but RBI
could prescribe separate norms for them
The restricted to few districts example Baroda Gramin
Bank
RBI is the ultimate regulator but the immediate
regulations lie with NABARD
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Bank Assets
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A bank places its funds in assets to earn profits.
The assets include investments, money at call
and short notice, loans and advances and bills
discounted and purchased.
Additionally, it covers the cash in hand with the
banks and also the cash held with the RBI.
The liabilities include deposits (both time and
demand) and borrowings.
Local Areas Banks
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(a) Advances
(b) Deposits
(c) Investments
(d) Money at call and short notice
10.9 SCHEDULED CO-OPERATIVE BANKS
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It is a type of financial entity which belongs to its
member and who at the same time the owners and
the customer of their bank.
According to the Cooperative Societies Act of 1912,
these banks are registered cooperative credit
institutions.
The Banking System In India
Co-operative banks have a three-tier structure:
1. Primary Credit Societies-PCSs (agriculture or
urban).
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2. District Central Co-Operative Banks- DCCBs.
3. State Co-Operative Banks-SCBs (at the apex level).
The cooperative banks are regulated by RBI and
governed by the

PREVIOUS YEAR QUESTION (PRELIMS)
1. Which of the following is not included in the assets
of a commercial bank in India?
(2019)
These banks are based on 1996 budget presented by
Finance minister Manmohan Singh
They are set up by private entities simply by applying
to RBI under Banking regulation act and registered
under companies act 1956
Being non scheduled banks CRR, SLR and PSL etc
apply but with some caveats
These banks are present in maximum 3 geographically
contiguous districts only one urban centre niche
district
They are regulated by RBI
These banks operate under the cooperative ideals of
helping one another.

Banking regulation act of 1949
Banking laws (cooperative societies) act of 1955
Features of cooperative banks
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Democratic control where one person one vote
principle applies.
Financial inclusion general in unbanked rural
masses.
Advantages of cooperative banking in India
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It provides cheap credit to rural masses.
It has discouraged unproductive borrowing for
personal consumption.
It has encouraged saving and investment instead of
holding money.
It has revolutionised agriculture methods through
the available credit for improved seeds, chemical
fertilizer, modern implements etc.
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Urban Cooperative banks (UCB):
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Urban Cooperative Banks (UCBs), which do not have a
formal definition, are primary cooperative banks that
are found in urban and semi-urban regions.
Due to their regional focus, the Urban Cooperative
Banks (UCBs), Primary Agricultural Credit Societies
(PACS), Regional Rural Banks (RRBs), and Local Area
Banks (LABs) might all be categorised as differentiated
banks.
These banks were only permitted to make loans until
1996 for non-agricultural uses. Today, this distinction
is no longer valid.
Since they primarily financed small borrowers and
enterprises, these banks were historically focused
on communities and local workgroups. Their current
businesses have a far wider range.
Challenges of the Urban Cooperative Banks:
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Dual Control: The state registrar of society and the
RBI both have dual control over the UCBs. However, all
UCBs and multi-state cooperatives were placed under
RBI’s control in 2020.
Changing Financial Sector: The continued existence
of the UCBs, which are typically small in size, lack
professional management, and have fewer operations
that are geographically diverse, is complicated by
shifts the financial sector and evolving microfinance,
FinTech companies, payment gateways, social
platforms, e-commerce companies, and Non-Banking
Financial Companies (NBFCs).
Government Interference: The government has
treated the movement patronisingly from the start.
The treatment of cooperative institutions was similar
to that of the government’s administrative structure.
Money Laundering and Corruption: Cooperatives
have also become the means of regulatory arbitrage,
enabling lending and anti-money laundering laws to
be avoided.
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Agricultural Credit is Declining: The RBI research
observed that despite the sector’s critical importance,
its percentage of all agricultural lending has been
steadily declining over time, from as high as 64% in
1992–1993 to just 11.3% in 2019–20.
Limited Exposure: Most of these societies only have
a small number of members, and they only operate
in one or two villages. They are unable to increase
their capabilities or their operational area since their
resources are constrained.
Rural Cooperative Bank
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Rural Cooperative Banks (RCBs) are crucial to the
daily life of rural residents.
Both short-term and long-term cooperative credit
systems are part of it.
Primary Agricultural Lending Societies (PACS),
District Central Cooperative Banks (DCCBs), and State
Cooperative Banks are the three levels of the shortterm cooperative credit framework (StCBs).
The Banking Regulation Act of 1949 does not apply
to PACS, hence they are not governed by the Reserve
Bank of India.
StCBs/DCCBs are governed by the Reserve Bank and
registered under the State Cooperative Societies Act
of the state.
The National Bank for Agricultural and Rural
Development (NABARD) has the power to inspect
State and Central Cooperative Banks under Section
35(6) of the Banking Regulation Act of 1949.
The Committee, led by Dr. Prakash Bakshi, advises
RCBs to make agriculture the recipient of at least 70%
of their loan portfolio.
RCBs play a significant role in ensuring that they have
the necessary skills to deal with the rapidly changing
rural economic scenario.
Difference between Urban Cooperative and Rural cooperative
Urban Cooperative
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Rural Cooperative
They are further divided depending upon They can be further divided into
scheduled or non-scheduled and single z Long term: examples are land banks cooperative agriculture and
state or multistate(see diagram)
rural development Banks
Since 2018 RBI allowed them to
 SCARDBs: State cooperative agriculture and rural development
voluntarily upgrade to small finance
banks
Banks.
 PCARDBs
primary cooperative agriculture and rural
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development Bank
Short term: For example state cooperative banks district Central
Cooperative Bank primary agriculture credit societies
Indian Economy
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to ‘Urban Cooperative banks’ in India
consider the following statements:
(2021)
1. They are supervised and regulated by local boards
set up by the State Governments.
2. They can issue equity shares and preference
shares.
3. They were brought under the purview of the
Banking Regulation Act, 1949 through an
Amendment in 1966.
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
District Central Co-operative Banks (DCCBs):
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Rural co-operatives include District Central
Co-operative Banks (DCCBs), State Co-operative Banks
(StCBs), and Primary Agricultural Credit Societies
(PACS).
3-tier structure of Short term Co-operative Banks:
1. State Co-operative Banks
2. District Central Co-operative Banks
Cooperative Banks Viz-A-Viz Commercial Banks
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Consider the following statements:
(2020)
1. In terms of short-term credit delivery to the
agriculture sector, District Central Cooperative
Banks (DCCBs) deliver more credit in comparison
to Scheduled Commercial Banks and Regional
Rural Banks.
2. One of the most important functions of DCCBs is
to provide funds to the Primary Agriculture Credit
Societies.
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
Cooperative Banks
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3. Primary Agricultural Credit Societies
Although the focus of rural cooperative lending is
agriculture, the share in credit flow to the agriculture
of rural cooperatives is only 12.1%, as compared to
76% of Scheduled Commercial Banks (SCBs), and
11.9% of Regional Rural Banks.
DCCBs mobilise deposits from the public and provide
credit to the public and PACS.
Commercial Banks
Co-operative Societies governed by the Co-operative
Societies Act, 1904.
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Lend finance to their members only, shareholders
borrow from a cooperative bank.
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Usually offer short, medium, and long-term finance to
agriculture and allied sectors.
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Operate on a relatively small scale.
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Cooperative banks operate as a federal structure in
India.
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The scope of activities of a corporate bank is limited
to providing different types of loans to their members.
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Co-operative Barks are subject to the supervision of
the state governments, NABARD and the RBI
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Commercial banks are joint stock companies that are
governed by the Banking Regulation Act, 1949.
Generally provide short medium and long-term
finance, to trade, commerce and industry
Lend to anyone who is willing to borrow and satisfies
the conditions of the bank.
Operations are on a large scale.
Commercial banks offer a wide range of financial
assistance and financial services.
A joint stock company’s structure is similar to that of
commercial banks.
The Reserve Bank of India has direct supervision over
commercial banks.
Difference Between The Scheduled Bank And Non-Scheduled Bank
Scheduled Banks
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Non-Scheduled Banks
They are required to deposit CRR money to RBI
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They are required to protect the interests of the
depositors and abide to RBI norms
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They are eligible to borrow or deposit funds in RBI is
window operation
z
These Bank sir for the subdivided into two parts
scheduled commercial banks and scheduled
cooperative banks
z
The Banking System In India
They can maintain the CRR money with themselves
Their borrowing from RBI is window operations
depends on RBI discretion
They also have to protect the interest of depositors
under Banking regulation act
There are a number of cooperative banks that are non
scheduled in nature
119
10.10 NATIONALIZATION OF THE BANKS:
I & II
z
z
z
z
z
z
z
Tectonic shift in the Indian financial sector was seen
when Indira Gandhi government nationalised the 14
biggest commercial banks in 1969.
During that time many Asian countries were switching
to market-based policies whereas India supported
socialist policies.
Presently the banking crisis has reignited a debate on
the privatisation of banks.
Nationalization is the process of handing over private
sector assets to the state or the central government
for management or ownership.
By the act of nationalisation in India, banks that were
previously operating in the private sector were moved
to the public sector, giving rise to the nationalised
banks.
The Banking Regulation Act of 1949 was used to
nationalise these banks.
Need for the Nationalization of Banks:
 For Social Welfare.
 For Developing Banking Habits.
 For Expansion of the Banking Sector.
 For Controlling Private Monopolies.
 To Reduce Regional Imbalance.
 For Prioritizing Sector Lending.
Factors that led to the nationalisation of banks
z
z
The planned economic development adopted by
government of India after independence necessitated
the nationalisation policy
It was also an outcome of trouble decade were due
to
 India has suffered economic as well as political
shocks example 2 wars with China and Pakistan
 Successive years of drought and food shortages
example PL 480 program where dependence on
American food shipment compromised national
security
 3rd year plan holiday affected aggregate demand
as public investment was reduce
 Industries witnessed a doubling of share in
credit from commercial banks between 1951 and
1968 whereas agriculture received less than 2%
of total credit.
Benefits of nationalisation
z
z
z
z
120
The branches of public sector banks rose
approximately 800%
Increased public faith and confidence about the
sustainability of the banks
Indian banking system has reached the remotest
corner of the country.
Public deposits in bank have witnessed a significant
increase.
10.11 BANKING SECTOR REFORMS IN
INDIA
The Indian banking sector has undergone constant
change, evolving from a sector that catered to a select
few to one that encourages social change and financial
inclusion. However, there have been many issues in
the financial sector recently.
z
For instance, a decline in asset quality, financial
soundness, and efficiency has hampered the operation
of the Indian banking industry.
z
The Ministry of Finance in its Economic Survey 2015–
16 offered the four R’s of Recognition, Recapitalization,
Resolution, and Reform as solutions to the NPA issue.
Narasimham committee report 1991: It was established
to bring reform to the financial sector of India. Some of the
major recommendations of the committee were
z
z
z
z
z
z
z
It’s suggested a three tier banking structure i.e.,
State → District → Village
it suggested higher norms of capital to risk weighted
adequacy ratio(CRAR) ratio suggested increase to
10%
Reduction in cash reserve ratio to 10% and statutory
liquidity ratio to 25% over a period of time
it’s suggested fixing at this 10% of the credit for
priority sector lending
it recommended deregulation of interest rates
to provide banks independence to set their own
interested for the customers
It emphasize that India should have three or
four large commercial bank with domestic and
international presence.
Recent reforms in the banking sector
z
z
z
z
z
Raghuram Rajan committee 2007 report title
the hundred small steps recommended broad best
reforms across the financial sector are going that
rather than concentrating on a few major and typically
politically controversial steps India must take 100
small steps in the same direction
The economics survey of 2015-16 the ministry
of finance suggested four R’s that is Recognition,
Recapitalisation, Resolution and Reform to address
the problem of NPA(Non-Performing Asset)
In May 2015 RBI advised all PSBs to appoint an
internal ombudsman for boost in the quality of
customer service.
The introduction of insolvency and bankruptcy
code(IBC) based on recommendation of TK
Viswanathan committee
PJ Nayak committee 2014 was set up by the RBI
to examine how Indian banks are governed by their
boards.
Indian Economy
PJ Nayak Committee:
z
z
It was formed by the RBI to give recommendations
on improving the governance mechanism of the bank
boards in India
The committee is also known as the committed to
review governance of boards of banks in India
Recommendation of the committee
z
z
z
z
To repeal the Bank Nationalisation Act, SBI act, etc
which compel the government to own more than half
of the banks
Government should transfer it’s Bank holdings to
Bank Investment Business(BIC) as a holding company
or a core investment company
Bank Board Bureau as an interim entity will be
constituted to perform the task of BIC
The Bank Board Bureau will guide the appointment
of the board also the chairman and other executive
directors of banks.
Payment Banks:
z
z
z
z
z
z
z
10.12 CONSOLIDATION OF PUBLIC
SECTOR BANKS
Merger Vs Amalgamation:
z
Amalgamation is the process of combining one or more
businesses into a new entity. This process differs from
merger in that neither combining business retains its
status as a separate legal entity; instead, two new
businesses are created to hold the combined assets
and liabilities of the merging businesses.
The procedure of merger
Bank mergers are regulated under Banking
Regulation Act 1949.
z
Any two public sector banking entities can initiate
merger talks but the scheme of merger must be
finalised by the government in consultation with the
RBI and that should be placed in the parliament.
z
The Parliament reserves the right to modify and
reject the merger.
z
Alternative Mechanism Panel for public sector
banks merger recently the government established
an alternative mechanism panel headed by the final
minister to oversee the proposal for the merger of PSP.
Note: Based on CAMEL Model (Capital adequacy, Asset
quality, Management, Earnings, Liquidity, and Sensitivity)
in India it is found that private sector banks are dominating
over public sector must bank in both profitability and
liquidity but the result is summer opposite in case of
capital adequacy and NPAs.
z
z
PREVIOUS YEAR QUESTION (PRELIMS)
Q. The establishment of ‘Payment Banks’ is being allowed
in India to promote financial inclusion. Which of the
following statements is/are correct in this context?
(2016)
1. Mobile telephone companies and supermarket
chains that are owned and controlled by residents
are eligible to be promoters of Payment Banks.
2. Payment Banks can issue both credit cards and
debit cards.
3. Payment Banks cannot undertake lending activities.
Select the correct answer using the code given below.
(a) 1 and 2 only
(b) 1 and 3 only
(c) 2 only
(d) 1, 2 and 3
Small Finance Banks
z
z
10.13 DIFFERENTIATED BANKS
It is a type of banking system where a section of the
population is made using small banks. As of 2019 about
20 crore people in India do not have access to banking.
The Banking System In India
These banks cannot lend loans and issue credit cards
but they can offer services such as net banking ATM
cards debit Banks and mobile banking.
Due to its smaller operation and lack of credit risk, a
payment bank differs from other banks.
It can accept demand deposits of up to rupees 1
lakh and remittances, mobile payments, transfers,
purchases etc are available services.
It was recommended by the Nachiket Mor committee
to serve low-income individuals and small businesses.
Minimum paid-up equity capital required is ₹100
crores and a minimum capital adequacy ratio of
15%.
They can access the inter-bank call money market
without collateral and repo and CBLO market with
collateral for temporary liquidity management.
Following entities are Eligible to be promoters
of Payment Banks Existing non-bank Prepaid
Payments Instrument (PPI) issuers, NBFCs Corporate
Business Correspondents, Mobile phone companies,
supermarket chains, public sector entities, and real
sector. cooperatives, etc. Payment Banks can accept
demand deposits. Credit cards cannot be issued by
payment banks, only ATM/debit cards.
Payment Banks are not permitted to engage in lending
activities under RBI standards.
z
Established under the Companies Act 2013. At least
25% of his banking branches should be in unserved
rural areas
Priority sector lending of 75% towards agriculture,
micro small and medium enterprise, export credit,
education, housing, social infrastructure and
renewable energy sectors.
50% of the company’s loan portfolio must be 25 lakh
or above.
121
Do You Know?
z
An External Advisory Committee reviewed and
evaluated the applications (EAC). The former RBI
deputy governor Usha Thorat served as the chairman
of the EAC for small banks.
z
Local Area Banks:
These banks are established in the private sector
with operation in at least three contiguous districts
to promote rural savings by local institutions
They should have a minimum capital of 5 Crore rupees
The PSL target of 40% from which the 25% must go
to weaker section
In 2014 RBI allowed On Tap Licencing to convert LABs
to SFBs
z
z
z
z
PREVIOUS YEAR QUESTION (PRELIMS)
1. The Service Area Approach was implemented under
the purview of __________________
(2019)
(a) Integrated Rural Development Programme
(b) Lead Bank Scheme
(c) Mahatma Gandhi National Rural Employment
Guarantee Scheme
(d) National Skill Development Mission
Lead Bank Scheme:
It aims at providing liquid banking and credit in rural
areas through a service area approach where one
bank is assigned one area it was introduced in 1969
this is scheme was based on Gadgil study group and
bankers committee
Recommendation of Gadgil committee
 There should be integrated banking facilities in
unbanked areas
 Area based approach in unbaked areas where each
bank should adopt area
 Help agriculture and supplemental security income
 District should be identified does the smallest
geographical unit for the purpose of scheme
z
z
Committees associated with LBS:
1. Prof. D R Gadgil Committee
2. Shri F. K. F. Nariman Committee
3. Usha Thorat Committee
PREVIOUS YEAR QUESTION (PRELIMS)
1. The basic aid 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 a particular
district for intensive development.
(d) All the banks should make intensive efforts to
mobilize deposits.
Service Area Approach (SAA):
z
z
122
It is a developed version of the “area approach”
method of the Lead Bank Scheme.
Under SAA, each commercial bank branch in the
rural and semi-urban area was designated to
serve 15 to 25 villages for the planned and orderly
development of the areas and the concerned
branch was responsible for meeting the needs of
bank credit of its service area.
The service area approach was introduced in 1989
as part of the Lead Bank Scheme.
The main goals of SAA were to boost lending
that was productive and create solid connections
between bank credit, production, productivity, and
rising income levels.
Microfinance:
z
z
z
z
z
A type of banking service provided to unemployed
or low-income individuals or groups to help them
to come out of poverty through income generating
activities.
Besides SCBs, RRBs, small finance banks, Cooperative
banks, NBFCs and NBFC-MFIs also provide
microfinance services.
Microfinancing is offering financial services to lowincome populations. These services include microloans, micro-savings and microinsurance.
Financial firms known as microfinance institutions
(MFIs) offer small loans to clients who lack access to
banking services. The term “small loans” has different
meanings in different nations. All loans in India under
`. 1 lakh are categorised as microloans.
Although the so-called interest rates are typically
lower than those imposed by conventional banks,
some opponents of this idea claim that microfinance
organisations profit by mismanaging the money of the
poor.
PREVIOUS YEAR QUESTIONS (PRELIMS)
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 and microfinance 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
Indian Economy
Difference between Payments Bank and Small Finance Bank
Parameters
Small Finance Banks
Definition
Payments Banks
The RBI has created Small Financial Banks to Similar to a regular bank, a payments bank
offer basic banking services to the country’s conducts business on a much smaller scale.
underserved and disadvantaged areas.
They are not permitted to offer their customers
any kind of credit aid.
Objectives
To promote financial inclusion by offering credit The main objective of having a payments bank
facilities and loans to small enterprises operating is the provision of financial inclusion by in underprivileged areas, marginal and small z providing small savings accounts
farmers, small and micro industries, and other z remittance of payments services to
firms notably functioning in the unorganised
migrant labourers, low-income groups,
sectors
small businesses, and other businesses
operating in the unorganized sectors.
Minimum
The minimum equity capital paid up for small The minimum equity capital paid up for the
payments bank is ` 100 crores.
Capital Required finance banks is ` 100 crores.
Time Deposit
Recurring and Fixed Deposits are accepted by Time deposits are not accepted by these banks
Small Finance Banks
Loans
They can offer small loans
Restrictions
First Launched
They operate like regular banks in disadvantaged They are unable to establish subsidiaries for
communities.
undertaking services related to non-banking
No financial restrictions are imposed on their financial activities
functioning
India’s first small finance bank was Capital Small India’s first payments bank was Airtel Payments
Finance Bank, which was launched in 2016
Bank, which was also launched in 2016
PREVIOUS YEAR QUESTIONS (MAINS)
1. Pradhan Mantri Jan Dhan Yojana (PMJDY) is necessary
for bringing the unbanked to the institutional finance
fold. Do you agree with this for the financial inclusion
of the poor section of Indian society? Give arguments
to justify your opinion.
(2016)
10.14 UNIVERSAL BANKING IN INDIA
z
z
z
They are not eligible to offer any loan
Universal banking is a system of Banking where
banks undertake blanket of financial services like
investment banking commercial banking development
banking insurance and other Financial Services.
Besides saving and loan the universal banks provides
services such as investing and security is credit cards
project finance remittance payment system for its
operation insurance etc overall universal banking
is a super store for financial product under one
umbrella.
The concept of universal banking was conceptualised
in India based on the recommendation of RH Khan
committee.
The Banking System In India
Advantages of universal banking
z
z
z
z
Increase in profitability and diversion.
Efficiency In resource utilization.
They provide value-added service.
Considerable decrease in transaction cost.
RBI guidelines on universal banking
z
z
z
z
z
z
Compliance with CRR and SLR requirements.
Compliance with section 10 of the Banking
Regulation Act, 1949 which requires at least 51%
of the total number of directors to have special
knowledge and experience.
Banks cannot hold shares more than 30% of the
paid-up share capital of that company
Compliance with section 20 of the Banking
Regulation Act, 1949 which prohibits the grant of
loans and advances by a bank or security office own
shares.
Compliance with the branch licensing policy of
RBI which is at least 25% of their total number of
branches in semi-urban and rural areas.
An annual financial report should be published in
accordance with the Banking Regulation Act, 1949.
123
Universal Banks versus differential Banks
Parameters
Open branches
Accepting
deposits
Giving loans
Universal Banks
They can open branches anywhere after opening Local area banks and regional rural banks have
25% of branches in unbanked rural areas.
geographical restrictions on branch opening.
They accept both time and demand deposits of They also accept both time and demand
any amount.
deposits except payment banks which can
accept a maximum of 1 lakh only.
They can give loans to anyone after 40% of the
priority sector lending norm
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. If another global financial crisis happens in the near
future, which of the following actions/policies are
most likely to give some immunity to India? (2020)
1. Not depending on short-term foreign borrowings
2. Opening up to more foreign banks
3. Maintaining full capital account convertibility
Select the correct answer using the code given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
2. With references to the governance of public sector
banking in India, consider the following statements:
(2018)
1. Capital infusion into public sector banks by the
Government of India has steadily increased in the
last decade.
2. To put the public sector banks in order, the merger
of associate banks with the parent
State Bank of India has been affected.
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
10.15 MARGINAL COST OF FUNDS BASED
LENDING RATE (MCLR)
z
z
z
z
124
Differential Banks
It replaced the Base rate to determine the lending
rates for commercial banks.
It is the lowest interest rate a bank can charge when
making a loan.
It is an internal benchmark that is tenor-linked,
meaning the bank determines the rate internally
based on how long a loan has to be repaid.
MCLR is closely linked to the actual deposit rates
and is calculated based on four components:
1. Marginal cost of funds
2. Tenor premium
3. Operating costs
4. Negative carry on account of cash reserve ratio
z
z
SFB and RRB have to provide 75% towards
priority sector lending
Payment Bank can’t give loans
Objective of MCLR:
z
z
z
z
Enhancing the policy rate’s transmission to the bank’s
lending rates
Increasing transparency in the techniques used by
different banks to determine interest rates
Ensuring that bank loans are available and have rates
that are reasonable for both lenders and borrowers
Enabling the lender and bank to be competitive and
improve their worth in the long run
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. 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 the availability of
bank credit at interest rates which are fair to the
borrowers as well as the banks.
Select the correct answer using the code given below.
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Difference between Base rate and MCLR
BASE RATE
z
z
z
MCLR
Uses the average cost
of financing
It’s calculation takes
into
account
the
minimum
rate
of
return
Affected
by
the
operating
expenses
and expenses required
to maintain the cash
reserve ratio
z
z
z
Based
on
the
incremental
or
marginal cost of money
It’s calculation factors
tenor premium
It is calculated taking
into account deposit
and repo rates as well
as operating costs and
the cost of maintaining
a cash reserve ratio
Transmission of monetary policy:
z
It describes how the changes made by RBI to the
policy rate affect other economic activity like lending
and inflation.
Indian Economy
z
For example if are we are reduces the policy rates
than the benefits of reducing landing rates should be
passed on to the customers.
Channels of transmission:
z
z
z
z
Interest rate: the interest rates in areas like
government debt market, credit market or equity
market, and the currency market are related
Credit: the bank lending and balance sheet channels
are crucial in monetary transmission because of high
Reliance on Bank funding
Exchange rate: currency rate depreciation is a major
source of inflation risk
Asset price: particularly stock prices changes with
interested change however the amount of influences
is less.
Challenges to monetary policy transmission:
Funding cost are not flexible as in India the large
chunk of lending is through the customer deposit
accounts whereas market borrowings through
issuance of debentures or commercial papers are
very less.
z
Increase in non-performing assets: because banks
keep the weighted average lending rate higher in the
marginal lending rate.
z
Four balance sheet problem: according to chief
economic advisor Arvind Subramaniam India’s
economic slowdown has hampered credit growth
which has resulted in less monetary policy.
z
Non-linking of policy rates to the market: because
the repo rate is administered by monetary policy
committee which cannot be considered as market
determined rate.
z
About 3/4th of the outstanding loans are not linked
to any external benchmark.
External benchmark lending rate: RBI in 2019 has
adopted a uniform external benchmark to ensure complete
transparency and standardization. Where RBI has offered
banks to choose from four external benchmarking
mechanisms which are:
z
The RBI repo rate
z
The 91-day treasury bill
z
The 182-day treasury bill
z
Any other benchmark suggested by financial
benchmarks India private limited
z
Priority Sector Lending (PSL)
z
The sectors that are important for the basic
needs of the country have to be given priority over
other sectors. These sectors are determined by the
government of India and the Reserve Bank of India.
The banks are under mandate to encourage the
growth of the sector with the adequate and timely
flow of credit.
The Banking System In India
z
Categories under priority sector lending are
farming, micro, small, and medium-sized enterprises,
export credit, education, housing, social infrastructure,
renewable energy and others.
Sub targets in PSL:
z
z
z
All scheduled commercial banks and foreign banks are
required to set aside forty per cent of their lending
to these sectors
Regional rural banks, cooperative banks and small
finance banks have to set aside 75% towards PSL
Penal action: the scheduled commercial banks which
fall short in lending to the sectors(PSL) shall allocate
some amount to a rural infrastructure development
fund (RIDF) established within NABARD as decided
by RBI from time to time.
RBI guidelines for PSL for scheduled commercial
banks:
z
z
z
z
z
z
40% of the total net bank credit should go to
advances to priority sectors.
10% of the priority sector advances or 10% of the
total net bank credit, whichever is higher
should go to the weaker section.
18% of the total net bank credit should go to
agricultural advances. Within the 18%
target for agriculture, a target of 8% of Adjusted Net
Bank Credit (ANBC) or Credit Equivalent Amount
of Off-Balance Sheet Exposure, whichever is greater,
is set for small and marginal farmers, to be achieved
in a phased manner.
5 of ANBC or Credit Equivalent Amount of Off-Balance
Sheet Exposure, whichever is higher should go to
Micro enterprises.
Priority Sector Lending Certificates (PSLCs):
z
z
z
z
In the event of a shortfall, banks can use Priority
Sector Lending Certificates (PSLCs) as a mechanism
to help them meet the priority sector lending target
and sub-targets.
This encourages surplus banks as well because it
enables them to sell any excess achievement over
targets, which increases lending to the priority
sector’s lending categories.
Eligible FIs: SCBs, RRBs, LABs, SFBs, Urban
Cooperative.
It is just an accounting concept as there is no transfer
of asset(or risk).
PREVIOUS YEAR QUESTIONS (PRELIMS)
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
125
Business Correspondent (BC) Model:
The Reserve Bank of India (RBI) launched the Business
Correspondent (BC) Model in 2006 to improve
financial inclusion in India.
Business Correspondents are representatives of
banks who are tasked with providing banking services
outside of ATMs and bank branches.
It makes it possible for government assistance and
social security benefits to be directly credited to
beneficiaries’ accounts, allowing them to withdraw
the money from the Bank Saathi or local business
correspondents.
Banks facilities are essentially brought to the
communities via the BC model. They can add money
to their account and withdraw it.
z
z
z
z
z
z
z
Following are its features:
z
z
z
PREVIOUS YEAR QUESTIONS (PRELIMS)
Q. What is/are the facility/facilities the beneficiaries
can get from the services of Business Correspondent
(Bank Saathi) in branchless areas?
(2014)
1. `It enables the beneficiaries to draw their subsidies
and social security benefits in their villages.
2. It enables beneficiaries in rural areas to make
deposits and withdrawals.
Select the correct answer using the code given below.
(a) 1 only
(b) 2 only
(c) Both 1 and 2 only
(d) Neither 1 nor 4
z
z
z
z
The difference between a bank’s total demand and
time liabilities (deposits) of a bank and its deposits in
the form of assets held by another bank is represented
by the term “Net Demand and Time Liabilities”. Thus,
the net demand and time liabilities of a bank can be
calculated by using the following formula:
 Bank’s NDTL = Demand and Time liabilities
(deposits) – deposits with other banks.
For example if a bank has deposited 5000 with the
other bank and its total demand and time liabilities
(including the other bank deposit) is 10,000.
Then the net demand and time liabilities will be 5,000
(10,000-5,000).
Therefore, a bank’s deposits are its liabilities, which
can include demand obligations, time liabilities, and
other types of demand and time liabilities.
1. 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) communications networking
(c) military strategies
(d) supply and demand of agricultural products
10.17 DEMAND AND SUPPLY OF MONEY
Demand: According to the Liquidity Preference Theory of
Keynes, People desire to hold money for 3 motives -
Transaction Motive: to carry out transactions.
Speculative Motive: when holding money is less risky
than lending the money or investing.
z
Precautionary Motive: to meet unforeseen
circumstances in future. E.g.sudden death due to any
reason.
Supply: It is the amount of money in circulation at any
given point in the economy. In India, the measure of the
supply of money is classified into four categories M1, M2,
M3 and M4 along with M0.
z
z
z
Marginal Standing Facility (MSF) Rate:
z
126
Marginal standing facility (MSF) is a window for
banks to borrow from the Reserve Bank of India
in an emergency when interbank liquidity dries up
completely.
Under the Liquidity Adjustment Facility (LAF),
banks borrow money from the RBI by guaranteeing
government assets at a rate higher than the repo rate.
A percentage point higher than the repo rate, or 100
basis points, is where the MSF rate is set.
Banks have the ability to borrow up to 1% of their
net demand and time liabilities (NDTL) under MSF.
The RBI receives applications for sums starting at one
crore rupees and increasing by multiples of one crore
rupees.
PREVIOUS YEAR QUESTIONS (PRELIMS)
10.16 NET DEMAND AND TIME LIABILITIES
(NDTL)
z
The RBI introduced the Marginal Standing Facility as
part of the monetary policy reform in 2011–2012.
Banks can borrow money from RBI at a penalty
rate once all borrowing assistance has been used
up.
Banks can borrow money at a rate that is higher than
the repo rate thanks to the Marginal Standing Facility,
also known as the Marginal Standing Facility Rate.
z
z
Reserve Money (M0): Currency in circulation +
Bankers’ Deposits with the RBI + other deposits with
the RBI. It is also called High Powered Money.
High Powered Money: It is the total liability of the
monetary authority of the country.
Narrow Money: This is highly liquid money which
banks cannot use to lend.
Indian Economy
M1 = Currency with the Public + Demand Deposits
with the Banking System + other deposits with the
RBI.
 M2 = M1 + Savings deposits of post office savings
banks
Broad Money: It is the total money in an economy
i.e., Aggregate Money Resource
 M3 = M1 + Time deposits with the banking system.
 M4 = M3 + All deposits with post office savings
banks.
The liquidity in descending order is - M1>M2>M3>M4

z
z
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. If you withdraw `. 1,00,000 in cash from your Demand
Deposit Account at your bank, the immediate effect
on aggregate money supply in the economy will be
_________(2020)
(a) to reduce it by `. 1,00,000
(b) to increase it by `. 1,00,000
(c) to increase it by more than `. 1,00,000
(d) to leave it unchanged
LEGAL TENDER
z
z
z
z
z
z
Legal Tender is a coin or a banknote that is legally
tenderable for discharge of debt or obligation.
The coins issued by the Government of India under
Section 6 of The Coinage Act, 2011, shall be legal
tender in payment (Coins of ` 1 and above can be
used as legal tender for dues up to ` 1000 Coinage
Act, 2011)
Every banknote issued by the Reserve Bank of India
is valid as legal money in India for the amount it
expresses unless it is withdrawn from circulation.
Cannot be refused for the settlement of any form of
transaction by any citizen of the nation.
There are two types of legal tender: limited and
unlimited.
In India, the legal tender status of currency notes is
unlimited but that of coins are restricted.
10.18 NPA AND STRESSED ASSETS
z
z
z
The reason behind NPA in India:
z
z
z
The Banking System In India
Huge Economic Growth (2004-2009): led to
increased lending activities without analysing the
financial health of companies and credit rating
Majority of the investment was in infrastructure
sectors like roads, power, aviation, steel, etc.
Later with the banning of mining projects, delays in
environmental permits led to a rise in prices of raw
materials which led to a big gap in demand and supply
thereby affecting the power, steel, and iron industries
which affected the capacity of the companies to repay
the loans
Classification of non-performing assets
z
Standard asset: it is a kind of performing asset which
generates ongoing income and repayments until they
become due. These assets carry normal risk and in a
real sense are not NPA.
Special Mention
Account
Principal/Interest Payment &
Partly/Wholly Due
SMA-0
1-30 Days
SMA-1
z
z
PREVIOUS YEAR QUESTIONS (PRELIMS)
Q. 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, drafts, bills
of exchange etc.
(d) The metallic money in circulation in a country
The non-performing assets are loans and arrears
that are lent by banks or financial institutions whose
principal and interest are delayed beyond 90 days
and which no longer generates income for the bank
The NPA is classified based on the number of days,
the principal paid and the due interest.
Based on the above factors they can be classified as
substandard assets, doubtful assets and loss assets.
SMA-2
31-60 Days
61-90 Days
When a loan whose principal or interest payment is
overdue for less than 90 days, it is called a Special
Mention Account (SMA).
Types of Assets:
 Sub-standard assets: These are loans and
advances which are non-performing assets for a
period of 12 months
 Doubtful assets: when an asset is non-performing
for more than 12 months
 Loss assets: These are the assets that cannot be
further recovered
Measures to curb NPAs in India:
z
To tackle the problem of NPA the government has
taken certain measures at legal financial and policy
levels the Narasimham committee recommendation
has been looked into to put some in practice
127
Debt recovery tribunal has brought down the time
to settle matters however in some location the cases
are pending for more than two years
z
A statutory body which can pass comprehensive order
like in Civil Court
z
Further appeal lies to Debt Recovery Appellate
Tribunal(DRAT)
z
Limitations: Courts took time and by then asset value
comes down to zero.
z
10.19 (SARFAESI) SECURITIZATION AND
RECONSTRUCTION OF FINANCIAL
ASSETS AND ENFORCEMENT OF
SECURITY INTEREST ACT 2002
Under this act banks allowed to acquire and dispose of
secured assets in NPA with an outstanding balance
of 1 lakh or more without the participation of any
court.
z
The act comes into play if a borrower defaults on his
payment for more than 6 month then the lender can
send a notice to the borrower for his dues within 60
days if the due is not clear then financial institution
can take possession of the secured assets and sell
transfer or manage them.
z
Limitations of the SARFAESI Act
z
z
z
Asset reconstruction companies were formed to extract
value from troubled loans; earlier the landers could only
enforce their security interest through the courts which
was a lengthy process. These are regulated by the RBI
as NBFC.
10.20INSOLVENCY AND BANKRUPTCY
CODE, 2016
z
z
z
Objective:
To provide legal framework for securitization activities
in India.
z
Gives procedure for transfer of NPAs to ARC for
reconstruction of asset value.
z
Methods: provide 3 alternate methods1. Securitization
2. Asset Reconstruction
3. Enforcement of Security (without court intervention)
z
z
Applicable only on a secured loan.
It gives teeth to DRT with an enforcement law
z
It can change the board of directors in such companies,
can auction such assets, can also sell such assets to
ARC, and NBFC
z
z
z
Lenders having SARFAESI power: All types of Banks,
HFCs, if an NBFC fulfils two conditions.
1. Asset size of ₹100 cr or more,
2. The loan given is at least ₹50 lakhs.
128
According to it, if 75% of the lenders don’t agree
to restructuring or resolution plan then assets will
be liquidated.
If an individual partnership firm or company defaults
on a business loan then financial creditors can
approach National Company Law Tribunal(NCLT)
for the initiation of proceedings.
NCLT accept the application then it will grant
moratorium of 180 to 270 days.
Then insolvency professional will present plan to
committee of creditors made up of financial creditors
If borrower is individual or partnership firm than first
he will approach Debt Recovery Tribunal then to Debt
Recovery Appellate Tribunal(DRAT)
If borrower is a company then National Company law
Appellate Tribunal.
IBC Amendment 2021: Pre- Packaged Insolvency
Resolution Process (PPIRP) for corporate MSMEs.
z
SARFAESI is not applicable on farm loans.
z
In accordance to an economic survey of India it was
created murder the Chakravyuha challenge which
was the problem of exit of Indian companies.
Appeal structure in IBC:
Other related SARFAESI facts:
z
The DRTs & DRATs are understaffed. 1 lakh + cases
pending (2016). This results in the asset value
declining.
In some businesses, auction or liquidation may not
yield the best returns. In such cases, if the loans were
restructured then banks could salvage more value.
But, the SARFAESI act doesn’t facilitate such
arbitration. So, Govt. came up with a new law i.e.,
the Insolvency & Bankruptcy Code.
z
It is a process where a resolution arrangement is
agreed upon between the corporate debtor (CDs)
and lender before approaching the National Company
Law Tribunal (NCLT) for bankruptcy proceedings.
It allows the Committee of Creditors (CoC) to make
a change in the management of the company and pass
control to the resolution professional by 66% voting
Indian Economy
in favour. Thus protects from fraudulent activities/
mismanagement.
Note: CoC is composed of financial creditors to the
Corporate Debtor (CD) or operational creditors in the
absence of financial creditors.
Timeline of NPA:
Year
Events
1993
z
2002
z
z
z
2014
z
2015
z
z
z
z
z
2016
z
z
2017
z
2018
z
2021
z
Formation of Debt Recovery Tribunal
SARFAESI Act
Asset Reconstruction Company
Prompt Corrective Action
PJ Nayak Committee
Indradhanush: Using the ABCDEFG
formula, it is the most extensive reform
effort made to enhance the performance
of the Public Sector Banks.
Banks Board Bureau
Strategic Debt Recovery: If corporations
that have borrowed money from banks
are unable to pay it back, the lenders
may convert all or a portion of the loan
into equity shares.
S4A: Sustainable Structuring of Stressed
Asset
IBC(Insolvency & Bankruptcy Code)
S4A: Sustainable Structuring of Stressed
Asset
IBC(Insolvency & Bankruptcy Code)
Recapitalisation Bond
Project Sashakt
NARCL
Important metric to identify the health of a bank
z
Based on 2 principles:
1. Early Identification
2. Resolution measures
z
Provides three risk thresholds: Capital, Asset Quality
and Leverage.
z
Applicability: it applies to all SCBs accept payments
banks and small finance banks (SFBs)
Note: For Urban Cooperative Bank there is a separate
mechanism called Supervisory Action Framework
z
10.22 MISSION INDRADHANUSH
z
z
z
Seven components of the Mission
Indradhanush
z
z
Insolvency and Bankruptcy Board of India
(IBBI)
z
z
z
It was established under Insolvency and Bankruptcy
code 2016
It regulates the insolvency and bankruptcy proceedings
in the country
It oversees the activities of Insolvency Professional
agency, Insolvency Professionals and Information
Utilities
z
z
z
Financial institutions with poor financial metrics
are placed under RBI supervision under the PCA
framework.
An early intervention mechanism for under-capitalised
banks because of poor asset quality
The Banking System In India
Appointment: Based upon global best practices the
government decided to separate the post of chairman
and managing directors. And the selection process of
position will be transparent manner based on merit
Board of Bureau: in order to replace the appointment
boards of whole time directors as well as non executive
chairman of public sector banks a body of eminent
professionals called Bank board bureau was to be
established
Capitalisation: in order to keep a safe buffer above
the minimum norms of Basel III Government of India
wants to adequately capitalised all the banks
Destressing public sector banks
By creating new Debt Recovery Tribunals for fast
tracking the recovery of bad loans
 Developing a vibrant debt market for public sector
banks to reduce the pressure on the banks for
further lending
Empowerment: Through a robust grievance
redressal mechanism to address the concern of the
customer in a time bound manner
Framework of accountability: in order to measure
the performance of public sector banks in new

10.21 PROMPT CORRECTIVE ACTION
(PCA)
z
Mission Indradhanush is a 7-stage program that
addresses the challenge encountered by the public
sector banks.
It aims at reorganising the operation of public
sector bank and empower them to complete with
their counterparts like private sector banks
Mission Indradhanush was launched by the Ministry
of Finance in 2015 based on
 the report submitted by PJ Nayak committee on
the Governance of the Boards of Banks in India and
 the growing economic compulsion to raise the
Asset quality of banks
z
z
129
framework of Key Performance Indicator to be a
established
Governance reforms: Gyan Sangam a conclave of
public sector banks and financial institution started
the process of governance reform it was a focussed
group discussion on 6 different topics for effective
banking.
z
10.23 PROJECT SASHAKT
Under the project it is mandatory for lenders to
enter into an Intercreditor Agreement (ICA)
while rebend the account of the borrower within
30 days from the date of its first default to any
lender where:
 Bank loans up to 50 crore rupees are managed at
Bank level with a deadline of 90 days.
 Bank loan above 50 crore rupees bank has to
enter an intercreditor agreement authorising the
lead Bank to implement a resolution plan in 180
days or refer the asset to a National company law
tribunal.
The project was proposed by a panel led by PNB
chairman Sunil Mehta to help consolidate stressed
assets.
z
z
z
z

z
Inter Creditor Agreement:
z
z
Unlike earlier processes where consensus was needed,
now agreement of 75% of the lender by debt value
or 60% by number is needed.
It says that the responsibility of initiating the
resolution process lies with the Lead Bank, which is
the bank which has the highest share (exposure)
in the loan.
10.24 MISCELLANEOUS: NPA
Interest Coverage Ratio:
z
z
z
z
A debt and profitability ratio called the interest
coverage ratio is used to evaluate a company’s capacity
to repay outstanding debt.
It is figured out by dividing a company’s earnings
before interest and taxes (EBIT) by the amount of
interest it paid over a specific time period.
In general, a coverage ratio is a metric used to assess a
company’s capacity to pay off debt and fulfil financial
commitments like dividends and interest payments..
The easier it is for the business to pay interest on the
debt, the higher the coverage ratio.
Teaser Loan:
z
130
Any loan that provides a lower interest rate for a set
period of time as a purchase incentive is a teaser loan.
z
Loan issuers frequently use teaser loans as a
promotional tool to draw in a variety of borrowers.
Common teaser loans include adjustable-rate
mortgages and credit cards with low introductory
rates. State Bank of India pioneered the teaser loan
concept in Home loans in 2009.
One facet of subprime lending is what is known as
teaser lending.
Entrepreneurs and first-time homebuyers are typically
offered/provided with teaser loans. Experience isn’t a
requirement.
Lending to borrowers with poor credit ratings who
run the risk of defaulting in the future is known as
subprime lending.
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. Why is the offering of “teaser loans” by commercial
banks a cause of economic concern?
(2012)
1. The teaser loans are considered to be an aspect of
subprime lending and banks may be exposed to
the risk of defaulters in future.
2. In India, teaser loans are mostly given to
inexperienced
entrepreneurs
to
set
up
manufacturing or export units.
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
2. What is the importance of the term “Interest Coverage
Ratio” of a firm in India?
(2020)
1. It helps in understanding the present risk of a firm
that a bank is going to give a loan to.
2. It helps in evaluating the emerging risk of a firm
that a bank is going to give a loan to.
3. The higher a borrowing firm’s level of Interest
Coverage Ratio, the worse is its ability to service
its debt.
Select the correct answer using the code given below.
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
10.25 BAD BANKS
z
z
A bad Bank financial entity which is set up to buy non
performing assets(NPA) with an aim of settling the
balance sheet of the banks to ease the burden and
lend to customer without any constraint
NARCL (National asset reconstruction company
limited): to setting up of NARCL was announced in
the Budget 2021- 22 it will acquire the bad loan from
banks and the India debt resolution company limited
which will then manage these assets and will enhance
their value
Indian Economy
z
z
NARCL will be 51% owned by public sector banks.
India Debt Resolution Company Limited (IDRCL)
established to assist NARCL, private and public banks
together to manage the acquired assets and try to
improve their value for final resolution
Proposal for a national Bad Bank:
z
z
Indian Bank Association in 2020 submitted a
proposal to the RBI and government to set up a
national bad bank according to which the bad Bank
would initially start with a book of approximate
75000 crore worth of bad loans
The Economic Survey 2016-17 recognising a
key issue called ‘the twin balance sheet’ problem
highlighted a need to set up a government-owned
asset reconstruction company, called PARA(Public
Sector Asset Rehabilitation Agency)
Asset Reconstruction Company:
z
z
Asset reconstruction is defined as ‘the acquisition of
bank’s right or interest in form of financial assistance
by an ARC for realization of the value of such financial
assistance.
They are incorporated under the Companies Act
and registered with RBI under section 3 of the
Securitization and Reconstruction of Financial Assets
and Enforcement of Security Interest (SARFAESI), Act
2002.
Provisioning Coverage Ratio (PCR)
z
z
z
It is part of RBI’s prudent regulation norm and gets
activated when an asset turns bad
According to it banks has to set aside a prescribed
share of their bad asset
Thus PCR is inversely proportional to
 Quality of asset
 Bank’s profitability
10.26 BASEL NORMS
z
z
The Basel norms are broad supervisory frameworks to
strengthen the international banking system through
coordination of Central banks around the world with
a common goal of Financial stability and Banking
Regulatory is standards
The Basel Committee on Banking Supervision is the
main body that develops international standards for
bank regulation.
BASEL I:
z
It was concerned with credit risk it introduced the
capital measurement system in 1988
z
The required minimum capital was set at 8% of
risk-weighted assets
z
It divided capital into two categories:
The Banking System In India
Tier1 capital: it forms the core capital of the bank
because it is a primary measure of financial strength
z
Tier2 capital: it is less reliable as it is used for
supplementary funding for the Tier 1 capital. These
are more difficult to liquidate.
Note: the BASEL II norms are yet to be fully implemented
but India follows these norms.
z
BASEL II:
Its guidelines were based on three pillars
z
Capital Adequacy Requirements: Capital Adequacy
Ratio(CAR) is the ratio of a bank’s capital in relation
to its risk-weighted assets and current liabilities.
(minimum of 8%). Every bank has to maintain it
irrespective of whether its asset become NPA or
not.
z
Supervisory Review: for monitoring and managing
all three types of risk that a bank faces that is credit
risk, market risk and operational risk.
z
Market Discipline: according to which banks
must report their CAR, risk exposure and related
information to the central banks regularly.
z
BASEL III:
The guidelines are to promote a resilient banking
system focusing on four parameters like Capital,
leverage, funding and liquidity
z
Capital: it requires a capital adequacy ratio(CAR)
of 11% where Tier 1 capital ratio at 9% and Tier 2
Capital ratio at 2% in addition to it banks must have to
maintain a capital conservation buffer of 2.5% and
the countercyclical buffer is also to be maintained
at 0-2.5%
z
Leverage rate is the ratio of banks tier 1 capital to
average total consolidated assets.The banks should
have a leverage ratio of 3%.
z
Funding and liquidity according to Basel III norms
are two liquidity ratio
z
Liquidity coverage ratio(LCR) which requires the
Bank to keep a buffer of high-quality liquid assets
to deal with the outflow of cash in an acute shortterm stress scenario it is also to prevent a situation
like Bank runs
z
Net Stable Funds Rate to maintain a stable funding
profile to their of balance sheet
z
Capital Conservation Buffer: Capital that should be
set aside beside CAR to use in stressed scenario(2.5%)
z
Thus total capital to set aside= CAR + CCB = 9 + 2.5
= 11.5%
z
Countercyclical capital buffer(CCCB): it helps a bank
to counter the effect of a downturn or displacement
in economic conditions. According to CCCB banks are
required to set aside a proportion of their capital
during good times when loans are growing rapidly
to use it during the time of distress.
z
131
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. 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
2. Basel III Accord’ or simply ‘Basel III’ often seen in the
news, seeks to ___________
(2015)
(a) Develop national strategies for the conservation and
sustainable use of biological diversity
(b) Improve banking sector’s ability economic stress
and improve risk management
(c) Reduce the 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
10.27 SYSTEMICALLY IMPORTANT
FINANCIAL INSTITUTIONS (SIFI)
They are the financial institution which is systemically
important because of their size, cross-jurisdictional
activity, complexity, lack of substitutability,
interconnectedness and lack of substitute.
z
They can also be perceived as Too Big To Fail which
provides Government support for this institution in
times of distress.
z
Banks whose overall asset is more than 2% of the
GDP are included in this group e.g SBI, ICICI Bank,
and HDFC Bank
z
The failure of the institutions can potentially cause
disruption to the essential services which they provide
to the banking system and the hampering overall
economic activity
z
Domestic systemically important banks: RBI for
dealing with domestic systemically important banks
has disclosed the names of the banks designated so
since 2015 and placed these banks in the appropriate
basket.
Note: Beside these the Domestic Systemically Important
Insurers have also been identified by Insurance Regulatory
and Development Authority of India for 2020-21.
z
Banking Ombudsman
z
132
An Ombudsman is a government official appointed
by RBI who deals with complaints and grievances of
ordinary people against public organisation
z
It covers all kinds of banks including public sector
banks, private banks, rural banks and also cooperative
banks.
RBI integrated ombudsman scheme:
z
z
z
It combines three RBI Ombudsman Scheme which
are the Banking Ombudsman Scheme of 2006 the
NBFC on Ombudsman Scheme of 2018 and the
Digital Transaction Ombudsman scheme of 2019
It provides an effective redressal of customer
grievance towards RBI regulated entities like and
NBFCs prepared instruments etc.
It also cover the non-scheduled primary cooperative
society with a deposit of rupees 50 crore and above.
10.28NON-BANKING FINANCIAL
INSTITUTIONS (NBFI)
z
NBFC is a company registered under companies act
1956 which is engaged in the business of loans and
advances, acquisition of shares of drugs bonds the
ventures we should buy government or local authority
and other marketable securities.
Criteria for NBFC licence:
z
z
z
They should be registered in the companies act.
It should be either a private limited company or
limited company.
It should have at least 2 crores as net owned fund.
Types of NBFCs:
It can be divided under 3 broad categories:
1. Based on nature of activity: examples are asset
Finance company, loan company, investment
company, systemically important core investment
company, infrastructure Finance company, NBFC
microfinance institution etc
2. Based on the basis of deposits: they are divided
into deposit-accepting NBFC and non-depositaccepting NBFC.
3. Based on their asset size: divided into Systemically
important NBFCs and Non-Systemically important
NBFCs.
z
Regulation of NBFCs
Regulation and supervision are based on three main
goals depositor protection, consumer protection and
financial stability
z
In an extreme situation the RBI is empowered to take
punitive action under RBI act 1934
z
RBI has recently proposed a progressive increase in
regulatory intensity through a four-tier mechanism
for NBFC
z
Reduction in the classification of NPAs of the base
layer and NBFCs from 180 days to 90 days.
z
Revised Scale-Based Regulatory (SBR) Framework:
According to it a Scale-Based Regulatory (SBR)
Framework will be applicable to NBFCs with Fourlayers based on their size, activity and perceived risk.
z
Indian Economy
Scale Based Approach-Introducing Scale Based Framework
New Category
Bank-Like Regulation
Arbitrages
Plugged
Top
Layer
Empty Top Layer-Supervisory direction
About 25-50 Upper Layer NBFCs
through a filtering process
Upper Layer NBFCs
(NBFC-UL)
Equivalent to NBFC-NDSI & NBFC-D
Middle Layer NBFCs
Equivalent to NBFC-ND but
with threshold at `1000
crore
(NBFC-ML)
Base Layer NBFCs (NBFC-BL)
NBFCs
Significance of NBFCs
z
Provides easy access to bank Finance in developing countries like India.
z
They provide services to the market sectors that provide higher risk and lower returns that commercial banks do
not serve.
NBFC vis a vis Commercial Banks
Parameters
Registration
Supervision
Commercial Banks
Under Banking regulation act 1949.
RBI
Entry capital 500 crores
Deposits
Prudential
z
z
z
z
Under companies act.
It varies like a mutual fund by SEBI and insurance
companies by IRDAI.
For microfinance institutions 5 crores for others it is 200
crore.
Can accept time and demand deposits Only deposit-taking NBFC and it is not insured under
which are insured under DICGI Act.
DICGCI Act.
CRR and SLR are applicable.
NBFC regulated by RBI
z
NBFCs
Investment and credit company: It is a new category
introduced in 2019 by merging previous NBFC
categories like Asset Finance company, loan company
etc.
Core investment company they do long-term
investment in companies example IL&FS owned by
SBI, LIC and corporates.
Asset reconstruction company they buy bad loans
from banks and other and try to recover the value
from the underlying assets.
Microfinance institution created in 2010 based on
the recommendation of Malegam committee. These
are regulated by RBI and ministry of corporate affairs.
Mudra Bank 2015 are non-deposit taking NBFC
which is owned by SIDBI with provides indirect loan
to micro enterprises based on PM Mudra Yojana.
The Banking System In India
Deposit-taking NBFC SLR is required but RBI can prescribe
different slabs CRR is not applicable to any type of NBFC
NBFC regulated by SEBI
z
z
z
z
Stock broker: the helpline to buy and sell shares and
bonds, example Sherkhan
Mutual fund: mutual fund manager invests in shares
and bonds from pooled money from their clients e.g.
SBI’s Sharia Equity MF
REITs/InVITs: pooled money is invested in real estate
and infrastructure project
Venture capital fund: the help startup company
through equity finance, example IFCI
NBFC regulated by others
z
IRDAI(Insurance Regulatory and Development
Authority of India) regulates life insurance
companies, general insurance companies and policy
aggregator platforms.
133
PFRDA(Pension Fund Regulatory and Development
Authority) regulates pension funds except EPFO and
other statutory funds.
National housing Bank: apex body to operate as
a principal agency to promote Housing Finance
institution both at local and regional level.
Ministry of corporate affairs: regulates Nidhi
companies and Microfinance companies.
State registrar of chit funds: Chit fund is an example
of a collective investment scheme with monthly
contribution and borrowing by the members.
z
z
z
z
exports to global markets, causing additional hikes in
energy and food prices that were already high owing
to COVID-19, supply shortages, unfavourable weather
shocks, and supply chain disruptions.
Alternatives of SWIFT:
10.29 SWIFT SYSTEM: SOCIETY FOR
WORLDWIDE INTERBANK
FINANCIAL TELECOMMUNICATION
z
z
z
z
z
Financial institutions can send and receive information
about their financial transactions using the secure and
dependable SWIFT global financial messaging service.
Although it acts as a middleman to verify transactional
data, SWIFT does not actually transfer funds.
However, neither does the organisation manage
accounts on behalf of people or financial organisations
nor does it hold any outside funds. Additionally, it
doesn’t carry out clearing or settlement duties.
It is identified by the eight-character SWIFT code
UNCRITMM The institution code is represented by the first
four characters (UNCR for UniCredit Banca).
 The following two characters are the country
code (IT for the country Italy).
 The following two characters are the location/city
code (MM for Milan).
 The final three characters are optional, but
organisations use them to designate codes to
certain branches.
z
Impact on India:
z
z
z
A bank’s exclusion from SWIFT will technically prevent
it from performing its and its customers’ financial
transactions with foreigners, fulfilling promises,
receiving payment for exports, or offering short-term
credit for imports.
This has the potential to halt all sectors of the economy
involved in international trade and banking.
Russia’s domestic payment system may also be
interrupted to the point where all transactions with
any card issued by the major credit card networks
(VISA, Mastercard, Amex, and so on) must go through
SWIFT.
The sanctions endanger both the countries that
imposed them and the global economy as a whole
because disruptions in Russia’s banking system might
impair energy supplies to Europe as well as commodity
v
134
Russian supply orders may be cancelled in India,
and domestic exporters may also choose to cancel
some. If all Russian banks are barred from using the
SWIFT network, payments will be delayed, potentially
disrupting trade.
Because India has a trade imbalance with Russia,
a barter system can be simply activated in certain
instances.
 Given the trade deficit, the impact on India will be
limited in the long run.
 India primarily purchases petroleum products,
diamonds and other precious stones, and
fertilisers from Russia. It also sends capital goods,
pharmaceuticals, organic chemicals, and car parts
to Moscow.
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How can the SWIFT Sanctions Impact Russia?
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SPFS (System for Transfer of Financial Messages) is
the Central Bank of Russia’s version of the SWIFT
financial transfer system. The Russian central bank
was founded following the 2014 invasion of Crimea.
The Bank of Russia’s financial messaging system
(FMS) provides an alternative electronic financial
messaging channel known as a “SWIFT analogue.”
The Cross-Border Interbank Payment System is a
Chinese counterpart to SWIFT (CIPS). CIPS, on the
other hand, is substantially smaller, with approximately
1,300 financial institutions participating, the majority
of which participate indirectly.
Cryptocurrencies are another option for cross-border
payments. Russia has also been developing a ‘digital’
rouble, which has yet to be deployed.
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Alternative Mechanism for India:
When the US imposed sanctions on Iran, payments to
local businesses were cleared using a system similar
to the rupee-rial architecture that India may adopt.
 The rupee-riyal method allowed Indian refiners
to purchase selected rupee accounts at UCO Bank
and IDBI Bank to import crude oil from Iran.
 Indian exporters were paid with this money in
turn. This went on until crude oil was removed
from the US sanctions list.
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#OpinionMatters
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v
Do you think rising NPAs in India are more related
to faults in banking governance than the structural
drawbacks of the economy?
v
Indian Economy
RBI and Monetary
Policy in India
11
11.1 MEANING OF CENTRAL BANK
A reserve bank has the exclusive right to expand the
nation’s monetary base, unlike a commercial bank.
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The majority of central banks around the world have
the oversight and control necessary to guarantee the
resilience of member institutions, avert bank runs,
and deter fraudulent activity by member banks and
financial institutions.
Usually they are in developed nations, they are
institutionally independent of political interference
in their functioning.
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11.2 HISTORY OF RBI
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Established 1 April 1935; 87 years ago
Ownership
Governor
(2023)
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Ministry of Finance, Government of India
Shaktikanta Das
The Reserve Bank of India (RBI) is the central bank of
India, and It was established as a shareholders’ bank
on April 1, 1935.
RBI is not a constitutional body. RBI is a statutory body
established through the RBI Act, of 1934 in response
to the report of the Hilton Young Commission (1926).
RBI was initially founded in Kolkata before being
relocated permanently to Mumbai in 1937.
It is the highest monetary authority of India.
The RBI also represents India’s membership in the
IMF as the government’s representative.
Conducting monetary policy in India is the
responsibility of RBI.
The RBI retained this character for a little less than
fourteen years. On January 1, 1949, it was nationalised
and since then it has remained wholly stateowned.Although RBI has considerable institutional
independence, it is under the control of the Ministry of
Finance, Government of India since it was nationalised
in 1949.
After nationalisation, it stopped being a ‘bank’ in the
technical sense, as it altogether stopped accepting
deposits from the public.
RBI has four regional representations: North in New
Delhi, South in Chennai, East in Kolkata and West in
Mumbai.
The Preamble of The
Reserve Bank of India
The Preamble of the Reserve Bank of India describes the
basic functions of the Reserve Bank as: "to regulate the
issue of banknotes and keeping of reserves with a view
to securing monetary stability in India and generally to
operate the currency and credit system of the country
to its advantage; to have a modern monetary policy
framework to meet the challenge of an increasingly
complex economy, to maintain price stability while
keeping in mind the objective of growth."
11.3EVOLUTIONARY HISTORY OF RBI SINCE INDEPENDENCE
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1950–1960
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1961–1968
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The Indian government created a centrally planned economic strategy that prioritised the
agricultural industry in the 1950s.
The government established, based on the 1949 Banking Companies Act—later known as the
Banking Regulation Act—and nationalised commercial banks.
The RBI was asked to establish and oversee a deposit insurance system in response to bank failures.
It was intended to reestablish confidence in the network of national banks.
The Indian government reorganised the national bank market and nationalised numerous financial
institutions. which forced the RBI to take the lead in managing and assisting this public banking
sector.
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1969–1984
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1985–1990
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1991–1999
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From 2010
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In the year 1969, the government nationalised 14 major commercial banks in India. Later when
Indira Gandhi returned to power in 1980, a further six banks were nationalised.
The central bank dominated the 1970s and 1980s and significantly increased its policies for a
variety of tasks, including interest rates, reserve ratios, and visible deposits.
The Banking Commission was established on 29 January 1969, to analyse banking costs, effects
of legislations and banking procedures, including non-banking financial intermediaries and
indigenous banking on the Government of India economy.
A new financial law enhanced the versatility of direct deposit by adding more security precautions
and liberalisation. The Discount and Finance House of India started operating in the currency
market in April 1988, and the National Housing Bank, established in July 1988, was compelled to
invest in the housing market.
The national economy contracted in 1991 as the Indian rupee was devalued.
The currency lost 18% of its value relative to the currency of the US dollar.
The Narasimham Committee recommended changing the statutory liquidity ratio of banks as well
as the temporarily reduced reserve ratio for the financial sector.
The central bank of India deregulated bank interests and some sectors of the financial market like
the trust and property markets.
In the wake of 2016, the Government of India amended the RBI Act to establish the Monetary
Policy Committee.
This limited the role of the RBI in setting interest rates, as the MPC membership is evenly divided
between members of the RBI and independent members appointed by the government of India.
The Reserve Bank of India (RBI) declared in 2018 that entities under its regulation "shall not
deal with or render services to any individual or business entities dealing with or settling virtual
currencies," including the cryptocurrency Bitcoin.
↓
Do You Know?
General Managers
Despite Burma (Myanmar)'s 1937 decision to leave
the Indian Union, the Reserve Bank continued to serve
as the nation's monetary authority until Burma was
occupied by the Japanese, and then until April 1947.
The Reserve Bank operated as Pakistan's central bank
following the partition of India until June 1948, when
the State Bank of Pakistan started operations.
↓
Deputy General Managers
↓
Asstt. General Managers
↓
Managers
↓
11.4INSTITUTIONAL ORGANISATION
OF RBI
Central Board of Directors
Asstt. Managers
↓
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Governer
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↓
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↓
Deputy Governeors
Deputy Governeors
↓
Executive Directors
↓
Principal Chief General Managers
↓
Chief General Managers
136
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Support Staff
In the institutional structure of RBI, the central board
of directors is the main committee of the RBI.
According to Section 8 of the RBI Act 1934, the
government of India appoints the directors for a
period of four years.
The board consists of a Governor
 Not more than four deputy governors
 Four directors to represent the regional boards
 Two – usually taken from the Economic Affairs
Secretary and the Financial Services Secretary
 Ten other directors from various fields.
Under Raghuram Rajan’s governorship, he wanted to
create a post of a Chief Operating Officer, in the rank
of Deputy Governor.
Indian Economy
Two of the four deputy governors are traditionally
from RBI ranks; they are selected among the bank’s
executive directors. One is nominated from among the
chairpersons of public sector banks, and the other is
an eminent economist.
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Governor Of RBI
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Appointment: The Financial Sector Regulatory
Appointments Search Committee (FSRASC), which
is presided over by the Cabinet Secretary, made the
recommendation for the appointment.
Term: According to Section 8 (4) of the RBI Act, the
Governor and Deputy Governors shall hold office
for such term not exceeding 5 years as the Central
Government may fix when appointing them.
Re-Appointment: They are eligible for
re-appointment
Qualification: The RBI Act does not provide for
any specific qualification for the governor.
Removal: The governor can be removed by the
central government.
PREVIOUS YEAR QUESTION (PRELIMS)
1. Consider the following statements:(2021)
1. The Governor of the Reserve Bank of India (RBI)
is appointed by the Central Government.
2. Certain provisions in the Constitution of India
give the Central Government the right to issue
directions to the RBI in the public interest.
3. The Governor of the RBI draws his power from the
RBI Act.
Which of the above statements are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
11.5STRUCTURE OF RESERVE BANK OF
INDIA
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Currently, the RBI has 26 departments for policy issues
in the functional areas and internal operations. To
manage different functional areas various departments
are created as mentioned below:
Departments of RBI
Markets
Research
Services
Support
1. Internal Debt Management Department.
2. Department of External Investments and Operation.
3. Monetary Policy Department.
4. Financial Markets Department.
5. Regulation, Supervision and Financial Stability.
6. Department of Non-Banking Supervision.
7. Department of Banking Supervision.
8. Department of Banking Operations and Development.
9. Urban Banks Department.
10. Foreign Exchange Department.
11. Rural Planning and Credit Department.
12. Financial Stability Unit.
1. Department of Economic and Policy Research.
2. Department of Statistics and Information Management.
1. Department of Government and Bank Accounts.
2. Department of Currency Management.
3. Department of Payment and Settlement System.
4. Customer Service Department.
1. Human Resource Management Department.
2. Department of Communication.
3. Department of Information Technology.
4. Department of Expenditure and Budgetary Control.
5. Premises Department.
6. Secretary’s Department.
7. Rajbhasha Department.
8. Inspection Department.
9. Legal Department.
RBI and Monetary Policy in India
137
11.6 FUNCTIONS OF RBI
The Reserve Bank of India was established on the model of the Bank of England.
It was entrusted with the task of performing all those functions that the Bank of England had then performed.
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Issuance of Currency Note
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Banker to the
Government
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Bankers' Bank
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The RBI is the sole authority for issuing currency notes (except one-rupee notes and
subsidiary coins) in the Indian economy. As RBI derives its power to issue currency
from Section 22 of the RBI Act 1934.
All currency notes issued by the RBI are legal tender in India's economy.
The RBI Act permits the issue of currency notes in rupees in the denominations of
two, five, ten, twenty, fifty, one hundred, five hundred, one thousand, five thousand
and ten thousand.
Or in any other amounts that do not exceed `. 10,000 that the Central Government
may specify at a later time.
The RBI acts as a banker to both Central and State governments.
As a banker, it renders a variety of banking services to the government, including
acceptance of money deposits, withdrawal of funds by cheque, collection of payments
to the Government and transfer of funds.
The Reserve Bank is under statutory obligation to render banker's services to the
Central Government
It is important to note here that, the State Governments, however, obtain these
services from the RBI under agreements entered with it.
The RBI, with its experts specializing in various areas, is in a position to advise the
government not only on banking and financial matters but also on issues about
overall economic planning.
The importance of this function has increased due to the need for integration
between monetary and fiscal policies.
The RBI does not deal with the public or business firms, it is only a bankers' bank.
The RBI provides financial support to commercial and other banks in the form of
rediscounting of bills as well as loans and advances against approved securities, for
durations of up to 90 days.
While giving advances to banks it has to discriminate between banks on the bases
of their financial positions, lending policies and the securities offered.
It is within the RBI’s powers to deny financial assistance to any bank wanting to
borrow from it without assigning any reason.
Foreign exchange management and control involve three main functions:
1. Maintaining the external value of the currency
2. Management of external reserves of the country
3. Exchange control
Foreign Exchange
Management and Control
These tasks must all be carried out by the RBI, the nation's central bank.
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Presently, the exchange value of the rupee is determined by the daily exchange rate
movements of a selected number of currencies of the countries which are India's
major trading partners.
The selection of the currency units and the weights to be assigned to them has been
left to the discretion of the RBI.
As a custodian of foreign exchange reserves, the RBI manages the investment and
utilisation of these reserves.
The exchange control is presently governed by the Foreign Exchange Regulation
Act, of 1973.
Indian Economy
Credit Control
Regulation of credit following the needs of the economy is perhaps the most significant
function of a central bank.
The monetary policy relying primarily on credit control also aims at realising this
objective by frequently changing CRR, SLR, Repo Rate and Reverse Repo Rate.
Thus, the control of the credit function of the RBI assumes unique importance.
To regulate the supply of credit, the RBI used quantitative and qualitative techniques.
As a Banker to Banks, the Reserve Bank also acts as the ‘lender of the last resort’.
It can help a bank that is solvent but is experiencing short-term liquidity issues by
providing it with much-needed liquidity when no one else will give that bank credit.
Lender of Last Resort
The Reserve Bank offers this facility in order to safeguard the interests of the bank's
depositors and avoid a potential bank failure, which could have a negative effect on
financial stability and, consequently, the economy.
the banking system throughout the nation by setting
Legal Tender
up various institutions like UTI,IDBI, IRCI,NABARDetc.
Thereby it promoted banking habits among the people.
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Legal tender refers to the national currency,
including coins and paper money, that is
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Providing Refinance for Exports: The RBI is
acknowledged by the law as acceptable for paying
providing refinance for export promotion. The Export
debts and other financial obligations.
Credit and Guarantee Corporation (ECGC) and ExportImport Bank (EXIM) were established initially by the
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Money that has been issued by the government or
RBI to finance foreign trade in India. They finance
central banks and is accepted as a form of payment
foreign trade in the form of insurance cover, long-term
in commerce is known as legal tender.
finance and foreign currency credit. However, they are
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The government and the RBI both print coins and
now functioning separately.
currency notes that are considered to be legal
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Providing Credit to Agriculture: The RBI makes
tender. Demonetization is the process of removing
institutional arrangements for rural or agricultural
this legal tender status.
finance. For example, the bank has set up special
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Note: The One Rupees notes and coins are issued
Agricultural Credit Cells. It has promoted Regional
by the Ministry of Finance.
Rural Banks with the help ofcommercial banks. It has
also promoted NABARD.
Supervisory Functions:
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Providing Credit to Small Scale Industrial Units:
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Under the RBI Act, 1934 and the
Commercial banks provide loans to small-scale
Banking Regulation Act, 1949
industrial units as per the directives issued by the RBI
the RBI has been given extensive
from time to time. The RBI encourages commercial
powers to control commercial
banks to render guarantee services also to the smallbanks.
scale industrial sector. The RBI considers advances
given to small-scale sectors as priority sector advances.
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Commercial
banks’
licence,
branch
expansion,
asset
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Providing Indirect finance to the Cooperative
liquidity,
management
and
Sector: The RBI has instructed NABARD to issue loans
to State Cooperative Banks, which in turn lend loans
operational procedures, mergers,
Control and
to the cooperative sector. Hence, the RBI provides
reconstruction, and liquidation are
Supervision of
indirect finance to the cooperative sector in India.
all subject to regulatory oversight.
Banks
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Making Industrial arrangements for Industrial
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For control, the RBI conducts
Finance: The RBI makes institutional arrangements
inspections of the banks and calls
for industrial finance. For instance, it has brought
for returns and information from
into existence several development banks such as the
them.
Industrial Finance Corporation of India (IFC), and the
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In case the operations of the bank
Industrial Development Bank of India (IDBI), which
are found to be unsatisfactory, the
provide long-term finance to industries.
RBI may recommend remedial
measures
to
improve
the
PREVIOUS YEAR QUESTION (PRELIMS)
functioning of that bank.
Promotional Functions of RBI:
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Promotion of Banking Habit: RBI helps in mobilizing
the savings of the people for investment. It expanded
RBI and Monetary Policy in India
1. In India, the central bank’s function as the ‘lender of
last resort’ usually refers to which of the following?
(2021)
139
1. Lending to trade and industry bodies when they
fail to borrow from other sources.
2. Providing liquidity to the banks having a temporary
crisis.
3. Lending to governments to finance budgetary
deficits.
Select the correct answer using the code given below.
(a) 1 and 2
(b) 2 only
(c) 2 and 3
(d) 3 only
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National Strategy for Financial
Education (NSFE): 2020-2025
2. Which one of the phenomena essentially 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, drafts, bills
of exchange etc.
(d) The metallic money in circulation in a country
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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) 2, 3 and 4 only
(c) 1, 2 and 3 only
(d) 1, 2, 3 and 4
4. 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 assets in the 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
5. 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 commercial banks in times
of need.
3. The RBI advises 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
11.7 SUBSIDIARIES OF RBI
National Centre for Financial Education (NCFE):
According to the Financial Stability and Development
Council’s (FSDC) National Strategy for Financial
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Education, it aims to promote financial literacy among
all demographic groups in India.
Through financial education campaigns across the
nation for all swaths of the population, it works to
improve their knowledge and understanding through
seminars, workshops, programmes, campaigns, and
discussion forums.
It is a Section 8 company that the Reserve Bank of
India has supported as being non-profit.
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Under the guidance of the Technical Group on
Financial Inclusion and Financial Literacy (TGFIFL),
the National Centre for Financial Education (NCFE)
developed this NSFE for the years 2020–2025 in
consultation with all financial sector regulators,
including the RBI, Securities and Exchange
Board of India (SEBI), Insurance Regulatory and
Development Authority of India (IRDAI), Pension
Fund Regulatory and Development Authority
(PFRDA), and others.
It has proposed a ‘5 C’ method to financial
education diffusion across the country:
1. Communication: Use technology, media
and innovative ways of communication for
dissemination of financial education messages.
2. Collaboration: Streamline efforts of other
stakeholders for financial literacy.
3. Capacity: Develop the capacity and ‘Code of
Conduct’ for financial education providers.
4. Content: Financial Literacy content for various
sections of the population.
5. Community: Evolve community-led approaches
for disseminating financial literacy sustainably.
National Housing Bank (NHB):
It was established on July 9, 1988, under the National
Housing Bank Act, of 1987.
In order to serve all facets of the population and
integrate the housing finance system with the broader
financial system, NHB was established to promote a
sound, healthy, viable, and affordable housing finance
system.
Its authorised capital is $1,450 crore, and the
Government of India owns 100% of it. It was in
response to the Narasimham-II committee report’s
recommendation.
NHB RESIDEX, a project of the National Housing Bank
(NHB), was started by the Ministry of Finance and is
the country’s first official index of housing prices.
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NHB Residex
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It is a set of benchmarks that tries to measure home
price indices across Indian cities.
A technical advisory council composed of
government representatives, bankers, and property
market participants created it.
Indian Economy
Deposit Insurance and Credit Guarantee Corporation of
India (DICGC):
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DICGC came into existence on July 15, 1978, and was
formed by merging Deposit Insurance Corporation
(DIC) and Credit Guarantee Corporation of India Ltd.
(CGCI).
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Its functions are governed by the provisions of DICGC
Act, 1961 framed by the Reserve Bank of India.
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It is a fully owned subsidiary of and is governed by
the RBI.
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It was established for providing insurance for deposits
and guaranteeing credit facilities.
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Currently, it insures each depositor of a registered
insured bank up to a maximum of `.5 Lakh for all bank
deposits, such as savings, fixed, current, and recurring
deposits.
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Except the following types of deposits:
 Deposits of foreign Governments.
 Deposits of Central/State Governments.
 Interbank deposits.
 Deposits made by the state cooperative banks to
the state land development banks.
 Any sum owing as a result of a deposit made
outside of India.
 Any sum that the corporation has expressly
exempted with the prior approval of the RBI.
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It has the power to cancel the registration of an
insured bank if it fails to pay the premium for three
consecutive half-year periods.
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If a bank files for bankruptcy or liquidation, DICGC
will pay the debt.
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The Corporation maintains the following funds:
 Deposit Insurance Fund
 Credit Guarantee Fund
 General Fund
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The first two are used to pay the corresponding
claims and are funded by the insurance premium and
guarantee fees received, respectively.
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The General Fund is utilised for meeting the
establishment and administrative expenses of the
DIGCG.
Deposit Insurance and Credit Guarantee
Corporation (DICGC) Bill, 2021
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Recently, The Deposit Insurance and Credit
Guarantee Corporation (DICGC) (Amendment) Bill,
2021, has been passed by Parliament.
The DICGC Act was amended by the Cabinet,
allowing customers to access their deposits up to `
5 lakh in just 90 days in the event that their banks
fail and are put on a moratorium.
RBI and Monetary Policy in India
Bharatiya Reserve Bank Note Mudran Private Limited
(BRBNMPL):
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It was established by RBI as its wholly-owned
subsidiary in 1995 and was registered as a Private
Limited Company under the Companies Act 1956.
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Its main role includes maintaining the production of
banknotes in India to enable the RBI to bridge the
gap between the supply and demand for banknotes
in the country.
Security Printing and Minting
Corporation of India Limited (SPMCIL)
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The SPMCIL is a company under the Department
of Economic Affairs.
It is in charge of managing the government of
India’s printing and minting operations.
It is under the ownership of the Ministry of
Finance, Government of India. Itwas incorporated
on 13 January 2006 with its registered office at
New Delhi.
It manufactures or produces money and banknotes,
security paper, non-judicial stamp papers, postage
stamps and stationery, passports and visas,
checks, bonds, warrants, special certificates
with security features, security inks, circulation
and commemorative coins, medallions, assaying
gold and silver, and other precious metals, as
well as security certificates, cheques, bonds, and
medallions.
Reserve Bank Information Technology Private Limited
(ReBIT):
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In 2016 Reserve Bank Information Technology Private
Limited was established.
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It has been set up by the RBI to maintain its IT and
cybersecurity needs and to ensure the cyber resilience
of Indian banking.
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Assist RBI in carrying out risk-based supervision of
regulated entities, deliver and manage IT projects
for RBI, and protect RBI assets by identifying and
addressing cyber threats.
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ReBIT will have four verticals to support its
mission: Cyber Security; Research and Innovation;
Systems Audit; Project Management.
Indian Financial Technology and Allied Services (IFTAS):
IFTAS, a wholly-owned subsidiary of the RBI, is
registered under the Companies Act, 2013.
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It is mandated to design, deploy & support IT-related
services to all Banks and Financial Institutions in the
country and also to the RBI.
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It manages and operates the Financial Messaging
Platform (FMS) that comprises Real-Time Gross
Settlement (RTGS) and National Electronic Funds
Transfer (NEFT).
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141
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The only community cloud in the nation, Indian
Banking Community Cloud, is run by IFTAS (Indian
Financial NETwork) and hosts cloud-based services
specifically for the banking and financial community.
The IFTAS has taken over the INFINET, Structured
Financial Messaging System (SFMS) and the Indian
Banking Community Cloud (IBCC) from the IDRBT,
effective 2016.
 IFTAS offers the Indian Financial Network
(INFINET), a private MPLS network for the
banking and financial industries.
 Structured Financial Messaging System (SFMS):
A messaging system facilitating RTGS, NEFT,
Government payments, receipts, etc.
 Indian Banking Community Cloud (IBCC):
Providing CBS and other software applications such
as SFMS, mobile banking, etc. as web service/s.
 Global Interchange for Financial Transactions
(GIFT): An integrated payment & settlement
system based on an open-source technology stack.
Reserve Bank Innovation Hub (RBIH):
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It had been registered as a section 8 company under
the Companies Act 2013 with an initial capital
contribution of `. 100 crore.
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It intends to build an ecosystem that promotes access
to financial services and goods for the country’s lowincome people.
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By utilising technology and fostering an innovative
environment, the RBIH was established to encourage
innovation throughout the financial sector.
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It is guided and managed by a Governing Council (GC)
led by a Chairperson.
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Swanari TechSprint was held at the RBI Innovation
Hub to develop long-term solutions for women-owned
businesses. TechSprint aims to increase women’s
digital financial inclusion in India.
Half-Yearly
Reserve Bank of India being the premier institute in
the financial sector of India as well as of being Central
Bank published a variety of papers at different time
frames.
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Annual
Publication
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Branch Banking Statistics
Handbook of Statistics on Indian
States
Handbook of Statistics on Indian
Economy
Report on Currency and Finance
State Finances: A Study of Budgets
Primary
(Urban)
Co-operative
Banks’ Outlook
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Quarterly
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Financial Stability Report
Report on Foreign Exchange Reserves
Quarterly Industrial Outlook Survey
Monetary Policy Report
Bank Lending Survey
Consumer Confidence Survey
Services and Infrastructure Outlook
Survey
11.9 MINIMUM RESERVE SYSTEM OF RBI
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The Minimum Reserve System is the procedure the
RBI uses when issuing foreign currency.
It was initially enacted in 1957. The RBI must maintain
a minimum reserve of 200 crore rupees, which must
be made up of foreign currency, gold coins, and gold
bullion (at least 115 crore rupees must be in the form
of gold).
This means that by maintaining the Minimum Reserve
System, there is no limit for the RBI to issue currencies
by keeping this minimum reserve.
Objectives Of Minimum Reserve System (MRS):
 Maintaining the economy’s money supply while
avoiding inflationary pressures and maintaining
the general public’s trust in the currency.
 To reassure Indian currency holders that the rupee
in their possession is lawful tender.
 Through MRS, the RBI hopes to guarantee a
sufficient flow of money into the economy.
 Through MRS, the RBI hopes to increase the
country’s economic growth without raising the
rate of inflation.
11.10 SOURCES OF INCOME OF RBI
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11.8 PUBLICATIONS OF RBI
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Open Market Operation (OMO): Being the central
Bank of India RBI earns money in a variety of ways,
Open market operations, in which a central bank
purchases or sells bonds in the open market to
regulate the money supply in the economy, are a major
source of income for the RBI.
Interest amount: It also receives a substantial amount
of interest from bonds that it purchases from the
government and international currency, the RBI may
also profit from favourable changes in bond prices.
Foreign exchange: RBI’s dealings in the foreign
exchange market also contribute to the enormous
profits of banks.In a way, the RBI may buy dollars
cheaply and sell them dearly in the future to pocket
profits.
Value of Rupee: But, unlike commercial banks, the
primary mandate of the RBI is not to earn profits but
to preserve the value of the rupee. Profit and loss
Indian Economy
generated in the process are thus merely a side effect
of its regular operations to shape monetary policy.
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11.11 EXPENDITURE OF RBI
11.11.1 Present Status
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The size of the RBI’s balance sheet has increased by
8.46 per cent as on March 31, 2022, primarily due to
favourable growth in its liquidity and foreign exchange
operations during the year.
While the income of RBI for the year 2021-22
increased by 20.14 per cent, expenditure increased
by 280.13 per cent.
According to the RBI Annual Report, the overall
surplus for the fiscal year 2021–22 was ` 30,307.45
crore as opposed to ` 99,122 crore the year before, a
decrease of 69.42 per cent.
The increase in the asset side was due to the increase
in foreign investments, domestic investments, gold,
and loans and advances.
On the liability side of RBI, the increase was due to an
increase in deposits and notes issued by it.
It is important to note here that domestic assets
constituted 28.22 per cent while the foreign currency
assets and gold (including gold deposits and gold held
in India) accounted for 71.78 per cent of total assets
as of March 2022 as against 26.42 per cent and 73.58
per cent, independently, a year ago.
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11.11.3 Liabilities of Reserve Bank
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11.11.2 Assets of Reserve Bank
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Foreign Currency Assets (FCA): Foreign Currency
Assets, Gold, SDR and Reserve Bank position with the
IMF are part of India’s Foreign Exchange Reserves.In
Foreign Currency Assets, it encompasses investments
in United States Treasury bonds, Treasury Bills of
other selected Governments, deposits with foreign
central banks, and foreign commercial banks.
Gold Coin Bullion: It represents the gold coin bullion
of the Issue Department and Banking Department.The
gold reserves of the Issue Department and Banking
Department are valued at monthly prices.
Rupee Securities: Rupee securities consist of
government securities from the ‘foreign country
maturing within ten years of the Issue Department
plus investment in government securities of the
Banking Department.
Loans and Advances: RBI gives loans and advances to
the Central & State Governments as well as commercial
and cooperative banks and others in terms of Sections
17 and 18 of the Reserve Bank of India Act, 1934,
which in total forms the asset part of RBI. Loans and
Advances to NABARD under section 17 (4E) of the
RBI Act.
RBI and Monetary Policy in India
Loans and Advances to Scheduled Commercial
Banks, State Co-operative Banks: Loans and
advances to SCBs, State Co-operative Banks made by
the RBI under Sections 17 & 18 of the Reserve Bank
of India Act, 1934.The loans and advances to SCBs
represent refinance capabilities provided to banks
primarily as a result of an increase in export credit
refinance.
Loans and Advances to others: It mainly includes the
loans given under special refinance schemes to EXIM
Bank and collateralized loans to primary dealers.
Bill Purchased and Discounted: RBI Act permits
holding internal bills of exchange and commercial
papers eligible for purchase. The assets of the RBI
also consist of discounted and bought Treasury bills.
Investment: It mainly represents the investment of
RBI in Non-Government securities.The major items
are DICGC share capital, Bharatiya Reserve Bank
Note Mudran share capital, NABARD share capital and
National Housing Bank share capital.
Other Assets: Generally it includes RBI’s fixed assets
like various Premises, furniture, fittings, non-movable
properties etc. at different centres, income accrued
but not received and Rupee coins.
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Notes Issued: The currency notes issued by the RBI
are the liability.
 Notes in Circulation: The notes in circulation
include notes issued by the Government of India
prior to 1935 and by the RBI since then, minus
notes held outside the Banking Department, i.e.
notes held by the public, banks treasuries, and so
on.The one rupee notes issued by the Government
of India from July 1940 are considered as rupee
coins and hence are not listed under this heading.
 Notes held in the Banking Department:
Notes held in the Banking Department reflect
the number of notes maintained in the Banking
Department of the Bank at various locations to
suit the Department’s day-to-day needs.Notes in
circulation and notes in the Banking Department
are both liabilities of the Issue Department.
Deposits: These represent the cash balances
maintained with the RBI by the Central and State
Governments, banks, and all Indian financial
institutions. According to sections 20 and 21, the RBI
serves as a banker to the Central Government. It also
acts as a banker to the State Governments by mutual
agreement in terms of section 21(A) of the RBI Act.
Market Stabilisation Scheme (MSS): It was
introduced in April 2004, where the Government issues
securities specifically for sterilisation operations.
Government paper is being issued under the MSS
in order to absorb extra rupee liquidity created by
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capital flows of an enduring nature.The proceeds from
the MSS were parked in a separate deposit account
maintained by the Government with the RBI which
was used only for redemption and/or buyback of
paper issued under the MSS.
Other Liabilities: include internal reserves and
provisions of the Reserve Bank such as Currency and
Gold Revaluation Account, Exchange Equalisation
Account, Contingency Reserve and Asset Development
Reserve.
 Contingency Reserve represents: The amount
set aside on a year-to-year basis for meeting
unexpected contingencies including depreciation
in the value of securities and risks arising out
of monetary/exchange rate policy compulsions.
These liabilities are called non-monetary liabilities
of the Reserve Bank.
 Currency and Gold Revaluation Account
(CGRA): CGRA is one of the important accounts
wherein unrealised gains/losses on the valuation
of Foreign Currency Assets and gold due to
movements in the exchange rates and price of
gold are not taken to the Profit & Loss Account
but instead booked under this head.
 Investment Revaluation Account (IRA): RBI
values foreign-dated securities at market prices
prevailing on the last business day of each month.
So, the appreciation or depreciation arising
therefrom is transferred to the IRA.
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Surplus Transfer
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The RBI’s Central Board decided on August 26th to
transfer a sum of 1,76,051 crore to the government,
consisting of 1,23,414 crore of surplus for the fiscal
year 2018-19 and 52,637 crores of excess provisions
identified as per the revised Economic Capital
Framework (ECF) adopted at the Central Board
meeting.
Bimal Jalan Committee: The RBI Surplus Distribution
Policy has been completed and complies with the
recommendations of the Bimal Jalan Committee,
which was established by the RBI in collaboration
with the Government to review the RBI’s current
Economic Capital Framework.
 The Jalan Committee suggested that the Contingent
Risk Buffer (CRB) be kept between 5.5% and 6.5%
of the RBI’s balance sheet.
 The excess transfer policy is now formula-based
and hence transparent, a significant shift from
previous policies.
 The risk provisioning will be handled by the
formula-based CRB, and the degree of risk
provisioning will be determined by the RBI’s
central board.
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1934 Act: According to Section 47 (Allocation
of Surplus Profits) of the Reserve Bank of India
Act, 1934, the RBI allocates the surplus - that is,
the excess of income over expenditure - to the
government.
Malegam Committee: A technical committee
of the RBI Board led by Y H Malegam (2013)
which evaluated the adequate amount of reserves
and surplus distribution policy suggested a
greater transfer to the government. With a few
exceptions, the amount of excess transfer averages
approximately 0.5% of GDP.
11.12.1 Reason For Huge Transfer
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11.12 RBI SURPLUS TRANSFER
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Key Parameter: The recommendations of the
Committee were based on a review of the role of central
banks’ financial resilience, cross-country practices,
legislative provisions, and the effect of the RBI’s public
policy mission and operational environment on its
balance sheet and the risks associated.
Financial stability: Given the RBI’s role as a lender
of last resort, it must retain some CRB to protect the
economy from any tail risk of a financial stability crisis.
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Overcapitalised RBI: For some time, the narrative
that the RBI is an over capitalised organisation has
been debated. According to the Economic Survey
2016–17, the RBI is one of the most capitalised central
banks in the world, and “there is no specific reason
why this excess capital should be held with the RBI.”
Cooperative capitalisation: Some central banks
throughout the globe (such as the United States and
the United Kingdom) hold 13% to 14% of their assets
as reserves, compared to the RBI’s 27% while some
(such as Russia) keep more.
Constructive use: Economists have previously
advocated for the RBI to release “excess” capital that
the government may put to constructive use. In 2013,
the Malegam Committee assessed the surplus to be
1.49 lakh crore.
11.13AUTONOMY AND INDEPENDENCE
OF THE RBI
11.13.1 Need for the Independence
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Separation of powers, in Montesquieu’s view,
guarantees the effective operation of important
governmental institutions since it prevents any
one entity from acquiring a political monopoly and
abusing its authority.
In their book “Why Nations Fail”, Acemolu and
Robinson make the case that inclusive political and
economic structures ensure the rule of law and foster
innovation via a diversity of viewpoints.
Indian Economy
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Extractive institutions, on the other hand, will result
in the concentration of resources in the hands of the
governing elites, inhibiting change and innovation.
11.13.2 Autonomy of Central Bank
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About twenty years ago, when the concept of central
bank independence first emerged, it was thought to
refer to a ‘functional’ independence.
In other words, the bank’s operations, including the
methods and tools it uses, would not be constrained
by the government.
Its independence was not intended to go as far as
“goal” independence, though. Without consulting the
bank, the government would decide what the central
bank’s objectives should be.
The major question at hand was whether the bank
should emphasise employment levels in addition to
inflation.
After a decade of discussion, it was agreed that the
former would receive all attention, and monetary
policy only came to be known as “inflation targeting.”
“A central bank is not expected to be subordinate to
the government.”
– YV Reddy, former RBI Governor
11.13.4 Reasons for Diminishing Autonomy
of RBI
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11.13.3 Autonomy of RBI
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The independence of the RBI is a crucial component
for the achievement of financial liberalisation after
1991.
The idea of autonomy is based on two fundamental
principles. The first is that monetary policy is seen as
a branch of the larger economic policy.
The central bank’s responsibility for implementing
economic policy includes ensuring the health and
efficiency of the banking system, which is crucial
for enhancing its ability to meet the demands of the
economy.
The ownership of the central bank by the government
and the central bank’s control over the monetary and
financial system must be clearly distinguished from
one another.
This line between the two is frequently blurred,
leaving the appearance that ownership also gives the
government the authority to control the monetary
system.
The RBI is not an autonomous organisation. RBI Act’s
Section 7, lays out things quite unambiguously.
 Part (1) of Section 7 states that “The Central
Government may from time to time give such
directions to the Bank as it may, after consultation
with the Governor of the Bank.”
 Whereas in parts (2) and (3) spell out the roles for
the Central Board and Governor.
 It made clear a ‘seniority’ principle with (1) taking
precedence over (2) which takes precedence over
(3).
RBI and Monetary Policy in India
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Least Independent: The RBI was ranked as the
least independent of the 89 central banks taken into
consideration in the analysis, according to a report
published in the International Journal of Central
Banking in 2014.
Monetary
Policy
Committee:
Since
the
implementation of inflation targeting in February
2015 and the establishment of the Monetary Policy
Committee in October 2016, these rankings are
probably better.
Commission On Financial Sector Legislative
Reforms: It was established under the previous
administration, and it produced a number of
suggestions to reduce the authority of the RBI.
Financial Stability Development Council: A financial
sector oversight group dubbed the Financial Stability
Development Council, which was to be presided over
by the finance minister, was founded in 2013.
Limited authority: In essence, RBI does not have
unlimited authority under the 1934 RBI Act. However,
it does possess a great deal of independence when
it comes to carrying out its monetary and regulatory
responsibilities.
11.13.5 Issues Between RBI and
Government
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Easing Norms of Prompt Corrective Action (PCA)
 Electricity firm: The government has requested
that the RBI exclude electricity firms from the PCA
framework.
 Credit Availability: The government wants
the RBI to relax lending regulations under PCA
because it can benefit MSMEs by increasing credit
availability.
 NPA: According to the RBI, such a move would
imperil all attempts to address the country’s NonPerforming Asset (NPA) Crisis.
Section 7 of RBI Act of 1934:
 Directives: The government, which owns 21
public sector banks, is issuing the directive to the
RBI, the banking regulator.
 Public Interest: This clause gives the government
the authority to offer directives to the RBI in the
public interest.
 Consultation clause: According to the clause,
orders must be issued following a consultation
with the RBI governor.
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RBI Surpluses:
Surplus: The RBI earns income on its domestic
and international bonds every year. This income is
utilised to conduct the operations of the RBI, with
the remainder accruing as a surplus. To maintain
its creditworthiness, the RBI keeps a portion of the
surplus as equity capital and gives the government
the rest.
 Risk assessments: After determining that its
equity position of about ` 10 lakh crore was
appropriate based on risk assessments in 2015,
the RBI chose to transfer its entire excess to the
government (around ` 65,876 crore for 2015-16).
 Larger funds: The government believes that the
RBI should pay larger dividends since it has built
up buffers such as the Contingency Fund and
Asset Reserve considerably in excess of what is
necessary to sustain creditworthiness.
 Inflation issues: According to the RBI, raising the
dividend payment to the government may cause
inflation since there would be more money in the
market, which may impair the RBI’s main objective
of macroeconomic stability.
 Contingency fund: The surplus is also intended
to cover a situation in which the rupee increases
against one or more currencies, or if the rupee
value of gold falls.
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11.14 NEW INITIATIVES BY RBI
11.14.1 RBI Retail Direct Scheme
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RBI Retail Direct Scheme: Retail Direct scheme
is a one-stop solution to facilitate investment in
Government Securities by Individual Investors. Under
Under this programme, individual retail investors can
open an RDG (Retail Direct Gilt) Account with the RBI
for a Gilt Securities Account.
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A G-Sec is a tradable instrument issued by the
Central or State Governments.
It recognises the government’s debt obligations.
Such securities are either short-term (called
treasury bills since they had initial maturities of
less than one year and are now issued in three
tenors: 91 days, 182 days, and 364 days) or longterm (usually called Government bonds or dated
securities with an original maturity of one year or
more).
In India, the State Governments only issue bonds
or dated securities, known as State Development
Loans (SDLs), while the Central Government issues
both Treasury Bills and Bonds or Dated Securities.
G-Secs have almost no default risk and are hence
referred to as risk-free gilt-edged products.
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Government Security (G-Sec)
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11.14.2 Integrated Ombudsman Scheme
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Combination of Ombudsman: The integrated
ombudsman system consists of three RBI schemes:
the 2006 banking ombudsman scheme, the 2018
ombudsman programme for NBFCs, and the 2019
ombudsman scheme for digital transactions.
One Nation-One Ombudsman: It is built on the
concept of “One Nation-One Ombudsman,” with a
single site, email, and address where customers may
report their complaints.
Inclusion: Non-scheduled primary co-operative
banks with deposits of ` 50 crore or more are also
included in the new plan.
The Principal Nodal Officer: In the position of a
General Manager at a Public Sector Bank or similar,
would be responsible for representing the Regulated
Entity and providing information in response to client
complaints.
Redressing grievance: It would strengthen the
grievance redress procedure for dealing with
consumer concerns against RBI-regulated firms.
Education and Protection: The combined
arrangement would put the RBI’s Executive Director
in charge of the Consumer Education and Protection
Department.
Single account: Customers will be able to use a single
email account to raise complaints, send documents,
track status, and provide comments.
Grievance remedies: There will be a toll-free
hotline in many languages that will give all essential
information on grievance remedies. It will be free for
bank clients and the public.
11.15 MONETARY POLICY OF RESERVE
BANK OF INDIA
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The use of instruments within the central bank’s
authority to govern the cost, availability, and use of
money and credit is referred to as monetary policy.
As a rising market economy, India now places a greater
emphasis on the creation of sound monetary policies.
In order to establish a statutory foundation for
implementation and bring accountability and
transparency, it was revised in 2016.
While the monetary policy regulates the amount of
money in the economy, the fiscal policy determines
how a government manages its taxing and spending.
Exerting Control: In order to preserve price stability
and boost economic growth, the RBI uses this method
to exert control over the amount of money available in
the economy.RBI is charged with carrying out monetary
policy in India in accordance with the Reserve Bank of
India Act, 1934 (as amended in 2016).
Indian Economy
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Type: Monetary policy can be expansionary or
contractionary.
Inflation Management: Additionally, it aids in
regulating different business cycles like inflation and
deflation.
Money control: The central bank controls the amount
of money and credit in circulation through monetary
policy.
Economic growth: The country’s economic growth
is influenced by monetary policy, which also manages
inflation by altering the money supply and interest
rates.
Economic objective: It directs money to the regions
where it is most needed to achieve overall economic
objectives.
By way of monetary policy, the government, or the
monetary authority of the country controls the:
 Supply of money
 Availability of money
 Rate of interest to attain laid down objectives
aimed at economic growth and stability.
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11.15.2 Characteristics Feature of Monetary
Policy in India
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Economic growth: By controlling the economy’s
prices and income, investment is made possible,
which boosts economic growth.
Employment Generation: Central banks play a
pivotal role in creating jobs in the economy through
successfully managing the Monetary policy of
respective countries.
Price stability: By controlling the value of money,
monetary policy aims to achieve price stability.
When there is a recession, interest rates on loans are
lowered to help the economy. Loans may occasionally
be granted with higher interest rates in an effort to
reduce the money supply.
Exchange rate stability: Maintaining exchange rate
stability is crucial for building global trade trust.
Exchange rate volatility may have unfavourable
consequences such as a decline in the value of the
currency, speculation, and a capital flight overseas.
Equilibrium of the Balance of Payments (BoP): The
BoP is a description of all transactions that occurred
between entities in one country and the rest of the
world during a given time period. The Reserve Bank
of India maintains the equilibrium through the use of
monetary policy.
Financial stability: The monetary policy aims to
maintain financial stability in the economy and to
lessen jarring, volatile oscillations in the financial
market and the overall level of volatility.
Inflation target: According to the RBI Act, the
Government of India must set an inflation target every
five years after consulting with the RBI.
RBI and Monetary Policy in India
A dynamic policy because the RBI creates it annually
and updates it four times a year.
The flow of money into the economy can be monitored
by the RBI.
Flexible since the RBI can alter it in response to market
circumstances by altering the various rates.
Promotes the nation’s trend of saving and investing.
The RBI offers a variety of tools and methods for
controlling credit.
11.15.3 Role of Reserve Bank of India in
Monetary Policy
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11.15.1 Objectives of Monetary Policy
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The Consumer Price Index (CPI) is expected to rise by
5.7% between 2021 and 2022, according to the RBI.
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The RBI is the supreme body and the nation’s Central
Bank, which oversees the banking sector and manages
the nation’s monetary policy.
“It has the function to regulate the issue of Bank
Notes and holding of reserves with a view to securing
monetary stability in India and generally to operate
the currency and credit system of the country to its
advantage,” the Preamble of the RBI states.
It controls everything related to banking, including
currency issuance, managing foreign exchange,
lending money to banks, selling government securities,
maintaining liquidity conditions, and financial
inclusion.
It functions as a banker’s banker and avoids micro
or macro banking. Its monetary strategy attempts to
stabilise the economy and provide a setting that is
favourable for economic expansion.
In addition to providing liquidity for profitable
industries, the RBI safeguards the stability of interest
rates and exchange rates.
It ensures the growth of financial institutions and
keeps track of the credit flow to various economic
sectors.
The RBI supports monetary stability as both a
currency note issuer and regulator.
11.15.4 Types of Monetary Policy
Expansionary Monetary Policy
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A particular economy’s money supply is to be increased
by an expansionary monetary policy.
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Reduced key interest rates and increased market
liquidity are used to implement an expansionary
monetary policy.
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A monetary policy that is expansionary is implemented
by reducing key interest rates and increasing
market liquidity.
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When the economy is in a recession, this is typically
done to raise the money supply, boost consumption,
and create demand.
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Another name for this is “Dovish Monetary Policy”.
Contractionary Monetary Policy
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Contractionary monetary policy aims to reduce
(decrease) the money supply in an economy.
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A contractionary monetary policy is achieved by
raising key interest rates, which decreases market
liquidity.
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This is typically used to lower the money supply,
lower demand, and lower consumption when the
economy is experiencing inflation.
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It also goes by the name “Hawkish Monetary Policy.”
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PREVIOUS YEAR QUESTION (PRELIMS)
1. If the RBI decides to adopt an expansionist monetary
policy, which of the following would it not do?(2020)
1. Cut and optimise the Statutory Liquidity Ratio
2. Increase the Marginal Standing Facility Rate
3. Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
2. Which one of the following is not the most likely
measure the Government/RBI takes to stop the slide
of the Indian rupee?
(2019)
(a) Curbing imports of nonessential goods and
promoting exports
(b) Encouraging Indian borrowers to issue rupeedenominated Masala Bonds
(c) Easing conditions relating to external commercial
borrowing
(d) Following an expansionary monetary policy
11.16 MONETARY POLICY STANCES
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Neutral stance: It implies that interest rates can move
in either direction—upward or downward.
Calibrated tightening: It implies that interest rates
can only rise.
Accommodative stance/Expansionary stance:
It refers to the insertion of additional funds into
the financial system.The RBI is motivated by falling
‘headline inflation,’ and such a stance is intended to
increase lending, investment, and growth.
Contractionary stance: It Entails removing cash from
the financial system.When more than optimal funds
are believed to be available in the financial system,
such a stance is generally taken. It is sometimes also
aimed at long-term inflation control.
Hawkish stance: Denotes a contractionary stance
aimed at preventing inflation from rising (related to
the statutory inflation targets of ‘headline inflation’).
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Operation Twist
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It is a Federal Reserve (Fed) monetary policy
programme that was previously used to lower longterm interest rates in order to further stimulate the
US economy when regular monetary tools were
unavailable through the timed buying and sale of
US Treasuries of various maturities.
11.17 TOOLS OF MONETARY POLICY OF
INDIA
The RBI can manage credit in the economy with the
aid of monetary policy. It gives the RBI the ability
to alter the quantity of cash in the economy. Under
monetary policy, there are two different sorts of tools
available for managing the nation’s credit.
A. Quantitative or General Measures
B. Qualitative or Selective Measures
A. Quantitative/General Measures: The RBI uses
quantitative or general measures to affect the overall
amount of credit and lendable resources held by
commercial banks.
The following are some quantitative tools:
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Bank Rate:
The long-term interest rate levied by the RBI for
providing funds or loans to commercial banks.
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It is often called a discount rate. The nation’s money
supply is directly impacted by this rate.
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For instance, commercial banks will pay more for
loans from the RBI if it raises the bank rate. As a result,
commercial banks will grant public loans at a higher
rate. As a result, fewer people will borrow money from
banks. As a result, there will be a credit contraction
in the nation.
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The RBI lowers the bank rate, however, in order to
increase the money supply.
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Repo Rate:
When banks run out of cash, they borrow from the
RBI.
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The repo rate is the interest rate at which the RBI loans
to commercial banks, usually against government
securities in short-term borrowing.
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Banks can borrow money at a lower cost when repo
rates are reduced, which increases the amount of
money in circulation.
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As a measure of controlling inflation, the RBI raises
the repo rate, making it more costly for commercial
banks to borrow from the RBI, thus limiting the money
supply.
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Indian Economy
The repo rate is used by the RBI to combat inflation
and encourage growth.
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Long-Term Repo (LTRO)
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In a first-of-its-kind move aimed at encouraging
increased lending and lowering the cost of shortterm funds for banks.
The RBI announced in February 2020 (6th
Bi-monthly Monetary Policy of 2019-20) that it
would offer a long-term repo operation (LTRO) of
1.50 lakh crores at a fixed rate (i.e., at the Repo
rate).
The LTRO will be valid for one to three years.
This was done to ensure long-term and deeper
liquidity in the financial system, as well as to
increase lending by lowering the cost of funds for
banks (enabling them to lend cheaper loans).
Reverse Repo Rate:
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It is the interest rate at which the RBI borrows money
from commercial banks on a short-term basis.
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If the RBI raises the reverse repo rate, commercial
banks will choose to store their money with the RBI
since it is safer and let them earn money..
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As a result, commercial banks will charge higher
interest rates to their consumers for lending them
money.
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In the wake of an excessive money supply in Indian
banks, the RBI used this tool.
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And a decrease in loan disbursement to help keep
the interest rate where it is while also reducing bank
losses.
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Since the start of the reform process, it has become
a crucial tool in pursuing the RBI’s broad policy of
low-interest rates.
Cash Reserve Ratio (CRR):
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Banks operating in the country are required by law to
maintain two types of “Reserve Ratios.”
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The Cash Reserve Ratio is one of them (the other is
the Statutory Liquidity Ratio).
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It is also the total deposits held by a commercial bank
with the RBI.
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The RBI uses this ratio to determine whether credit
should be expanded or reduced.
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Lower economic liquidity results from higher CRR
with the RBI, and vice versa. The CRR may be altered
from 3% to 15% by the RBI.
Statutory Liquidity Ratio (SLR):
z
Each financial institution is required to keep a specific
percentage of its total time and demand obligations on
hand, that is in non-cash or liquid assets form.
z
In fact, banks are unable to invest this cash in liquid
assets of their choice, but must instead invest in
various types of Government securities (i.e., G-Secs).
RBI and Monetary Policy in India
z
z
z
That percentage is known as the Statutory Liquidity
Ratio. This ratio’s main objective is to enable banks to
return deposits to depositors as and when required.
Changes in the SLR frequently affect the availability of
funds in the banking system for lending to the private
sector.
The statutory liquidity ratio might range between
25% and 33.75%.
Parameters
Meaning
Form
Uses
Reserved
With
National
Impact
CRR
SLR
It is a percentage
of the amount of
money that a bank
must retain with
the RBI.
It is the proportion
of liquid assets to
time and demand
liabilities.
Maintained in the Conserved in the
form of cash.
form of gold, cash,
and governmentsecurities.
Regulate the flow Ensures the
of money in the solvency of banks.
economy.
Reserved with the Reserved
with
RBI.
commercial banks.
Regulates the
liquidity of cash in
the country.
Maintains the
credit growth of
the country.
RBI action in
OMO
Effect on the
economy
Open Market Operations (OMO):
z
involves buying and selling government securities on
the open market with the intention of expanding and
contracting credit.
z
When the RBI wishes to increase the money supply, it
buys assets from the market, and vice versa.
Monetary
policy
Expansionary
Contractionary
Buys
Sells
Injects Money In
Removes Money Out
Market Stabilisation Program (MSS):
This monetary management tool was released in 2004.
z
Under this scheme, excess liquidity resulting from
big capital inflows is absorbed by selling short-dated
government securities and treasury bills.
z
The cash that has been mobilised is maintained in a
separate government account with the RBI.
z
All the characteristics of current Treasury Bills and
dated securities would apply to the Treasury Bills and
dated securities issued under the MSS.
z
Specifically, these would be issued and serviced like
any other marketable government securities and will
thus be eligible securities for Statutory Liquidity Ratio
(SLR), repo and Liquidity Adjustment Facility (LAF).
z
149
Call Money Market (CMM):
z
The overnight borrowing market (also known as
money at call) is essentially an interbank money
market where money is borrowed and lent for a single
day.
z
For a maximum of 14 days (referred to as short notice),
money may be borrowed or raised. In this market,
borrowing can happen with or without securities.
z
The interest rate in this market ‘glides’ with the ‘repo
rate’ of the time, but the principle is simple—the
longer the period, the higher the interest rate.
z
The real call rate varies in this market around the
current repo rate according to the supply and demand
for funds.
Liquidity Adjustment Facility (LAF):
z
The LAF is a critical component of the RBI’s monetary
policy operating framework (introduced in June 2000).
z
On a daily basis, the RBI is ready to lend to or borrow
money from the banking system at fixed interest rates,
depending on the needs of the time (repo and reverse
repo rates).
z
LAF operations, in addition to moderating bank fund
mismatches, assist the RBI in effectively transmitting
interest rate signals to the market.
z
After 2013, the facility’s fundamental dynamics were
altered by recent changes involving a borrowing limit
for repo transactions and the availability of term repo.
Standing Deposit Facility Scheme:
z
The Union Budget 2018-19 proposed the new scheme.
The RBI proposed such a tool in November of 2015.
z
The scheme is intended to assist the RBI in better
managing liquidity.
z
Especially when the economy is flush with extra cash
(as was the case after the high-value currency notes
were demonetised after November 2016).
B. Qualitative or Selective Measures: Credit regulation
or control with regard to certain programmes, places,
or commodities.
Loan Margin Requirement:
z
The difference between the loan value and the value
of the security used to secure the loan.
z
If the lending margin requirement is 20%, commercial
banks can authorise loans of up to 80% of the market
value of a security. But collateral for agriculture and
the personal loan will be different.
z
As a result, if a person wants to borrow `. 80,000, he
or she must furnish an `. 1,00,000 security (market
value).
z
As a result, if the RBI lifts this margin, the general
people will be able to get lower-interest loans against
comparable-valued assets.
150
Directions:
The Banking Regulation Act of 1949 authorises the
RBI to provide instructions to commercial banks to
help them in setting lending policies.
z
Through directives, the central bank can affect the
credit structure and supply of credit to a certain extent
for a specific purpose.
z
Credit Limit:
z
The RBI has the authority to restrict commercial bank
loans to a specified level.
z
Commercial banks will be hesitant to issue public
loans in this situation. Banks will lend to certain
industries, such as agriculture and priority sectors.
Moral Suasion:
On occasion, the RBI requests and persuades
commercial banks not to provide loans for unproductive
reasons that promote inflation and do not contribute
to economic growth, i.e., it urges banks to limit credit
availability for speculative purposes.
z
Direct Action:
z
The RBI has the right to impose sanctions on a bank
that fails to comply with its instructions.
z
The Reserve Bank of India has the option of refusing
to rediscount its bills and securities.
z
The central bank can even forbid an individual bank
from operating if it does not execute its directions and
violates monetary policy objectives.
Credit Monitoring:
z
All commercial bank loans of `. 5 crores or more given
to a single party are reviewed by the RBI.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the Indian economy, demand-pull
inflation can be caused/increased by which of the
following?(2021)
1. Expansionary policies
2. Fiscal stimulus
3. Inflation-indexing wages
4. Higher purchasing power
5. Rising interest rates
Select the correct answer using the code given below.
(a) 1, 2 and 4 only
(b) 3, 4 and 5 only
(c) 1, 2, 3 and 5 only
(d) 1, 2, 3, 4 and 5
2. In the context of the 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
Indian Economy
(GOI) and the Reserve Bank of India (RBI) came
to an agreement known as the Monetary Policy
Framework Agreement (MPFA).
Cheque Truncation System
z
It is the technique of stopping the flow of a physical
cheque issued by a drawer en-route to the paying
bank branch by the presenting bank.Instead, an
electronic image of the check is transferred to the
paying branch via the clearing house, together with
important information such as MICR band data,
date of presentation, presenting bank, and so on.
11.18.2 The Monetary Policy Process
z
z
11.18 MONETARY POLICY IN INDIA
z
z
z
z
z
The RBI’s policy objectives and instruments have
evolved throughout time in response to local needs
and global structural developments.
The Indian economy was in its early stages of
growth in the early years. As a result, there was an
urgent need to construct infrastructure and increase
manufacturing capacity.
Fiscal policy was discovered to be more significant
than monetary policy during this time. In order to
increase government spending, the government
normally runs a large budget deficit.
These shortfalls were covered using ad-hoc treasury
bills or public-sector bank borrowings. Such a way of
funding deficits was frequently inflationary, especially
during the 1980s.
The monetary policy framework was changed in 1986
to put more emphasis on increasing the M3 money
supply as a means of reversing this trend.
11.18.1 Changes Post 1991 Reforms
z
z
z
z
z
z
The RBI’s function changed dramatically following
the 1991 economic reforms. Steps have been taken
to limit the monetization of the budget imbalance.
However, the major problem of public debt in auctions
continued to monetize the budget imbalance.
To put an end to these methods of deficit financing,
the RBI was barred from subscribing to the principal
issue of public debt in 2006.
The Interim Liquidity Adjustment Facility (ILAF)
was established in April 1999 in response to the
Narasimham Committee’s recommendations.
Repo and reverse repo rates developed as the RBI’s
key policy rates, diminishing the importance of CRR
and SLR as instruments of the RBI to control liquidity.
The ILAF, on the other hand, suffered from the lack of
a ceiling rate and a single policy rate. As a result, since
May 2011, the only rate that fluctuates independently
under the Revised Liquidity Adjustment Framework
(RLAF) is the repo rate. The only objective of Indian
monetary policy as of 2016 is inflation targeting..
In order to control inflation and keep it below 4%
in the fiscal year 2016–17, the Government of India
RBI and Monetary Policy in India
z
z
z
The Union Government established the Monetary
Policy Committee (MPC) in 2016 under Section 45ZB
of the modified RBI Act, 1934, with six members.
Its primary role is to control inflation within the limits
specified by the government, which, in cooperation
with the RBI, calculates the interest rate required to
accomplish the inflation objective.
The Monetary Policy Department of the RBI assists the
MPC in determining the policy repo rate or repurchase
rate by taking into account the perspectives of all
stakeholders and participants in the economy.
Since 2016, the only goal of Indian monetary policy
has been to aim for inflation at 4% per year, with a
2% tolerance zone.
If the RBI does not achieve the aforementioned goals,
it is accountable to the government and must by a
certain date explain why and how it will do so in the
future.
11.18.3 Monetary Policy Committee (MPC)
z
z
z
z
In 2014, the Urjit Patel Committee advocated the
formation of the Monetary Policy Committee.
It is a legislative and institutionalised framework
established by the Reserve Bank of India Act of 1934
to preserve price stability while keeping growth in
mind.
The MPC determines the policy repo rate required to
achieve the inflation target (which is 4%).
Decisions in MPC were taken by the majority with the
RBI Governor having the casting vote in case of a tie.
Composition of MPC:
The MPC has the following six members
 Governor of the RBI as Chairperson, and ex-officio.
 Deputy Governor of the RBI, in charge of the
monetary policy – Member, ex-officio.
 Officer of the RBI to be nominated by the Central
Board(1) – Member, ex-officio.
 The other three members are to be experts in
the field of economics, or banking or finance or
monetary policy.
z
They have a term of four years unless it is extended.
z
Urjit Patel Committee:
Raghuram Rajan, the former governor of the Reserve
Bank of India (RBI), established the Urjit Patel
Committee on September 4, 2016. The committee was
largely responsible for evaluating and enhancing the
RBI’s Monetary Policy Framework.
z
151
z
z
Key Recommendations:
 The headline CPI should be the nominal anchor for
monetary policy and the RBI should make this the
predominant objective.
 For a two-year horizon, the nominal anchor for
inflation should be set at 4% with a 2% margin
of error.
 By 2016-17, the Central Government must lower
the fiscal deficit to 3.0 percent of GDP. Administered
prices, wages, and interest rates are barriers
to monetary policy transmission and should be
eliminated.
 Monetary policy decisions should be made by a
Monetary Policy Committee (MPC), which should
include the Governor, the Deputy Governor, and
the Executive Director in charge of monetary
policy, as well as two external full-time members.
 The MPC will make decisions through voting.
Members will be held accountable for failure to
meet the target, which is defined as failing to meet
the target for three consecutive quarters.
 Real policy rates ought to be greater than zero.
The weighted average call rate and the single
policy rate would be the primary objectives in the
initial phase.
 The RBI should offer a compensated standing
deposit facility to stifle excess liquidity.
 Government debt and cash management should be
taken over by the government’s Debt Management
Office, not the two programmes Dependence on
Market Stabilisation Scheme (MSS) and Cash
Management Bills (CMBs).
 All sector-specific refinancing should be phased
away, as pledged to the Asian Development Bank
in 1992.
Government’s Response:
 In 2016, a formal shift to flexible inflation targeting
was made, and a six-member MPC was established
to set the policy repo rate. These changes were
made in response to the RBI’s Expert Committee
Report to Revise and Strengthen the Monetary
Policy Framework.
 The Central Government announced in the Official
Gazette on August 5, 2016, that the CPI inflation
goal for the period from August 5, 2016, to March
31, 2021, will be 4% with a 2% tolerance range.
 In February 2015, the Government of India and
the RBI signed the Monetary Policy Framework
Agreement (MPFA) to formally embrace the
Flexible Inflation Targeting (FIT) framework.
 This was followed by a modification to the RBI Act
of 1934 in May 2016 to give a legislative foundation
for the FIT framework’s implementation.
152

India joined the group of countries that adopted
inflation targeting as their monetary policy
framework, starting with New Zealand in 1990,
with this step toward modernising the monetary
policy process.
PREVIOUS YEAR QUESTION (PRELIMS)
1. 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
Advantage of Monetary Policy
When opposed to fiscal policy, monetary policy has
a shorter time lag between perceived ‘action needed’
and ‘action taken’ time points.
z
The reductions in the various rates/ratios (BR/CRR/
SLR/RR) are effective immediately. Such adjustments
can be made at any time of year.
z
However, these benefits are not being fully realised,
as indicated by the ‘inflationary rise in prices that has
occurred on several occasions.
z
Limitations of Monetary policy
z
Higher Proportion of Non-Banking Loans:
 Non-Banking Institutions lend a significant amount
of credit (NBIs). Alterations to the bank rate and
ratios have no effect on this segment.
 The connections between banks and NBIs are not
sufficiently developed. Furthermore, banks have
heavily relied on non-deposit resources such as
call money market and participation certificates.
 The RBI has no authority over call money rates
in general.
z
Monetary Instrument Limitations:
 The frequent adjustments in the rates of monetary
policy instruments are criticised because they
create an atmosphere of uncertainty for productive
investment.
 Furthermore, as the Indian financial sector becomes
more integrated with the world’s financial system,
the RBI’s monetary policy must take into account
global developments.
 It has also been discovered that changing interest
rates to reduce lending favours unproductive
sectors significantly more, harming the interests
of equity and growth.
Indian Economy
In the shifting environment of the globalised
economy, the efficacy of monetary policy
instruments is therefore plainly circumscribed.
Effects of New Financial Institutions:
 Institutions such as mutual funds, venture capital
firms, and public offerings issued on the open
market have a significant impact on total liquidity
in the economy.
 Remember that mutual funds account for
approximately a quarter of total household savings
in the economy.
 Therefore, the new financial institutions account
for a considerable amount of overall liquidity,
resulting in a high degree of disintermediation.
The impact of the RBI’s actions is negligible in
certain parts of the financial system.
High Currency-Deposit Ratio:
 Because a huge part of vast rural sectors still lack
banking habits, the currency-deposit ratio remains
high.
 The influence of the RBI’s monetary policy
instruments is limited to the deposit segment.
 This led to ineffective monetary regulation in the
economy.
Weak Monitoring System:
 The RBI has retained various preferential
rediscount facilities to motivate lenders to extend
credit to support certain sectors like agriculture,
small industries, export financing, and so on.
 There is also the additional consideration that rural
groups such as small farmers and craftspeople
should be protected from lending limits.
 Furthermore, there is a lack of the necessary good
statistics and monitoring systems to ensure that
favoured sectors benefit from such programmes.
Because of these choices and gaps, the work of
monetary policy has become limited in its reach
and effect.
Stiff Policies and Growing Fiscal Needs:
 Credit policy for a given year is generally based
on the preceding year’s developments in terms of
money supply and pricing patterns.
 In contrast, the need of the hour is to shift to an
evaluation of the credit needs for the coming year
based on the expected rise in real output.
 The rising monetisation of budget deficits also
contradicts fiscal and monetary policy objectives.
 Sukhamoy Chakravarty Committee emphasised
the importance of bridging the gap between
the RBI’s responsibility to oversee and manage
the monetary system on the one hand and the
authority required to do so on the other.This leads
us to consider the issue of RBI autonomy.

z
z
z
z
RBI and Monetary Policy in India
11.19 UNCONVENTIONAL MONETARY
POLICY
z
z
z
z
For numerous decades, central banks in advanced
economies employed a policy interest rate as their
monetary policy instrument.
In response to the global financial crisis (GFC) of
2007-2009 and the significant recession, central
banks in several industrialised nations cut interest
rates to near-zero levels.
As economic growth remained subdued, interest
rates remained around zero, and several central
banks employed ‘unconventional’ monetary policy to
encourage economic activity.
As central banks throughout the world respond to
the catastrophic economic effects of the coronavirus
(COVID-19) worldwide epidemic, these unorthodox
approaches have resurfaced.
11.19.1 Negative Interest Rate Policies
(NIRPs)
z
z
z
z
z
Negative interest rates are actually unusual since it
is difficult to justify taxing depositors for depositing
monies with banks.
Conventional wisdom held that policy rates had a
“Zero Lower Limit” (ZLB), suggesting that interest
rates could never reach negative.
The ZLB, on the other hand, was not a limitation
because certain AE central banks, including those in
Denmark, Sweden, Switzerland, and the Eurozone,
elected to introduce NIRPs immediately following the
global financial crisis (GFC).
Commercial banks, on the other hand, avoided
negative rates by establishing a floor of zero on retail
deposit rates.
However, in emerging market economies (EMEs),
NIRPs can produce huge cross-border spillovers in
the form of capital inflows looking for yield, creating
enormous monetary policy and financial stability
difficulties.
Negative Interest Rate Policies (NIRPs): Pro Vs Cons
Pro
Reduces
expenses.
Cons
borrowing Negative interest rates
pressurize the whole
yield curve.
Help contribute to a nation's Reduce the profit margins
currency's depreciation by that financial firms get
making it a less appealing from lending.
investment than other
currencies.
A lower currency gives
a country's exports a
competitive advantage while
also increasing inflation by
raising import costs.
If sustained ultra-low
rates harm the health of
financial institutions, they
may delay lending and
harm the economy.
153
11.19.2 Zero Interest Rate Policy (ZIRP)
z
z
z
z
z
z
ZIRP is a strategy that promotes economic growth
while maintaining interest rates close to zero.
The ruling central bank can no longer lower interest
rates under this approach, rendering traditional
monetary policy ineffectual.
Thus, in order to increase the monetary base,
unconventional monetary policy is used, such as
quantitative easing.
However, as witnessed in the Eurozone, going too
far with a zero-interest-rate strategy might result in
negative interest rates.
As a result, many economists have questioned the
efficacy of zero-interest rate policies, citing liquidity
traps as one of numerous potential hazards.
A negative interest rate policy, or NIRP, would be used
as an emergency remedy.
z
z
z
11.20 THE MONETARY AUTHORITY- NEW
EMERGING CHALLENGES
z
11.19.3 Helicopter Money
z
z
z
z
z
It is also known as a helicopter drop, and is an
uncommon monetary policy instrument that involves
printing enormous amounts of money and delivering
it to the general population in order to stimulate
economic development during a recession.
Milton Friedman, an American economist and
statistician, employed the expression in his seminal
article “The Optimum Quantity of Money” (1969).
Helicopter money is a type of unconventional
monetary policy tool that involves printing massive
quantities of money and giving it to the general public
in an effort to boost economic growth, production,
and inflation. The term “Helicopter Money” was first
used by American economist and statistician Milton
Friedman.
The idea behind helicopter money is that by giving
money to the general public (consumers), their
disposable income would increase, leading to more
consumer spending, which would increase economic
output.
According to current thinking, helicopter money
should be viewed as a last resort monetary policy
instrument when more routinely utilised stimuli
have failed to reinvigorate the economy.
Helicopter Money Compared to Quantitative
Easing:
z
z
z
154
Most of the time Helicopter money is frequently
confused with quantitative easing.
Although both are monetary policy measures that
increase the money supply, their effects on the central
bank’s balance sheet are distinct.
The central bank builds reserves for quantitative
easing by acquiring government securities from
commercial banks and other financial institutions.
On the other hand, helicopter money involves
distributing cash to the general public, which doesn’t
result in the addition of assets to the balance sheet of
the central bank.
In essence, quantitative easing increases the money
supply by acquiring government assets, whereas
helicopter money increases the money supply by
dispersing cash to the general populace.
The main issue of helicopter money:
 Irreversible nature.
 The possibility of hyperinflation.
 The depreciation of the home currency.
z
Inelasticity of domestic supply:
 Limits on the elasticity of aggregate domestic
supply impose additional burdens on monetary
policy, especially in the short term.
 Although trade opening has increased the supply
potential in several economies, it does not appear
to have significant short-term beneficial effects on
the elasticity of supply.
 The inflation-sensitive nature of persistent supplyrelated fluctuations in prices of goods and services
means that they can have a long-lasting impact on
inflation expectations. Therefore, the burden and
dilemma of structural supply issues are greater
due to their continued impact on inflation.
 Managing
these structural problems while
maintaining low inflation and stability without
disrupting growth momentum is an important
challenge for monetary policy going forward.
Changing Global Economic Environment:
 New developments in the global economy have
exacerbated the challenges facing monetary
authorities. The new environment of increasing
financial globalisation presents a significant
challenge.
 As a result, economies are more susceptible to
shocks related to exchange rates, capital flow
volatility, and changes in domestic demand.
 As a result, monetary policy-making between
economies has become more interdependent than
ever and must take into account developments
in the global economic situation, international
inflation, interest rates, exchange rate fluctuations
and capital flows.
 So while local developments continue to dominate,
global factors are becoming increasingly important.
 Large-scale
cross-border
capital
flows,
globalisation of financial markets, and advances
Indian Economy
z
z
in information technology have collectively
dramatically changed the choice of monetary
policy instruments and transmission mechanisms.
Challenges in other industries:
 Monetary policy is also linked to the following
challenges in other industries:
 Fiscal imbalances remain large by international
standards and need to be managed nondestructively
 The execution of monetary policy is made more
difficult by the ongoing intensity of foreign
exchange inflows.
 In an environment of increased demand
pressures, interest rate hikes may be advocated
to support and sustain growth in a noninflationary manner.
 However,
high-interest rates increase the
likelihood of new capital inflows and can reduce
the effectiveness of the monetary policy. In
India, the standard of living of a large part of the
population is not sufficient to resist the strong
financial volatility which affects real activity.
 Therefore, monetary policy must take into account
the impact of financial market volatility on these
sectors of the economy, often linked to shifts in
capital flows.
Multiple objectives:
 There are also multiple objectives in rapidly
integrating economies, such as
 Fixed exchange rates
 Free movement of capital
 Independent monetary policy
 All these three have been identified as the
“Impossible Trinity”.
 The management of this trinity necessarily involves
constant arbitration between the national, the
global and expectations.
 This requires greater coordination between
political circles.
 There is considerable ambiguity in the clarity
required to interpret underlying macroeconomic
and financial developments, vague price signals
and the monetary authorities’ focus on the
performance of the real economy.
 As a result, dealing with the Impossible Trinity has
become more complicated than before.
11.21 MONETARY POLICY TRANSMISSION
z
z
In the Indian context, the repo rate has a considerable
influence on the transmission of short-term policy.
The repo rate is used to determine the interest rate
in the economy.
RBI and Monetary Policy in India
z
z
z
z
The extent to which a change in repo rate can trigger
a commensurate change in interest rate by banks is
now determined by the financial state of the banking
system.
Monetary policy is extremely important in allocating
cash from the financial system. Bank lending rates
must be responsive to the central bank’s policy rates
in order to achieve this. Referred to as monetary
transfer’
However, in recent years, the system has lacked a
robust monetary transmission. The RBI has been
worried about a broad lack of monetary transmission
in the banking sector since 2015-16.
The RBI has taken efforts such as implementing the
MCLR and external benchmarks on banks in order to
determine their lending rates till April 2020.
Importance of Monetary Policy Transmission:
Multiple impacts: Monetary policy transmission has
an impact on economic growth, pricing, and other
areas of the economy.
z
Interest rate: Bank lending rates and bond yields will
climb when central banks raise the official interest
rate.
z
Cost of borrowing: It can impact the cost of borrowing
for businesses and consumers by changing the official
interest rate.
z
Cash Flow: Changes in the official interest rate
influence the discount rates used to determine the
present value of cash flows, which is utilised to
evaluate the value of securities.
z
Economic players: Changes in official interest rates
have a significant influence on economic players’
expectations.
z
Economic agents: They would anticipate more lending
as a result of reduced borrowing costs, or increased
asset values as a result of lower discount rates and
predictions of faster growth if official interest rates
were decreased.
z
Exchange rates: They are impacted by shifts in the
official interest rate. When a country’s interest rates
rise, investing in that country becomes more tempting,
everything else being equal.
z
Difficulties in Transmission of Monetary Policy:
Unchangeable Funding Costs:
 Customer deposits account for the great bulk
of cash provided by banks in India, whereas
market borrowings via the issue of debentures/
commercial papers are minor.
 The cost of money is often constant because the
majority of these deposits are contracted at set
rates.
 Furthermore, as compared to bank rates, interest
rates on modest deposits remained high. As a
result, bank deposits have decreased.
z
155
Banks have been unable to lend at reduced deposit
rates due to a shortage of capital.
 Until and unless this issue is resolved, banks will
be unable to communicate monetary policy signals
at the required speed and amplitude.
Policy rates are not market-linked:
 The repo rate cannot be called a market-determined
rate because it is handled by the Monetary Policy
Committee.
 Regardless of the cost of lending cash, banks must
tie their lending rates to the repo rate.
Almost three-quarters of outstanding loans are
not tied to external standards:
 The proportion of outstanding loans related to
external standards has increased from 2.4% in
September 2019 to 28.5% in March 2021.
High Non-Performing Assets (NPAs):
 As a result of the build-up of big NPAs, bank
profitability has deteriorated.
 As a result, banks maintain the weighted average
lending rate at a far higher level than the marginal
lending rate.
Four Balance Sheet Issues:
 According to Arvind Subramanian, India’s former
senior economic advisor, the country is facing a
“four balance sheet issue.”
 This has impeded credit development in India and,
as a result, monetary policy transmission.

z
z
z
z
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the 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
11.22 RBI AND DIGITAL CURRENCY
11.22.1 Cryptocurrency
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It is a digital currency that may be used in place of
cash.
Cryptography is employed in cryptocurrencies to
safeguard and verify transactions. It is also used to
regulate cryptocurrency supply.
It is backed by the blockchain, a decentralised peerto-peer network.
In 2009, Satoshi Nakamoto created the first
cryptocurrency, Bitcoin.
The Central African Republic (CAR) just became the
second country, after El Salvador, to recognise Bitcoin
as legal cash.
India’s Union Budget 2022-2023 proposes the
introduction of a digital currency.
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Digital Rupee
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RBI will create a digital currency dubbed Digital
Rupee in the coming fiscal year.
A central bank digital currency (CBDC) is an
electronic record or digital token (or region) that
simulates a country’s fiat currency.
Consumers would be able to transfer money from
bank accounts into smartphone wallets in the
form of digital tokens, which, like cash, would be a
responsibility of the Reserve Bank of India.
That proposal states that a digital rupee will be
similar to banknotes but devoid of ATMs.
11.22.2 Central Bank Digital Currency
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A CBDC is similar to a currency in that it exists in
digital form, but it is not the same thing.
The CBDC will be stored in a central bank-supervised
digital wallet. The RBI will oversee the digital rupee
in India, though it may cede some authority to banks.
It should be highlighted that the RBI’s digital rupee
will not immediately replace bank demand deposits.
Banks will continue to utilise physical currency, and
consumers who want to withdraw cash from financial
institutions may do so. They can, however, choose to
convert their bank deposits into the new digital rupee.
The RBI will need to thoroughly examine the
technology ecosystem before selecting the appropriate
technology to introduce CBDCs.
The financial data acquired on digital currency
transactions will be sensitive, and the government
must carefully consider the regulatory design.
This would necessitate tight collaboration between
banking and data protection regulators.
The Government of India has declared in its Budget
2022-23 that its central bank will begin issuing digital
currency as early as 2022-23.
The supporters of the digital rupee argue that an
electronic representation of India’s legal money will
strengthen the country’s digital economy. However, it
is equally important to evaluate the risks associated
with a quick switch to a Central Bank Digital Currency
(CBDC).
Objectives:
 The major goal is to reduce the risks and expenses
associated with handling real cash, such as
Indian Economy

the price of phasing out soiled notes, shipping,
insurance, and logistics.
It will also dissuade people from using
cryptocurrency as a form of money transmission.
Benefits of Crypto/digital currency:
Reduced Entry Barriers: Unlike traditional banking
institutions, there are no entrance hurdles. The
transaction is immediate, and because the network
is worldwide, it may be completed anywhere in the
world.
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Universal Acceptance: Several cryptocurrencies
are legal in different countries. The transaction is
instantaneous and may be completed across the
network.
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Low transaction cost: Transaction fees and levies are
quite minimal.
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Security: Identification concealment is achieved
through the use of pseudonyms and ledger systems.
It employs cryptographic technology that is nearly
difficult to crack. A Bitcoin transaction is permanent
and can’t be reversed.
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Absence of Interference from the Banking System:
It is outside the scope of financial systems. Since there
is no gatekeeper like the government or central banks,
users are responsible for all transactions.
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Concerns:
Security Threats: Wallet cyber-attacks, exchange
mechanism (Cryptojacking). They are vulnerable
to assaults such as hijacking, Routing Attacks, and
Distributed Denial of Service (DDoS).
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Outside of regular financial institutions: there is a
lack of liquidity and lower acceptability.
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Price turbulence: Price volatility and waste of
processing resources are common.
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Inadequate Consumer Protection: There are no
dispute resolution methods.
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Global Trends:
The Bahamas was the first to establish a national
CBDC, Sand Dollar.
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Nigeria is another country that will launch eNaira in
2020.
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China became the first significant economy in the
world to test e-CNY, a digital currency, in April 2020.
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Korea, Sweden, Jamaica, and Ukraine are among the
countries that have started using digital currencies,
with many more expected to join soon.
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Way Forward:
Payment focused: To address some of CBDC’s
shortcomings, use should be payment-focused in
order to improve the payment and settlement system.
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Disintermediation: Then it can escape the risks
of disintermediation and its large monetary policy
implications by shifting away from functioning as a
store of value.
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Data security: Data held with the central bank
in a centralised structure will present serious
security threats, necessitating the implementation of
comprehensive data security solutions to avoid data
breaches.
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Technology: As a result, it is critical to apply the
appropriate technology to support the CBDC issue.
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Infrastructure: If payment transactions are conducted
using the same approach, scaling the infrastructure
necessary for the CBDC will remain difficult.
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Ecosystem: The RBI will need to thoroughly examine
the technology ecosystem before selecting the
appropriate technology to introduce CBDCs.
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Regulation: The financial data acquired on digital
currency transactions is going to be confidential,
and the government must carefully consider the
regulatory design.
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Collaboration: This would necessitate tight
collaboration between banking and data protection
regulators.
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11.23 TIMELINE OF INDIA AND CRYPTOCURRENCY
Year
Development in India related Cryptocurrency
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2013
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2017
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The Reserve Bank of India issued a warning to persons in India who deal with virtual currencies about
financial, legal, operational, and security concerns.
The government formed a committee led by the Special Secretary (Economic Affairs) to assess the current
state of virtual currencies in India and throughout the world.
Examine the worldwide regulatory and legal systems that are now in place.
Measures should be suggested (related to consumer protection, money laundering, etc).
The Ministry of Finance published a statement clarifying that virtual currencies are not legal cash in
India and are not subject to any regulatory oversight or protection.
The government does not regard cryptocurrencies as legal tender, according to the Finance Minister,
who made this statement in the budget address for 2018–19.
Government would take all efforts to prevent their use in financing illegal activities and the payment
system.
RBI and Monetary Policy in India
157
2018
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2019
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2020
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2021
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2022
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The RBI prohibited banks and other regulated companies from enabling cryptocurrency transactions.
An inter-ministerial committee proposed that all private cryptocurrencies be banned.
The Supreme Court rules that the prohibition is unconstitutional.
The Court notes that the RBI has not claimed that any of the institutions it controls, including nationalised
banks, scheduled commercial banks, cooperative banks, and NBFCs, have suffered a loss or other
unfavourable effect because of virtual currencies (VCs), either directly or indirectly.
As a result, the RBI circular is "disproportionate" to the central bank's generally consistent stance that
VCs are not forbidden in the country.
Before releasing the circular, the RBI did not assess the availability of alternatives, according to the court.
Despite two draft Bills and multiple committees, the Centre has failed to create an official digital rupee,
according to the court.
The Cryptocurrency and Official Digital Currency Regulation Bill, 2021 is introduced.
This idea calls for the prohibition of private digital currencies in favour of RBI-backed money.
A 3-6-month grace period before prohibiting crypto trade, mining, and issuance.
Finally, Cryptocurrencies, albeit unregulated, are not prohibited in India.
Definition of crypto assets: In the Union Budget for 2022-23, the government issued a definition for
crypto assets for the initial time, as well as a list of ideas for taxing this new asset class.
Coverage: The tax plan included all developing digital assets, such as non-fungible tokens (NFTs), assets
in the metaverse, digital currencies, and tokens.
Tax deducted at source: According to the Budget, a 1% TDS (tax deducted at source) will be levied on
payments made for the transfer of digital assets.
Loss from the transfer of virtual digital assets: In the proposed revisions, it will not be allowed to
be set against income derived from the transfer of another VDA.
30 per cent tax on income: The government will define virtual digital assets in order to collect a 30%
tax on any transactions of such assets. Section 115 BBH was added to the Finance Bill 2022 to tax the
transfer of VDAs, among other things.
The cost of infrastructure: The taxman will not allow a deduction for expenses incurred in mining virtual
digital assets, such as cryptocurrencies.
Penalty: The deduction of surcharges and cess, which has been claimed and accepted by the taxpayer,
will be considered under-reported income and will result in a 50% penalty. They can declare such
categorization freely and avoid the penalty.
3. Online payments can be sent without either side
knowing the identity of the other.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to ‘Bitcoins’, sometimes seen in the
news, which of the following statements is/are
correct?(2016)
Select the correct answer using the code given below.
(a) 1 and 2 only
(c) 3 only
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.
v
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v
(b) 2 and 3 only
(d) 1, 2 and 3
#OpinionMatters
Considering the present trends in inflation, do you think
monetary policy should be decoupled from inflation
targeting?
v
Indian Economy
12
Financial Institutions in India
12.1NATIONAL BANK FOR
AGRICULTURE AND RURAL
DEVELOPMENT (NABARD)
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National Bank for Agriculture and Rural Development
is a regulatory body for regulations of all regional rural
banks in the nation. It is an apex banking institution
which works under the Ministry of Finance and is
headquartered in Mumbai (the financial capital of
India). It has been entrusted with matters like finance
for agriculture and expansion of economic activities
in rural areas through small-scale industries, cottage
industries etc.
NABARD has established through an act in July 1982 on
the recommendations of the B. Sivaraman committee
on the insistence of RBI with an initial share capital
of RS 100 crore. It was formed by replacing the
Agricultural Credit Department (ACD), Rural Planning
and Credit Cell (RPCC) and Agricultural Refinance and
Development Corporation (ARDC).
Vision: Development of the nation through rural
prosperity.
NABARD (Amendment) Bill, 2017 enabled the
Center to increase the capital from `. 5,000 crore to
`. 30,000 crore which was just `. 100 crore in 1981.
Center and RBI together hold at least 51% of the
share capital of NABARD.
Under the NABARD Act, it is responsible for providing
credit facilities to MSMEs (Micro, Small and Medium
enterprises) and other industries.
Functions:
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It promotes integrated development by providing
investment and credit facilities for development
activities in rural sectors.
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It provides funds for short-term loans to Commercial
banks, State cooperative banks, RRBs, and State land
development banks.
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It monitors and evaluates the projects refinanced
by it. Gives financial assistance to the farm sector in
different activities such as agriculture, horticulture,
farm mechanization, animal husbandry etc.
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Helps in the development and regulation of
institutions which finance rural infrastructure and
work for upliftment.
Regulates cooperative banks and the RRBs
established throughout the country. It works to
integrate them with Core Banking Solutions (enabling
customers to operate the account and avail of banking
services from any branch).
It lends to Self-Help Groups because they majorly
work in rural India and comprise poor working
women.
It helps the Union government in the development
and implementation of schemes in rural areas.
Provides training opportunities to handicraft
artisans and gives them marketing platforms for the
sale of their products.
With International affiliations like World-bank,
getting help in the fields of rural development,
agriculture, advisory services, financial assistance etc.
helps in the upliftment of rural people.
Structure of Governance:
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Board of Directors: Appointed by GOI in consonance
with the NABARD Act which constitutes;
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The Chairperson.
3 Directors from directors of RBI,
3 Directors from among the officials of the central
government,
4 Directors from amongst the officials of state
government,
Managing Director,
3 Directors from amongst experts in rural
economies, rural development, village & cottage
industries, small-scale industries, persons having
experience working in co-operative banks
or regional rural banks, or any other matter
considered useful by the central government.
Executive committees: Consisting of the number
of directors prescribed and discharge functions as
delegated by the Board of Directors.
NABARDs Contributions To The Development Of the Rural Economy:
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Financial
Contributions
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Developmental
contributions
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Short-term loans like crop loans are given to farmers for production purposes, food security
etc.
Long-term loans and credits to financial institutions for farm and non-farm activities.
NABARD and RBI together set up Rural Infrastructure Development Fund (RIDF) to help
through funds for priority sectors like rural infrastructure funds.
Long-Term Irrigation Fund (LITF) was set up for irrigation projects.
To provide loans for warehouse infrastructure to protect agricultural commodities.
NABARD Infrastructure Development Assistance (NIDA) offers long-term loans for projects
such as rural connectivity to urban, renewable energy, Swachh Bharat Mission-Gramin and
other infrastructure projects.
The Kisan Credit Card scheme for farmers started in 1998 for crop loans.
RuPay Kisan Cards technology to help rural financial institutions help farmers.
The Umbrella Programme on Natural Resource Management started in 2007 for investment
in rural areas, utilizing natural resources, investments in rural areas, and providing business
opportunities.
To help Self Help Groups, SHG-Bank Linkage Programme for the credit facility.
E-Shakti to digitize SHGs.
For the promotion of skill development and entrepreneurial opportunities to rural youth in
the off-farm sector.
Marketing opportunities to rural artisans and producers to help them with the sale of
products.
Challenges:
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States of the Northeast are receiving fewer shares of
funds compared to other states.
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Need for coordination between the central bank
and development institutions for rural development
and resolving the agrarian crisis.
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Requirement to exploit the opportunities for
reduction of poverty, and socio-economic development
and provide credit facilities for improvement of rural
economy.
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A large section of the Rural population depends
on agriculture which highlights the demand for
infrastructure investments.
12.2SMALL INDUSTRIES DEVELOPMENT
BANK OF INDIA (SIDBI)
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Small Industries Development Bank of India is a
bank and a regulator which issues licenses to MSME
(Micro, Small and Medium) enterprise companies. It
works under the Ministry of Finance, headquartered
in Lucknow and branches across the nation. It
contributes to the development of MSMEs through
production, the flow of credit, employment, exports,
technology upgradation, skill development etc.
It was established in 1989 through a parliament
act to strengthen the flow of credit, and help in
developmental and financial gaps felt in MSMEs. It is
one of the four Indian financial institutions regulated
by RBI. The other three are EXIM Bank, NABARD and
NHB.
Purposes:
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Principal to provide credit services to MSMEs.
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Providing refinance facilities to banks and other
financial institutions.
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Lending and working capital facilities to industries.
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Performs statutory role in financial markets through
credit facilities, refinance and long-term loans.
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Extends credit options through microfinance
institutions and focuses on rural entrepreneurship
development and promotion.
Functions:
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Helps MSMEs by fulfilling financial and non-financial
demands, promotion and development to make them
competitive.
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Work as a nodal agency by implementing and acting
as a facilitator to help various ministries of GOI.
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Coordinates with different financial institutions such
as RRBs, cooperative banks, industrial corporations
etc. to strengthen the financial ecosystem.
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Works in other fields such as Technology
modernisation, upgradation of skills, support for
marketing activities, development etc.
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Sustainable development of MSMEs by working on the
Economy, Social and Environment sectors.
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Indirect lending to banks, NBFCs, Fin-techs etc to
reach indirectly to MSMEs.
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Direct lending to fill credit gaps of financing, and risk
capital and support entrepreneurship culture through
start-ups.
Indian Economy
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Offers marketing channels to help small-scale
industries in their expansion in different markets.
Promotes employment opportunities in semi-urban
areas.
SIDBI Vision 2.0:
To accelerate, and transform its current position and
limit to a financial institution but integrate credit
facilities with development support to in inclusive
growth. It wants to be on par with sustainable
development and work on Environment, People and
Profit.
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Financial Contributions:
Direct finance by providing working capital, long-term
& short-term loans, venture capital funds etc.
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Indirect finance by providing refinance to Primary
Lending Institutions (PLI) like NBFCS for easy credit
flow.
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Small entrepreneurs and businesses receive
microfinance facilities for venture capital and startups.
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Schemes by SIDBI to Different Sectors:
SMILE: SIDBI Make In India Loan for MSMEs with a
range of 10 lac rupees to 25 lacs.
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SEF: Smile Equipment Finance to entities existing for
3 years and financial help of a minimum of 10 lac
rupees.
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SPEED: SIDBI loan for equipment for the development
of enterprise. It should be operational for at least 3
years and have financial help of 1 crore rupees.
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TULIP: Top-up loan for immediate proposals with a
maximum of 2 crore rupees and business expanded
at the same location and same business.
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STAR: SIDBI long-term loan Assistance for Rooftop
Solar PV plants with 10 lac rupees to 3.5 crores.
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12.3 EXIM BANK
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EXIM Bank or Export-Import Bank is a financial
institution in India which works for the integration
of foreign trade and investment models to help in the
growth of the economy. Its headquarters is in Mumbai
and was founded in 1982 by GOI through an act of
parliament.
It is regulated by the RBI but owned by GOI. It
lends to companies which export from India and are
doing business abroad as well as supporting overseas
buyers to bring in foreign currency inflows.
Aims of the EXIM Bank:
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To finance, promote foreign trade and enhance exports
from India.
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Financial support to those initiatives and technologies
which are working at grassroots levels having export
potential.
Financial Institutions in India
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To help small businesses, NGOs and producer groups
to get compensation through promoting exports.
Board of Directors:
Chairman, One Managing director, Two deputy
MDs, One Director appointed by RBI, One Director
nominated by IDBI Bank Ltd., One Director nominated
by ECGC Ltd., Not more than 12 Directors nominated
by Central government who are professionals with
experience in export/import or financing activities.
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Visions:
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To act as a primary financial institution to provide
assistance to exporters and importers to enhance a
country’s international trade.
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To expand export capabilities by providing a different
range of products, services, credits etc. to empower
business operations.
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Help Indian companies through leadership and
finance to match up globally.
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To help companies achieve their aspirations and
globalize Indian businesses.
Functions:
Provides credit facility program to Indian exporters
and offers credit to foreign buyers to import goods
from India.
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Extends credit to exporters from India in expansion
and to enter international markets.
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Act as a corporate bank by offering different financing
channels to support the export competitiveness of
Indian companies internationally.
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It gives loans or makes overseas investments to Indian
companies.
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Encourages Indian companies in getting contracts
abroad.
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It helps to finance imports & exports of goods and
services from both the United States and abroad.
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Provides short-term loans to governments, foreign
banks and foreign banks.
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Expert knowledge and business advisory services to
foreign projects.
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Help Indian companies in their business abroad and
growth of industries, products, services etc.
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Financial Contributions:
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The facility of buyer’s credit through which foreign
buyers can issue letters of credit to Indian exporters
where payment can be made later.
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Help by giving financial options to enhance the export
competitiveness of domestic companies.
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Long-term loans to help exporters to finance projects,
expansion, purchase of new equipment, research &
development, working capital etc.
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Equity investments in overseas companies, ventures
and owned subsidies.
Provides advisory services and helps exporters
to evaluate business opportunities and improve
competitiveness.
NHB Residex
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12.4 NATIONAL HOUSING BANK (NHB)
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NHB (National Housing Bank) is a financial institution
set up in 1988 under the National Housing Bank
Act, of 1987. Its headquarters are in New Delhi and
established to promote housing finance organisations
at the local and regional levels.
To help them financially and support their situational
needs. It works under the jurisdiction of the Ministry
of Finance.
RBI is the parent organization which contributed to
its initial share capital of `. 100 crore. Now GOI owns
it completely since 2019 after its purchase for `. 1450
crores. This was done on the recommendations of the
report by the Narasimha-II committee in 2001.
Vision: Promotion of inclusive growth with stability
in the housing finance market.
Mission: To promote the market demands and serve
the housing needs of all segments of the population by
focusing on low and moderate-income housing.
Objectives:
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To promote a profitable and sound housing finance
system to fulfil the demands of the population.
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To dedicatedly serve different groups and regions.
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To make housing credit more affordable and less
cumbersome.
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To regulate and supervise activities related to housing
finance companies.
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To make resources available for the housing sector,
building materials, and land availability and channel
them to upgrade housing stock.
Functions:
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The most important function of the NHB is to perform
supervisory roles of Housing Finance companies
(HFCs) and their registrations.
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Grievance redressal of HFCs.
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It raises funds to refinance the HFCs. It lends loans
to individuals, cooperative banks and housing
infrastructure companies.
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It ensures that HFCs follow the capital requirements
given by BASEL guidelines.
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It raises funds through bonds, borrowings, debentures
etc.
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The bonds of NHB work as security for commercial
banks to meet the statutory liquidity.
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Arrangement of different resources and use them for
housing finances.
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It was established in 2007 as the first housing
price index under GOI. The RESIDEX helps housing
finance companies, banks, policymakers, builders,
investors etc., to analyze the housing prices in
different cities of India.
The NHB’s foremost objective is to encourage
housing finances in India. It works with overseas
housing finance organizations that directly
influence the housing finance situations in India.
12.5EXPORT CREDIT GUARANTEE
CORPORATION LTD (ECGC)
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Export Credit Guarantee Corporation Ltd. 2014
(formerly called Export Credit Guarantee Corporation
of India Ltd.) is a government-owned export credit
provider which is headquartered in Mumbai. It
was established in July 1957 to enhance exports by
covering the risk of credit.
It comes under the jurisdiction of the Ministry of
Commerce and Industry but is managed through a
company having representatives of GOI, RBI, Banking,
Insurance and Export community.
The maximum share (more than 80%) of export credit
services is delivered to Indian markets and MSMEs
get the majority of support. In 2021-22, the Union
government decided to infuse ` 4400 crore capital and
propose its listing through IPO (Initial Public Offering)
to expand its reach to support industries.
Objective: It provides export credit insurance services
to support Indian exporters against non-payment
risks by foreign buyers.
Functions:
It provides credit risk insurance to exporters against
loss of goods and services.
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It also guarantees financial institutions to help
exporters to get better facilities.
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It provides insurance to Indian companies which
are dealing overseas and does their investment like
equity, loans, advances etc.
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Guidance in export-related activities.
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Helps to get easy export finances from financial
institutions.
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It also helps exporters in recovering bad debt.
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Provides information on foreign buyers on their
creditworthiness.
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It helps to improve the competitiveness of exports of
India helping through credit insurance.
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It issues various export credit insurance schemes to
fulfil the requirements of banks which offer export
credit.
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Indian Economy
It comprises working capital financing, credit risk
protection, credit insurance to banks and extending
credit facilities to exporters.
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NIRVIK (Niryat Rin Vikas Yojana)
Scheme:
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Implemented under ECGC for easy lending and
availability of loans to boost export-oriented
services and provides insurance cover to protect
exporters.
On February 1st, 2020, the Finance Minister
announced its launch during the Union Budget.
Features:
Export-oriented support will include both pre and
post-shipment credits to give relief to exporters
against the risk.
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To assist small exporters, services for export credit
risk insurance provide coverage of up to 90%.
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There is a different premium rate slab of ` 80 crore
for luxury items (gems, gold jewellery, diamonds etc)
and other exporting items due to a higher risk of loss.
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It expanded the limit of inspection of records by
officials for losses incurred between ` 10 crore which
was `. 1 crore.
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The banks must pay a premium amount on a monthly
basis along with interest.
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Benefits:
To enhance the easy access and availability of loans
to exporters.
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To make Indian exports competitive in foreign markets
and help in the reduction of trade imbalance.
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Help to make procedures customer-friendly, less
cumbersome and time efficient.
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Availability of working capital on a timely basis to
meet the demand according to the supply.
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Insurance cover will help to bring down the rise in
the cost of credit.
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Objectives:
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To enhance economic growth.
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To refinance collateral-free loans to small borrowers.
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Help in employment generation and increase GDP by
providing credit facilities to micro-enterprises.
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Monitoring and regulations of MFIs.
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Integration of informal economy i.e. not protected and
affiliated by law into the formal sector to increase tax
benefits.
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To promote financial inclusion and credit delivery.
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To alleviate financial stress for borrowers.
Types of Loans:
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Loans provided under this scheme are collateral-free.
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Shishu: <INR.50,000
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Skishor: Above INR.50,000 upto INR.5,00,000
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Tarun: Above INR.5,00,000 upto INR.10,00,000
Need of the hour:
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Critically evaluate before providing loans so that other
regions don’t remain neglected.
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Client reach expansion helps to reduce the risk of
concentration of credit demand to one place and
provides a wider base.
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Recognition of risks at the right time helps to regulate
and overcome challenges.
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Banks should monitor the repayment of clients and
incentivise those who repaid the loan amount before
the timeline.
12.7FINANCIAL STABILITY AND
DEVELOPMENT COUNCIL (FSDC)
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12.6 MUDRA
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To provide credit facilities to all businesses in the
country, the Union government launched MUDRA
(Micro Units Development and Refinance Agency)
Bank.
It was launched in 2015 by the honourable Prime
Minister for providing Low Rate Loans to Microfinance
Institutions (MFIs), Non-Banking Financial Banks
(NBFCs), Small Finance Banks, Commercial Banks etc.
Eligibilities for Loans:
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A person should be a citizen of India.
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Loans for people having businesses in the NonFarming Sector.
Financial Institutions in India
Income generation from Non-Farm activities through
Manufacturing, Processing, Trade, Service Sector or
any other field whose Credit demand is less than `.
10 lacs.
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A regulatory body called the Financial Stability and
Development Council (FSDC) was established by the
government of India to handle financial regularities
in the financial sector.
It is a non-statutory apex body but was constituted
on the recommendation of a committee headed
by Raghuram Rajan in 2010 under the Ministry of
Finance.
It is an initiative of India to prevent global economic
meltdown which puts pressure on economies of
developed and developing countries to regulate their
economic assets.
It functions to strengthen the financial stability,
development of the financial sector, regulation and
monitoring of the economy. No funds are separately
allocated for its activities.
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Responsibilities: Financial Stability, Financial
Sector Development, Inter-Regulatory Coordination,
Financial Literacy, Financial Inclusion, macroprudential oversight of the economy that includes the
operation of large financial conglomerates.
Way Forward:
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Steps to provide liquidity and support through the
availability of capital to stabilize financial institutions
for the long term.
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Fiscal support, regulation and liquidity provisions to
help in economic recovery.
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Government to find out policy measures, private
investment tools, sector-specific programmes etc.
to protect from the current crisis of slowdown and
threats of insolvency.
Board of Directors:
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Chairperson: The Union Finance Minister.
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Members: They include the heads of all financial
sector regulators such as the Governor of RBI, SEBI,
PFRDA, IRDA, the Finance Secretary, the Secretary of
the Department of Economic Affairs, the Secretary of
the Department of Financial Services (DFS) and the
Chief Economic Advisor.
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In 2018, the government reformed the FSDC members
list to include the Minister of State responsible for
the Department of Economic Affairs, the Secretary
of the Department of Electronics and Information
Technology, the Chairperson of the Insolvency and
Bankruptcy Board of India (IBBI) and Revenue
Secretary.
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The Chairperson may invite any person whose
presence is necessary for the meetings.
Functions:
To work for the improvement of financial stability.
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Critically inspect the operations of financial companies.
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Vigil about the economy and evaluate the performance
of these financial companies.
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Financial Stability Report is released by RBI every
2 years to keep an update on the financial stability
and resilience.
PREVIOUS YEAR QUESTION (PRELIMS)
1. 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 macroprudential 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
(d) 1, 2 and 3
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v
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#OpinionMatters
v
Do you think the financial sector of India is strong
enough to achieve the goal of financial inclusion? How
can micro-financial institutions be strengthened to
eliminate poverty?
v
Indian Economy
13
Insurance Sector
13.1 ORIGIN OF INSURANCE
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Insurance is a method of paying losses sustained by a
few by collecting modest amounts of premium from
numerous people and businesses.
The individual insured who is exposed to unpredictable
and unintentional loss can obtain protection through
the payment of a tiny but defined cost, namely a
premium, in this way.
In other words, the insured’s risk is passed to the
insurer.
Insurance, defined as a strategy that provides
protection against unforeseeable occurrences in
exchange for a fee, originated with bottomry bonds
issued by Mediterranean merchants as early as the
fourth century B.C.
There is now insurance for many elements of daily life,
including business, auto, health, life, and travel. Each
of those categories has sub-categories, which branch
out into several divisions.
13.2 RISK AND HAZARD
Risk:
Risk is the uncertainty of a loss happening. Risk
indicates some uncertainty about the future outcome,
which puts us in a worse situation.
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Risk may be described as the prospect of loss, the
uncertainty of loss, or risk as a mix of hazards.
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Hazard:
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In general, the term hazard refers to an incident
that produces loss as well as the circumstances that
influence the result of that loss. For example, suppose
a house is built on a beach and there is a hurricane
threat. ‘Peril’ is a major source of loss that is frequently
beyond human control, such as fire, lightning, flood,
earthquake, theft, accident, explosion, and so on.
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As a result, the cyclone is a source of loss, and the
residences built on the shore impact the outcome.
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A hazard is a circumstance that enhances the
likelihood and magnitude of loss. As a result, the
house’s proximity to the water poses a risk.
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Hazards are factors that have an impact on the result.
They amplify the severity of risks, resulting in loss.
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There are two categories of hazards:
1. Physical Danger: It is a situation caused by the
physical properties of an object that enhances the
likelihood of loss from specified hazards. Physical
risks include icebergs (a hazard for ships), earth
faults, thick woods (a hazard for fire), and so on.
2. Moral Danger: moral risks emerge from the
insured’s mindset. The insured performs things
on purpose to cause damage or file a false claim.
Moral risks are the actions of dishonest people.
13.3 PROXIMATE CAUSE
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Proximate cause indicates that the influence of the
cause is active and starts a sequence of events between
the occurrence of covered dangers and property
damage or destruction.
For example, a fire starts in the house owing to an LPG
explosion in the kitchen and spreads to the bedroom,
causing significant damage to the furniture, curtains,
and fabric.
Because fire is the proximate cause of loss, the full loss
is covered, including water damage.
13.4 INSURABLE RISKS
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Personal Risks
 These dangers have a direct influence on the
individual.
 Personal
hazards include early mortality,
dependent old age, illness or incapacity, and job
loss.
 These are the dangers with the greatest potential
for harm.
Premature Death Risk
 Naturally, the first and primary contingency
covered in every life insurance plan is death.
 Death is unavoidable, but when it will occur is
always unknown.
The Risk Of Living Too Long
 The risk of living too long is the second most
significant contingency to consider.
 It is true that death rates are falling all around the
world.
As a result, this is a contingency that must be
planned for in order to meet the insured’s and
spouse’s post-retirement obligations.
Unemployment Risk
 The possibility of unemployment is the most
important single economic challenge that industrial
employees confront.
 Such coverage is not currently accessible in India.
 Illness/disability risk
 The possibility of complete incapacity is another
major condition.
 Disablement, unlike death and retirement, is
simply a possibility.
 However, it is a disastrous one since it not only
reduces or destroys an individual’s capacity
to make a livelihood, but it also necessitates
additional costs for rehabilitative therapy and the
acquisition of specific equipment to compensate
for the new constraint.
Property Dangers
 Individuals who own property are subject to
property risk, which is the danger of having their
property damaged, lost, or destroyed as a result
of a fire, lightning, flood, cyclone, earthquake, or
other natural catastrophe.
 There are typically two types of losses related
to property destruction or theft: direct loss and
consequential loss.
Direct monetary loss
 It is a monetary loss caused by physical damage,
destruction, or theft of property.
 For example, if a business burns down, the physical
damage to the shop represents a direct loss.
Consequence loss
 It is a monetary loss caused by the incidence of
direct physical damage or theft.
 In addition to physical harm, the store would lose
profit for some months or rent till the shop is
reconstructed.
Liability Risks
 These dangers are significant because, under the
law, you can be held legally accountable if your
actions cause serious bodily harm or property
harm to someone else.
 A court of law may require you to make hefty
restitution to the person or people you have
harmed. For example, a driver is legally accountable
if he causes a crash because of reckless driving.

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13.5DEFINITION OF INSURANCE AND
BASIC ITS CHARACTERISTICS
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Insurance: It is a risk-transfer mechanism.
 The losses of the unlucky few are shared by the
fortunate many via insurance.
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All people who are likely to suffer the same loss
circumstance share the loss of a person.
 In other words, insurance is the pooling of
unanticipated future losses through the transfer
of such risks to insurers who undertake to
compensate the insured for such losses.
Seventh Schedule: Insurance as a subject is mentioned
in the Union list.
Risk pooling: Insurers pool the risk, distributing the
losses of a few unfortunate individuals across the
entire group. Actual loss is replaced by average loss
during the procedure.
Risk transfer: It occurs when an insurer agrees
to cover a potential loss and the uncertainty of the
financial outcome is passed to the insurer from the
insured.
Indemnification: The insured is brought back to their
approximate financial standing before the loss.
 When acquiring insurance, an individual pays a
premium and can file a claim if an insured event
occurs.
 The primary purposes of insurance are risk
transfer through the establishment of a common
pool in which the losses of a few are matched by
the contributions of many.

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13.6 BASIC PRINCIPLES OF INSURANCE
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Contract
 A contract is a binding agreement. It involves a set
of legal commitments, and if those promises are
broken, the law offers a remedy.
 Hence, Insurance is governed by the Contract Act.
Non-life insurance plans are indemnity contracts
that cover the insured’s insurable interest.
Uberrima fides or Utmost Good Faith
 Insurance contracts are made in good faith,
which means that each party must disclose every
important truth in an insurance contract.
Example: Durgesh should inform his insurance
provider about his heart condition when purchasing
a life insurance policy if he is a heart patient.
Principle of Insurable Interest
 Insurable interest arises only if the insured
would suffer economic loss if insured goods were
damaged or destroyed.
 For example, consider home or shop insurance;
damage to the house will result in financial loss
to the owner.
Principle of Indemnity
 This idea contends that people should not be
allowed to benefit from the contract and should
instead be returned to the same financial
circumstances that existed before the incidence
of loss.
Indian Economy
The primary goal is to prevent the insured from
profiting from the incidence of loss, and the
secondary goal is to decrease moral hazard.
 Example: If a person suffers a loss of `. 1 lakh in
a fire, the insurance company will only accept a
claim of up to `. 1 lakh.
Subrogation
 Subrogation is another provision in the insurance
contract that prevents the insured from profiting.
 Subrogation is the process of replacing the insured
with the insurer in order to obtain payment from a
third party for a loss that the insured has already
paid for.
 Example: If a person receives `. 1 lakh for damaged
stock, ownership of the stock is transferred to the
insurance company, and the individual has no
authority over the stock.
Contribution
 It is an insurer’s entitlement to collect a proportional
amount from other insurers who have covered the
obligation for the same loss after paying a loss
under a policy.
 Example: If person A insures his or her home for `.
2 lakh with insurer B and for `. 1 lakh with another
insurer, say, C, and suffers a loss of `. 90,000,
insurers B and C will pay A `. 90,000 and no more.
Proximate cause
 According to the proximate cause principle, the
cause of a loss or damage to the insured object
must be related to the subject of the contract.
 Example: If a person suffers a loss in a fire, this
should already be included in the contract in order
for that person to claim the insurance amount.
Deductibles
 Deductible is a provision that deducts a certain
amount from the loss payouts, normally payable
to the insured.
 A deductible is utilised to avoid petty claims and
the administrative costs associated with changing
them.
 The deductible is the amount of loss that the
insured must pay for every claim, and in return,
substantial premium reductions are achievable.
 Example: If your insurance policy has a deductible
clause of ` 5,000, you must pay this amount
regardless of whether the claim is for ` 10,000 or
` 1 lakh.

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13.7INSURANCE SECTOR IN INDIA:
DATA AND FIGURES
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The insurance industry is massive and increasing
at a pace of 15-20%. Insurance services, together
with financial services, contribute around 7% to the
country’s GDP.
Insurance Sector
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Despite being the world’s second most populous
country, India now contributes less than 1.5 percent
of overall insurance premiums and roughly 2% of life
insurance premiums.
The penetration of the Indian insurance industry
is less than 5% of the GDP. IRDAI data shows that
India’s insurance penetration was 4.2% of the GDP
in 2021-22.
With around 360 million policies, India’s life insurance
business is the largest in the world, and it is predicted
to grow at a compound annual growth rate (CAGR) of
12-15 percent over the next five years.
Between 2019 and 2023, the life insurance sector is
predicted to grow at a 5.3% CAGR.
Based on worldwide insurance penetration and density
metrics for analysing the potential and performance
of the insurance sector, as per the Economic survey
2022-2023:
 Insurance penetration in India increased
steadily from 2.7 percent around the turn of the
millennium to 4.2 per cent in 2020 and remained
the same in 2021.
 In 2021, India had a life insurance penetration
rate of 3.2%, which was slightly higher than
the global average and nearly twice as high as
emerging markets.
 Insurance density in India has increased from
US$ 11.1 in 2001 to US$ 91 in 2021 (density for
Life insurance was US$ 69 and Non-Life insurance
was US$ 22 in 2021) in keeping with the relatively
faster expansion of the insurance market in the
country.
 The gross direct premium of non-Life insurers
(inside and outside of India) increased by
10.8% year over year in the financial year
2022, with the health and motor segments
being the main drivers of this growth.
During the Covid-19 Pandemic time, the government
expanded the allowable FDI limit in the insurance
sector from 49 percent to 74 percent via the automatic
approach, allowing foreign ownership and control
with protections.
13.8HISTORY AND EVOLUTION
(INCLUDING NATIONALISATION) OF
INSURANCE SECTOR
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Insurance may be traced back to prehistoric times in
India. The joint family system has long been seen as a
kind of social insurance. However, modern insurance
began in England in 1818.
The Oriental Life Insurance Company was founded to
assist widows from India’s European community.
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Bombay Mutual Life Assurance Society was the first Indian firm to be established in this field in 1870, charging
standard premiums from Indians.
That same year, the government passed the Insurance Act. Many more businesses were established between 1870
and 1900.
Many significant political events, such as the Swadeshi Movement of 1905-06, the Non-Cooperation Movement of
1919, and the Civil Disobedience Movement of 1920, resulted in a rise in the number of Indian firms.
In 1912, the British government passed regulations to control the insurance industry. It was the 1912 Life Insurance
Companies Act.
REGULATION OF INSURANCE SECTOR:
In the Pre-Independence Period:
 A Comprehensive Act was passed in 1938 to
provide the state strong control over both life and
general insurance.
 It was also to investigate insurance firms’
investments, expenditures, and administration, in
addition to the rates they charged.
 The post of Controller of Insurance was established
and given broad responsibilities.
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Regulation Following Independence:
 Initially, the government of independent India
followed the Insurance Act, 1938, but in 1956, it
decided to make a significant alteration.
 It took over the Indian life insurance business.
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NATIONALISATION OF LIFE INSURANCE:
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Following independence, the Government of India
planned to impose the “ultimate form of regulation”
on the insurance sector in 1956.
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It established the Life Insurance Corporation of India
and assumed control of all 245 insurance companies/
societies in the nation.
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This method was motivated by the increasing number
of scams and discrepancies.
Another set of justifications for the government’s
actions stemmed from insurance companies’ dubious
investing practices.
The other inducement was also critical in light of the
economic developments that were in the works at the
time.
Insurance companies were in charge of large financial
resources. The Life Insurance Corporation of India
has always placed a premium on assurance and
endowment.
NATIONALISATION OF GENERAL INSURANCE:
After 16 years, in 1972, the Government of India took
over general insurance and established the General
Insurance Corporation (GIC).
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While the Life Insurance Corporation of India (LIC)
has remained a single entity, the GIC was created as a
holding company for its four subsidiaries, which are:
 National Insurance Company Limited.
 New India Assurance Company Limited.
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Indian Economy
Oriental Fire & General Insurance Company
Limited.
 United India Insurance Company Limited.
Only aircraft insurance is handled directly by the GIC.
The subsidiaries are obligated to obtain and pay
premiums for GIC reinsurance of their obligations. GIC
also has a 20 per cent stake in their company.

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



13.9ECONOMIC REFORMS AND
REOPENING OF THE INSURANCE
SECTOR
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
The nationalisation of life insurance in 1956
established a monopoly in the industry.

Similarly, we established a monopoly in general
insurance in 1972. These public sector monopolies
worked hard to achieve significant volume growth
while also broadening the scope of insurance coverage.

Nonetheless, they attempted to function as
bureaucratically controlled government offices the
majority of the time.


There was little emphasis on client service. They were
unwilling to accept neither technology nor corporate
work culture.
Indeed, it is unclear that the life industry would have
increased as much if the savings investment had not
been made.
Linked insurance instruments are not tax-free.
Perhaps the same factor explains why UC chose not
to seek out the rural sector.
With relatively low insurance penetration, only 20%
of the Indian market seemed to be a veritable gold
mine to global financial behemoths.
In any case, the World Trade Organisation was
breathing down the Indian government’s neck with
its provisions on Trade-Related Investment Measures.
So, eventually, in 1993, the Government of India
appointed a Committee under the chairmanship of
Shri R.N. Malhotra to examine the issue in depth and
make appropriate recommendations.
The Committee’s report was issued in 1994, and it
made the following recommendations:



The government’s share in LIC and GIC is reduced
to 50%
No private firm may enter the sector unless it has
a paid-up capital of at least `. I 00 crores
No private company may enter both life and
general insurance
Insurance Sector

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Foreign corporations will be allowed to operate
solely in collaboration with Indian businesses
Postal life insurance will be extended to rural
regions
LIC investment in government securities would be
decreased from a mandatory 75% to 50%
GIC and its subsidiaries may not own more than
5% of the company
Promoters may not own more than 40% of newly
established insurance businesses. If they possessed
it, they were supposed to reduce it to that level in
a certain amount of time
To compete, public sector insurers must modernise
technology and reorganise to become more
efficient
As a stopgap solution, restore the office of
Controller of Insurance to its former grandeur
Withdraw the exemption granted to LIC and GIC
from numerous clauses of the Insurance Act
GIC should become a pure reinsurer and cease to
operate as a holding company.
The government purchases GIC’s stake in its
subsidiaries.
The paid-up capital of these subsidiaries should be
increased from `.40 crores to `.100 crores, with
the government holding 50% of the shares.
In August 2000, the insurance business was fully
opened to private companies. But first, the Insurance
Regulatory and Development Authority (IRDA) was
established in April 2000 under the IRDA Act of 1999.
13.10 HOW INSURANCE IS DIFFERENT
FROM THE BANKING SECTOR?
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Instrument: An insurance policy is a type of debt
instrument.
Intermediaries: Insurance businesses are risk-based
financial intermediaries.
Standards: Risk capital or solvency capital standards
are generally higher. (Banks - CRR, SLR, and so on.)
Policy premiums: Statistics, probability theory,
demographic trends, financial market returns, and
current market conditions are used to calculate policy
premiums.
Terminology: Insurance is “sold,” but never
“purchased” (barring some compulsory insurances
such as a motor vehicle)
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Year
Regulators
1948-49
1955-56
1969
1972
1980
Reforms In 1990s
Banking Sector
Insurance Sector
RBI
IRDAI
Nationalization of RBI
Nationalization of the Life Insurance sector and LIC
came into existence.
Nationalization of SBI
—
Nationalization of 14 Private Banks
—
Nationalization of 6 Private Banks
—
CRR, SLR, BASEL
Solvency Margin and Investment Pattern.
For
instance, insurance companies must invest a minimum
"specified percentage" of premium in G-Sec and
are not permitted to invest more than a "specified
percentage" of premium in shares or debentures of
private companies. They must refrain from investing
in businesses with credit ratings below "AA," etc.
—
GIC Act - GIC and its 4 subsidiaries took over - 107
(privately owned) General Insurance Companies.
Narasimham Committee I (1991) Malhotra Committee (1993), Private insurance
and II (1998) + privatization and companies were allowed and FDI was liberalized
liberalization of banking sector
Safeguards
Priority Sector Lending (PSL) norms, Norms for Rural and Social Obligation - policies
25% branches in unbanked rural areas must be sold in rural areas, PH/backward etc.
Financial Inclusion
Further Insurance companies are required to invest
and goal of Welfare
a minimum “specified” in affordable housing projects,
State government fire equipment etc.
Delivery Channel
Endowment
Term
Unit Linked
Insurance Policy
Bank branch Business Correspondence Agents & brokers, Banks selling insurance
Agent (Bank Mitra)
(Bancassurance), Surveyor/Loss Assessors, Third
Party
Yes, savings returned
Term
Yes
13.11 TYPES OF INSURANCE
13.11.1 General Insurance
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Everything, but life can be covered by general
insurance. It provides financial compensation for
losses other than death. General insurance protects
all assets and obligations from loss or damage. The
insurance provider offers to pay the guaranteed
quantity to cover losses caused by the car, medical
treatments, fire, theft, or even financial difficulties
while travelling.
Types of general insurance:
Health insurance:
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Health insurance is an important risk management
strategy since it prevents out-of-pocket payments
during a medical emergency.
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A universal health insurance policy is an indemnity
policy that covers hospitalisation expenditures up to
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Yes
Yes
Yes
the covered amount. While you may get a separate
health insurance policy, family floater policies cover
everyone in your family.
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Critical illness plans, on the other hand, are fixedbenefit plans that offer a lump sum upon diagnosis
of a critical disease and cover medical expenditures
such as pre-and post-hospitalization charges.
Home insurance:
A house insurance policy, as the name implies, protects
your home and its contents from damage caused by
man-made or natural calamities.
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Some house insurance plans may cover temporary
living expenses if you are renting while your property
is being renovated.
Travel insurance:
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If you are travelling overseas, the travel insurance
coverage will protect you against costs caused by lost
luggage, flight delays, and trip cancellation.
Indian Economy
If you are hospitalized while travelling, your travel
insurance may provide cashless hospitalisation in
specific instances.
Motor insurance:
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Motor insurance protects your car from accidents,
damage, theft, and vandalism, among other things.
This type of insurance is available in two varieties:
comprehensive and third-party. Comprehensive auto
insurance coverage protects your car from all sides,
including flood, fire, and riot damage.
It also includes a rider or add-on benefit, personal
accident coverage, and third-party liability.
The Motor Vehicles Act of 1988 mandates that
every vehicle on the road be covered by third-party
insurance.
13.11.2 Life Insurance
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Life insurance protects your life. The insurance
company pays the nominee the amount insured if
the policyholder passes away during the policy’s term.
Life insurance, one of the most important financial
products, assists your family in remaining financially
independent, paying off loans, maintaining the lifestyle
given, and staying on track with important goals.
Types of life insurance:
Term life insurance:
The most fundamental kind of life insurance available
is called term insurance. Term insurance is a simple
protection strategy that offers high levels of protection
at a reasonable cost.
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A term plan allows you to select a sum assured that
is 15-20 times your yearly income.
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If you pass away while the policy is in effect, it pays
the promised sum to your nominee.
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The insurance proceeds assist your family in meeting
everyday costs and paying off debts. It should be noted
that pure-term plans have no maturity advantages.
This implies that if you outlive the policy period, you
will not get these benefits.
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However, insurers have recently introduced return
of premium term insurance policies, which repay all
premiums paid if you survive the policy period.
Endowment plans:
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Endowment plans to combine insurance and investing
in a single package to provide life protection and
create a corpus for important life goals.
A portion of the premium goes to the sum insured,
while the remainder is invested in low-risk channels.
If a person dies during the policy term, their nominee
receives the sum insured.
If they survive the insurance period, they will get the
money promised as well as any collected bonuses.
Insurance Sector
Thus, endowment programmes meet both insurance
and investment demands.
Money-back policies:
Money-back guarantees are comparable to endowment
plans in that they pay a certain sum at predetermined
intervals during the policy period. When the insurance
matures, it pays the maturity benefits as well as the
collected bonuses.
Unit Linked Insurance Plans (ULIPs):
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ULIPs, which combine insurance and investment in a
single product, provide life insurance as well as the
chance for financial gain by investing in various funds
with varying degrees of risk. ULIPs, like endowment
plans, offer life insurance while the remainder is
invested in the markets to produce profits.
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Every ULIP contains underlying funds that invest in
various asset types such as stocks, debt, and hybrid
to create profits.
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ULIPs allow for partial withdrawal once the lock-in
period (5 years) has expired, as well as the ability to
move from one fund to another.
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This feature is useful when you are getting close to
your target since it allows you to transition from an
aggressive fund to a debt fund.
Whole Life Insurance:
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Whole life insurance. provides insurance coverage for
your whole life. Whole life insurance policies have a
policy term of up to 100 years, and as long as the
premiums are paid, the policy’s benefits are preserved.
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The policyholder is eligible for the maturity benefits
if they live out the policy term. Whole life insurance
policies are a fantastic alternative if you wish to be
protected for the rest of your life.
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13.12 KEY DISTINCTIONS BETWEEN LIFE
AND GENERAL INSURANCE
Parameters
Definition
Life insurance
General insurance
Protects
your
life while also
providing a means
of saving and
investing
A general insurance
policy
is
an
indemnity contract
that covers non-life
assets
Term
of Requires paying
Contract
premiums
for
several years for
Long-contract
Generally,
annual
contracts
which
need to be renewed
every year
Payment of It is payable in It is reimbursed
claim
case of the death during
an
of the policyholder eventuality
during the policy
term or on policy
maturity
Component Present
of Saving
Absent
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13.13 FDI REFORMS IN LIC
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The Union Cabinet has approved a change to the
FDI Policy that will allow up to 20% FDI under the
“automatic route” in Life Insurance Corporation (LIC)
ahead of its anticipated Initial Public Offering (IPO).
The government expects the proposed share sale to
raise ` 63,000-66,000 crore, which will help it fulfil
its disinvestment objective of ` 78,000 crore for fiscal
year 2021-22.
The government owns the entire company. It was
founded in 1956. It controls the majority of the Indian
insurance market.
In most cases, disinvestment refers to the sale of a
government-owned firm by the government, either
partially or entirely. Typically, a firm or government
organisation will disinvest an asset as a strategic move
for the company or to raise resources.
At the moment, the FDI policy makes no particular
provision for foreign investment in LIC, a statutory
corporation founded under the LIC Act of 1956.
13.14 DISINVESTMENT OF LIC
The Union government has submitted a draft document
to the stock exchange regulator for the sale of 5% of its
shares in the Life Insurance Corporation of India (LIC).
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The IPO is a 100% OFS [offer for sale] by the
Government of India, with no new shares issued by
LIC.
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Six crore shares are up for grabs, representing 5% of
the government’s stake in the company.
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According to the regulatory filing, up to 10% of the
offer might be allocated for LIC policyholders, with
another 5% designated for workers.
Issues:
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The Government of India owns the LIC, an Indian stateowned insurance group and investment business.
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It was established in 1956 when the Indian Parliament
passed the Life Insurance of India Act, which
nationalised the Indian insurance business.
z
The state-owned LIC was formed by the merger
of over 245 insurance companies and provident
organisations.
Impacts of listing of LICs
z
z
z
172
Profitable for the government: Because LIC is one of
the few remaining profit-making enterprises owned
by the government, the government is attempting to
capitalize on its brand value.
Better returns: Listing will increase LIC efficiency
and thus policy returns.
z
z
z
Reforming the insurance industry: LIC will also
become more competitive. This will put pressure
on its competitors to innovate, which will benefit
policyholders in terms of cost, product features, and
services.
Better financial position: Less government
involvement will be beneficial to LIC’s financial health.
Danger-free: As long as a sovereign guarantee over
the maturity proceeds and the sum assured continues,
policyholders will not sense any risk.
13.15 EMPLOYEES’ STATE INSURANCE
CORPORATION (ESIC)
Legal Status Statutory Body (Employees'
Insurance Act of 1948)
HQ
Ministry
Country
Launched
New Delhi
State
Ministry of Labour and Employment, GOI
India
24 February 1952
Prof. B.P. Adarkar was commissioned by the
Government of India in March 1943 to provide a
report on the health insurance system for industrial
employees.
z
ESIC, formed under the ESI Act, is an independent
corporation of the Government of India’s Ministry of
Labor and Employment.
z
The Employees’ State Insurance Act of 1948 envisioned:
 An
integrated need-based social insurance
scheme that would protect workers’ interests in
contingencies such as sickness, maternity, and
temporary or permanent physical disability.
 Death due to workplace injury resulting in loss
of wages or earning capacity, and death due to
workplace injury resulting in loss of wages or
earning capacity.
z
The Act also guarantees employees and their
immediate families reasonable medical care.
z
Following the passage of the ESI Act, the Central
Government established the ESI Corporation to
manage the Scheme.
z
The Act also released employers from their duties
under the Maternity Benefit Act of 1961 and the
Workmen’s Compensation Act of 1923.
z
Employee benefits offered under the Act are also in
accordance with International Labour Organisation
(ILO) norms.
z
The statute was originally designed for manufacturing
workers, but it was eventually expanded to include
any enterprises with 10 or more employees.
Benefits:
z
Six advantages are anticipated for subscribers under
Section 46 of the ESI Act, 1948.
z
Indian Economy
Medical advantage
Illness insurance
 Maternity leave
 Disability benefit
 Advantages for Dependents
z
Employees enrolled in the system are entitled to medical
care for themselves and their family, unemployment
cash benefits in certain circumstances, and maternity
benefits in the case of female employees.
New Amendment:
z
The Employees’ State Insurance Corporation (ESIC)
increased the monthly wage limit for coverage from `.
15,000 to `. 21,000, effective January 1, 2017.
z
Effective July 1, 2019, the contribution rate was
cut from 6.5% to 4% (employer’s share 3.25% and
employee’s share 0.75%).

z

PREVIOUS YEAR QUESTION (PRELIMS)
1. Consider the following:
(2012)
1. Hotels and restaurants
2. Motor transport undertakings
3. Newspaper establishments
4. Private medical institutions
The employees of which of the above can have the
‘Social Security’ coverage under Employees’ State
Insurance Scheme?
(a) 1, 2 and 3 only
(b) 4 only
(c) 1, 3 and 4 only
(d) 1, 2, 3 and 4
2. 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 microfinance 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
13.16 DEPOSIT INSURANCE AND CREDIT
GUARANTEE CORPORATION
(DICGC)
Deposit Insurance and Credit Guarantee Corporation
Formation
15 July 1978
Headquarters
Mumbai, India
Jurisdiction
Act
Under Reserve Bank of India, Ministry
of Finance.
The Deposit Insurance and Credit
Guarantee Corporation Act of 1961
Insurance Sector
z
z
After the financial crises in Bengal in 1948, the notion
of safeguarding deposits retained with banks got
attention for the first time.
The issue was revisited in 1949, but it was agreed to
put it on hold until the Reserve Bank of India secured
proper systems for bank inspection. Following that,
the Rural Banking Enquiry Committee backed the
notion in 1950.
On August 21, 1961, the Deposit Insurance Corporation
(DIC) Bill was tabled in Parliament. After being enacted
by Parliament, the Bill received the President’s assent
on December 7, 1961, and the Deposit Insurance Act,
of 1961 went into effect on January 1, 1962.
Deposit Insurance and Credit Guarantee Corporation
(DICGC):
z
It is a specialized section of the RBI that reports to the
Ministry of Finance, Government of India.
z
It was founded in July 1978, which was under the
Deposit Insurance and Credit Guarantee Corporation
Act of 1961, to guarantee deposits and credit facilities.
z
Up to a limit of `. 500,000 per depositor in a bank,
the DICGC insures all bank deposits, including savings,
fixed, current, and recurring deposits.
z
The cap has been increased by the government from
1 lakh to 5 lakhs. (after the 2020-21 budget)
Reforms:
z
The Financial Industry Legislative Reforms
Commission (FSLRC) was established in March 2011
by the Ministry of Finance of the Government of
India to evaluate and rebuild the legal-institutional
architecture of the Indian financial sector.
z
The FSLRC advocated in its report a regulatory system
of seven organizations, including a deposit insurancecum regulatory body.
z
The FSLRC concept, based on best worldwide practise,
included a unified resolution corporation that will
deal with a variety of financial organizations such as
banks and insurance companies; it will not only be a
bank deposit insurance corporation.
z
It will focus on all financial institutions that make
high-stakes guarantees to customers, such as banks,
insurance companies, defined benefit pension plans,
and payment systems.
z
To implement these reforms, the Government of
India presented the Financial Resolution and Deposit
Insurance Bill, 2017.
13.17 EXPORT CREDIT GUARANTEE
CORPORATION OF INDIA (ECGC)
Export Credit Guarantee Corporation of India
Founded
30 July 1957
Ministry
Ministry of Commerce and Industry
Headquarters
Sector
Mumbai, Maharashtra
Export Credit Insurance
173
z
z
z
z
z
z
Export marketing became necessary almost soon
after independence in 1947. At a meeting of the
Export Advisory Council in 1953, a proposal for the
establishment of an Export Credit Guarantee Scheme
was made.
The Ministry of Commerce and Industry thoroughly
examined the advantages and disadvantages of the
Export Credit Insurance Program, and a draft bill
proposal for the scheme was presented to the Export
Advisory Council in 1955.
The government adopted the Kapur Committee’s
recommendations, and the Export Risk Insurance
Corporation (ERIC) was established as a private
limited company on July 30, 1957, in Mumbai.
Company registered under the Companies Act having
a paid-up capital of `.25 lakhs and an authorized
capital of `.5 crores.
Export Risk Insurance Corporation’s name was
changed to Export Credit & Guarantee Corporation
Ltd in 1964, following the introduction of insurance
covers to banks between 1962 and 1964.
In 1983, the name was changed to Export Credit
Guarantee Corporation of India Ltd.
It was later renamed ECGC Ltd in August 2014.
Need for export credit insurance:
Payments for exports are risky even in the best of
circumstances.
z
A declaration of war or civil war may prevent or delay
payment for commodities shipped.
z
A coup or insurgency may also have the same effect.
A government may be forced to impose restrictions
on either the import of specific goods or the transfer
of payments for imported goods due to economic
hardships or balance-of-payment issues.
z
Furthermore, exporters must deal with the business
risks of customer insolvency or prolonged default.
z
Business risks associated with a foreign buyer going
bankrupt or losing his ability to pay are increased by
political and economic uncertainty.
z
Export credit insurance is intended to shield exporters
against the implications of both political and economic
payment risks, allowing them to develop their foreign
company without fear of loss.
z
13.18 REGULATORY INSTITUTIONS:
PENSION FUND REGULATORY
AND DEVELOPMENT AUTHORITY
(PFRDA)
Pension Fund Regulatory and Development
Authority (PFRDA)
Export Credit Guarantee Corporation of India Ltd:
The ECGC Limited is a state-owned export credit
agency. It offers export credit insurance to Indian
exporters. In terms of coverage of national exports,
ECGC Ltd. is the world’s sixth-biggest credit insurance.
Functions:
z
Provides exporters with a variety of credit risk
insurance coverage against loss in the export of
products and services.
z
Provides guarantees to banks and financial institutions
in order for exporters to obtain better terms from
them.
z
Overseas Investment Insurance is provided to Indian
enterprises who participate in joint ventures abroad
in the form of equity or loan and advances.
Facilities by ECGC:
z
z
z
z
z
z
z
174
Provides insurance to exporters against payment
risks.
Gives advice on export-related operations.
Provides information on several countries, each with
its own credit rating.
It is now much easier to secure export financing from
banks and financial organizations.
Aids exporters in the recovery of bad debt
Provides information on the creditworthiness of
foreign purchasers.
z
z
z
z
z
z
Type
z
Industry
z
Founded
z
Headquarters
z
Owner
z
Regulatory body
Pension
23 August 2003
New Delhi, India
Ministry of Finance
The Government of India commissioned a nationwide
project termed “OASIS” (an abbreviation for Old Age
Social and Income Security) in 1999 to investigate
policy relating to old age income security in India.
In accordance with the recommendations made by
OASIS, the Government of India implemented a new
Defined Contribution Pension System for new entrants
to Central/State Government employment, with the
exception of the Armed Forces, replacing the current
Defined Benefit Pension System.
The Interim PFRDA was founded in August 2003 by
a resolution of the Government of India to promote,
develop, and regulate the Indian pension industry.
The National Pension System (NPS) went into force
on January 1, 2004. The NPS was then expanded
on a voluntary basis to all nationals of the country
beginning May 1, 2009, including self-employed
professionals and those in the unorganized sector.
On September 19, 2013, the PFRDA Act was approved.
PFRDA regulates NPS, which are purchased by the
staff of the Government of India, state governments,
private institutions/organizations, and unorganized
sectors.
Indian Economy
z
The Authority is composed of a Chairperson and no
more than six members, at least three of whom must
be full-time employees nominated by the Central
Government.
National Pension System(NPS):
z
The National Pension System is a defined contributory
pension system established by the Government of
India.
z
It became required for all Central Government workers
on January 1, 2004.
z
With effect from 1 May 2009, it is open to all citizens
of India, including those in the unorganized sector, on
a voluntary basis.
z
The Reserve Bank of India (RBI) permitted NonResident Indians (NRI) to subscribe to NPS from
October 29, 2015.
z
OCI (Overseas Citizens of India) and PIO (Person
of Indian Origin) cardholders and Hindu Undivided
Family (HUFs) are not eligible for NPS.
Minimum Assured Return Scheme (MARS):
The PFRDA has suggested the MARS, which will give
savers and salaried individuals an alternative for their
investments.
z
Return: This will be the pension regulator’s first
scheme to provide investors a guaranteed return.
z
Growth: India’s pension assets under management
have already surpassed ` 7 lakh crore and are likely
to reach ` 7.5 lakh crore by the end of the fiscal year
2021-22.
z
By 2030, PFRDA hopes to have an AUM (Assets Under
Management) of ` 30 lakh crore.
z
PFRDA’s Proposal under MARS:
 Returns: To have a separate programme
that can offer NPS (National Pension System)
users, particularly those who are risk averse, a
guaranteed minimum rate of return. Currently,
z

the NPS provides annual returns based on market
conditions.
Mechanism: The real returns will be determined
by market conditions. The sponsor will make up
any shortfall, and any excess will be credited to the
subscribers’ accounts.
13.19 REGULATORY INSTITUTIONS:
INSURANCE REGULATORY AND
DEVELOPMENT AUTHORITY OF
INDIA (IRDAI)
Insurance Regulatory and Development Authority
Formation
z
Legal status
z
Act
z
Headquarters
z
Sector
z
Ministry
z
z
z
z
z
1999
Statutory body
Insurance
Regulatory
and
Development Authority Act, 1999
Hyderabad
Insurance of India
Ministry of Finance
In 1914, the Indian government began publicizing the
results of insurance companies.
The Indian Life Assurance Companies Act of 1912 was
the first governmental act to govern the life insurance
industry.
The Indian Insurance Companies Act was passed in
1928 to allow the government to gather statistical
data on both life and non-life business performed in
India by Indian and international insurers, including
provident insurance organizations.
To safeguard the interests of the insurance public, the
preceding law was unified and revised by the Insurance
Act of 1938, which included extensive measures for
effective oversight over insurers’ actions.
Ministry of Finance
Government of India
Insurance Regulatory and
Development Authority
(IRDAI)
Life Insurance (24 General Insurance (27 Specialised Insurers
Standard Health
players)
players)
(2 players)
Indurance (7 players)
Public (1)
Public (23)
Public (6)
Public (21)
Insurance Sector
Public (2)
Public (7)
Re-insurance (including
Foreign Reinsureres
Branchess/Lioyd's India)
(12 players)
Public (1)
Public (11)
175
Mains Agencies were disbanded by the Insurance
Amendment Act of 1950.
 However, there were several insurance firms, and
competition was fierce.
 There were also claims of improper business
practices.
 The Indian government decided to nationalise the
insurance sector as a result.
z
In January 1956, an Ordinance was passed to
nationalize the life insurance business, and the Life
Insurance Corporation was established the same year.
z
The LIC absorbed 154 Indian insurers, 16 non-Indian
insurers, and 75 provident societies, totalling 245
Indian and international insurers.
z
The LIC held a monopoly until the late 1990s, when
the insurance industry was reopened to competition.
Malhotra Committee:
technology-driven solutions, to ensure insurance
coverage in rural areas and vulnerable parts of society.
z
In 1999, the IRDAI was established as an autonomous
agency to regulate and promote the insurance market
in response to the recommendations of the Malhotra
Committee report.
z
In April of 2000, the IRDA was established as a
legislative organization.
The key objectives of the IRDA:
z
Competition should be encouraged in order to improve
customer happiness through expanded consumer
choice and reduced rates, while also guaranteeing the
financial soundness of the insurance sector.
Structure:
z
The composition of the authority is specified in
Section 4 of the IRDAI Act 1999.
z
It is a ten-member committee with a chairman, five
full-time and four part-time members nominated by
the Indian government.
Functions: Section 14 of the IRDA Act, 1999 lays down
the functions of IRDAI:
13.20 REINSURANCE
Reinsurance is also known as stop-loss insurance or
insurer insurance. Reinsurance is the process by which
insurers, through some kind of agreement, transfer
portions of their risk portfolios to other parties in
an effort to reduce the likelihood of having to pay a
sizable obligation resulting from an insurance claim.
z
The reinsurer is the person that assumes a portion of
the possible responsibility in exchange for a share of
the insurance premium.
z
Reinsurance helps insurers to stay in business by
recovering some or all of the money given to claimants.
z
Reinsurance lowers the net liability on individual risks
while also providing catastrophe protection against
large or numerous losses.
Benefits:
z
z
z
z
z
z
z
z
z
z
z
z
z
z
176
Insurance sector regulation and customer protection
Competition is encouraged in order to improve
customer satisfaction.
promoting insurance professional organisations
Insurance intermediary licencing and standardisation
Lowering premiums to ensure the insurance sector’s
financial security.
Defining financial reporting standards for insurance
businesses
Regulating insurance firms’ investment of policyholder
cash
Insurance firms must maintain their solvency margins.
It will also advise adjustments in the distribution
structure, if necessary, including mobile-based and
z
Reinsurance offers the insurer additional protection
for its equity and solvency by enhancing its ability
to resist the financial load when uncommon and
large events occur by insuring it against accumulated
individual obligations.
Through reinsurance, insurers may underwrite
policies that cover a greater quantity or volume of risk
without increasing administrative expenses.
To meet their solvency margins, reinsurance provides
insurers with considerable liquid assets in the event
of extreme losses.
Insurers are required by law to have enough reserves
to cover all potential claims under issued policies.
Types of Reinsurance:
z
Facultative Coverage:
 This sort of coverage covers an insurance provider
just for a certain individual, risk, or contract. If any
risks or contracts must be reinsured, each must
be negotiated independently. The reinsurer has
complete discretion over whether to accept or
reject a facultative reinsurance proposal.
z
Treaty of Reinsurance:
 A treaty policy, unlike a facultative policy, is in
force for a certain length of time rather than on
a per-risk or contract basis. The reinsurer agrees
to pay all or a portion of the risks incurred by the
insurance business being covered for the life of the
contract.
z
Proportional Reinsurance:
 The reinsurer will get a prorated part of the
premiums for all policies sold by the insurance
firm being covered under this form of coverage.
Indian Economy




z

Only damages that exceed the insurance company’s
retention limit will be covered by the reinsurer
under this type of non-proportional coverage.
What distinguishes this sort of contract is that it
is often used for catastrophic events. It can cover
the insurance firm either per incidence or for
all cumulative losses over a predetermined time
period.
Reinsurance with Risk Attachment:

z
In non-proportional coverage, the reinsurer will
only become engaged if the insurance company’s
losses surpass a certain level, known as the priority
or retention limit. As a result, the reinsurer does
not have a proportional part of the insurance
provider’s premiums and losses. The priority or
retention restriction may be set for a specific type
of risk or for an entire business category.
Reinsurance for Excess-of-Loss:

z
Such charges are sometimes known as ceding
commission.
Non-proportional Reinsurance:

z
As a result, when claims are filed, the reinsurer
will face a percentage of the losses as well.
The proportion of premiums and losses shared
by the reinsurer will be determined by an agreedupon percentage.
The reinsurance firm will also compensate the
insurance company for all processing, business
acquisition, and writing costs in proportional
coverage.
All policy claims created within the effective term
of the reinsurance coverage will be covered under
this form of contract, regardless of whether the
losses happened outside of the coverage period.
In contrast, no coverage will be provided for
claims that arise outside of the coverage period,
even if the losses occurred during the term of the
reinsurance contract.
Loss-occurring Insurance:

This is a sort of treaty coverage in which the
insurance company can collect all losses that occur
throughout the term of the reinsurance contract.
The most crucial criterion to examine is when the
losses happened, not when the claims were filed.
Recent Development:
z
To increase the business of overseas reinsurers
in India, insurance regulator IRDAI decreased the
proportion of required cession from the domestic
Insurance Sector
z
z
z
z
z
general insurance market for state-owned GIC Re to
4% from 5% on January 20, 2022.
In 2020-21, the Indian general insurance market was
worth more than ` 2 lakh crore. It has expanded at
a rate of more than 15% in previous years, except in
the last two years, when it has experienced severe
obstacles due to the Covid-19 epidemic and has grown
at a rate of less than 10%.
In fiscal year 2020-21, the Indian reinsurance industry
is expected to be worth roughly ` 55,000 crore.
The government announced the new obligatory
cession quantum on Monday, which will take effect
on April 1, 2022.
Domestic general insurers will be required to pay GIC
Re 4% of their premium on every general insurance
policy sold in the coming fiscal year.
Obligatory cession was 10%, which was later lowered
to 5%, and international reinsurers with operations
in India are requesting that the obligatory cession
for GIC Re be completely removed to provide a fair
playing field in the Indian reinsurance industry.
Obligatory Cession
This is the portion of a general insurance company’s
business that must be ceded to the national reinsurer
GIC Re.
13.21 MICRO-INSURANCE
Microinsurance protects low-income persons against
specific risks in return for recurring premium payments
that are proportional to the likelihood and expense of the
risks involved.
Key Dimensions:
z
To encourage insurance coverage among economically
vulnerable parts of society, the Insurance Regulatory
and Development Authority of India has introduced
a specific type of insurance plan known as microinsurance policies. Micro-insurance is defined and
enabled under the IRDA Micro-insurance Regulations,
2005.
z
A micro-insurance policy is a general or life insurance
policy with an amount insured of less than ` 50,000.
Micro-Insurance: General
z
Contract for health insurance.
z
Any contract involving personal property.
z
Hut.
z
Livestock.
z
Instruments or tools.
z
Any personal injury contract.
z
Individually or in groups it can be done.
177
Micro-Insurance: Life
z
A term insurance policy with or without a premium
refund.
z
Any endowment insurance policy or contract.
z
A contract for health insurance.
z
They might have an accident benefit rider or not.
z
Either alone or in groups.
Microinsurance Delivery Methods:
z
z
z
z
z
z
z
178
z
Model of community/mutual aid: Everything
is administered by policyholders or clients, who
collaborate with external healthcare providers to
provide services.
The IRDAI formed a committee in February 2020
to prepare a concept paper on freestanding microinsurance businesses.
Micro-insurance products provide coverage to lowincome populations with few resources and are
designed primarily for lower-value assets.
In doing so, the 10-member panel must analyse the
appropriateness and feasibility of forming freestanding
micro-insurance firms; review the legal and regulatory
framework that would allow such a company to exist,
and determine the maximum sum insured per person
that the proposed firm would accept.
The Insurance Regulatory and Development Authority
of India (IRDAI) recently formed a 13-member
Committee to evaluate the regulatory environment
on microinsurance and suggest strategies to stimulate
demand for such products in April 2019.
Insurance penetration is the proportion of
insurance premiums to a country's Gross Domestic
Product (GDP).
Insurance Density
z
Model of full-service: In it, the microinsurance
scheme is in charge of everything, including product
creation and delivery to clients, in collaboration with
external healthcare providers.
Suresh Mathur Committee:
z
Insurance Penetration
Partner-agent model: The microinsurance scheme
and an agent collaborate to create this concept. In
some circumstances, a third-party healthcare provider
is involved.
Recent Development:
z
13.22 CONCEPT OF INSURANCE
PENETRATION AND INSURANCE
DENSITY
It is difficult to provide microinsurance. There are
several ways and models available, which might vary
depending on the company, institution, and provider
involved.
Model based on providers: The healthcare provider
is the microinsurance plan, and it is responsible for all
operations, delivery, design, and service, much as the
full-service model.
Under the supervision of IRDAI Executive Director
Suresh Mathur, the committee has been entrusted
with developing product designs with customerfriendly underwriting, as such.
z
z
z
The ratio of insurance premiums to the entire
population, on the other hand, is known as
insurance density.
It indicates how much each person in a country
pays on insurance in terms of premiums.
In other words, it is the country's per capita
premium, computed by dividing the total insurance
premium by the population.
13.23 REASONS FOR POOR INSURANCE
PENETRATION
z
According to the different volumes of the IRDA’s
Annual Reports and other Government papers,
there have been multiple reasons accountable for
the country’s underdevelopment of insurance
penetration and density:
 The financial health of public-sector insurance is
not good
 Insufficient investment in insurance goods
 The general people are unaware of many policies
 Product pricing issues
 Overcrowding in several industries
 Rural areas have a low penetration of private
insurers
 Complex and time-consuming claim settlement
processes
 Insurance firms’ policies and regulations are hazy
and difficult to understand
 People’s lack of education and awareness
 Population with lower income levels
 Social and cultural aspects
 In the industry, there is a lack of a fair playing field,
and the regulatory structure is less vibrant.
Indian Economy
Graphs: Increasing penetration and density of insurance over the years
Fig:
Steady
increase
Insurance
Fig: Figure
Steady IV.26
rose in
Insurance
b: Steady
rose in
Figure IV.26a:
Steadyinincrease
in
Penetration
Density
Insurance Density
Insurance Penetration
70
0.9
60
0.8
2
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
2019-20
2020-21
2021-22
2.4
z
40
0.6
30
z
z
z
z
z
z
z
Encourages Savings: Savings are encouraged by life
insurance because regular premium payments allow
for methodical savings. Life insurance acts as a form
of investment which encourages savings and instills
the habit of conserving money by paying a premium.
Financial Resources: Meets legal criteria by satisfying
contractual and regulatory standards, as well as
providing evidence of financial resources.
Economic Growth: Insurance has a substantial
economic influence by mobilising domestic savings.
Insurance transforms collected cash into profitable
ventures. That means insurance acts as critical to an
economy’s long-term prosperity.
Medical Assistance: Medical insurance is one of the
insurance products that cover many forms of health
risks. In the event of medical insurance coverage, the
insured receives medical assistance.
Risk Transfer: Insurance permits the transfer of risk
from the insured to the insurer. The basic premise of
insurance is to disperse risk over many people. Many
people purchase insurance plans and pay monthly
premiums to the insurer. When a loss occurs, it is paid
from the insurer’s money.
Cash Flow Uncertainty: Manages cash flow
uncertainty when payment capacity is severely
decreased during a loss.
Safety and security: Insurance provides financial
help while also reducing uncertainty in business and
personal lives. It provides protection and security
against a specific event.
Generates Financial Resources: Insurance generates
financial resources by collecting premiums. These
funds invest in government securities as well as
Insurance Sector
z
z
15
50
0.7
13.24 NEED AND IMPORTANCE OF
INSURANCE SECTOR
20
US$
1
2.8
25
10
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
2019-20
2020-21
2021-22
Percent
3.2
Non-Life Insurnace (RHS)
80
US$
3.6
Life Insurnace
Non-Life Insurnace (RHS)
1.1
Percent
Life Insurnace
5
equities. These monies are profitably utilised in a
country’s industrial growth in order to generate
additional cash, which are then used for the country’s
economic development.
Source Of Investment Funds: The efficient utilisation
of the insured’s resources as a source of investment
funds. It provides a source of investment cash.
Premiums are collected by insurers and invested in a
variety of investment vehicles.
Lessens the Social Burden: It reduces the social
burden by minimising uncompensated accident
victims and societal uncertainty.
13.25 CHALLENGES TO INSURANCE
SECTOR
z
z
z
z
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Insurers Lack Capital:Insurers in India lack sufficient
capital, and their financial health, particularly that of
public-sector insurers, is unstable.
 Furthermore, the total banking and NBFC
industries were harmed by the crisis.
Split Of The Risk Pool: The risk pool has been divided
as a result of the multiplicity, overlap, and redundancy
of government-sponsored insurance programmes.
The Missing Middle: The impoverished poorer
portions and the comparatively well-off do not qualify
for either subsidised health insurance (for the poor)
or social health insurance (for the organised sector).
Lack of Adequate Money: Insurance in India lacks
sufficient capital, and their financial health is unstable,
particularly for public-sector insurers.
Huge Insurance Gap: Compared to global levels,
insurance penetration is low. Large sectors of the
Indian population are uninsured, indicating an
insurance gap.
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Rural-Urban Divide: Rural insurer participation
remains low, and life insurance companies, especially
private ones, gravitate toward the urban population.
The dominance of the Public Business: Although the
insurance sector has transitioned from an exclusive
State monopoly to a competitive market, public-sector
insurance companies continue to have a larger market
share despite being fewer in number.
Budding Non-life Insurance: The life insurance
industry has a far larger percentage (74.7%) than the
non-life insurance sector (25.3%).
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13.27 INSURANCE SECTOR REFORMS
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13.26 WAY FORWARD
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Growth in certain segments:
 Increase in microinsurance due to the government’s
increasing emphasis on financial inclusion.
 As a result of the constantly developing vehicle
sector, there is an increase in demand for
automobile insurance.
 Health insurance firms in the non-life insurance
sector grew by 41% in March 2021, owing to a
growing demand for health insurance products
amid the COVID-19 rise.
 Group insurance has also been a significant
contributor to the country’s insurance expansion.
Digital disintermediation:
 In
the Indian insurance business, digital
disintermediation is accelerating.
 The number of start-ups selling internet insurance
has increased, with Policy Bazaar being the most
prominent.
 Policy Bazaar, which is backed by SoftBank and
Singapore’s Temasek, has a 50% market share
in online insurance sales and plans an IPO in
2021, with listings in the US and India.
 Indian start-ups are likewise working on increasing
client access to insurance.
Growth In Financial Industry:
 Overall financial industry growth - a rising working
population with more disposable money.
 Raising awareness of financial items such as
insurance.
Efficiency and innovation:
 Increase in prospective insurance consumers,
people and businesses from various industries,
small and medium-sized businesses, and
multinational corporations
 Expansion of the insurance world as a result of
company professionalisation.
 The application of IoT in the Indian insurance
business has expanded beyond telematics and
client risk assessment.
 According to S&P Global Industry Intelligence,
India is the second-largest insurance technology
market in Asia-Pacific, accounting for 35% of
the country’s US$ 3.66 billion insurtech-focused
venture investments.
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Competition:
 There is an increasing number of insurance carriers
offering a variety of sophisticated solutions at
affordable pricing.
 Regulations that promote the growth of the
industry.
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Since July 2004, the government’s policies have focused
on developing and reforming the financial sector,
regulating markets and upgrading their organisational
and legislative frameworks, strengthening the capital
structures of financial institutions, and protecting
investors’ rights.
The non-bank financial sector reform initiative is
divided into two phases: the first (2005-2008) and
the second (2009-2012).
The first phase aimed at establishing financial
institutions, verifying their soundness and subjecting
them to severe supervision to improve the financial
sector’s effectiveness and ensure its stability and
liquidity.
The Insurance Laws (Amendment) Act, 2015 was
enacted to remove archaic and redundant clauses
from insurance laws, empowering the Insurance
Regulatory and Development Authority (IRDA).
By increasing the foreign equity investment cap in
an Indian insurance company with the safeguard of
Indian ownership and control.
The Act cleared the way for important reform-related
modifications to the 1938 Insurance Act, the 1972
General Insurance Business (Nationalization) Act,
and the 1999 Insurance Regulatory and Development
Authority (IRDA) Act.
It gives the IRDAI more authority, to make the
insurance regulatory environment more flexible,
effective, and efficient.
Insurance Sector Reforms (Insurance Laws Amendment)
Act, 2015:
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Health Insurance:
 The Act defines ‘health insurance business’ as
including travel and personal injury protection and
discourages non-serious players by maintaining
capital requirements for health insurers at the
level of 100 crores, opening the way for health
insurance to be promoted as a separate sector.
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Promoting the Reinsurance Industry in India:
 It allows foreign reinsurers to establish branches
in India and defines reinsurance as “the insurance
of a portion of one insurer’s risk by another insurer
that accepts the risk for a mutually acceptable
premium,” thereby excluding the possibility of a
company ceding 100% of its risk to a reinsurer,
which could lead to companies acting as front
companies for other insurers.
Indian Economy
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Promotion of Foreign Investment:
 With the protection of Indian ownership and
control, Indian ownership and control climbed
from 26% to 49%.
 In Budget FY21, Finance Minister Nirmala
Sitaraman declared a 74% FDI ceiling for
insurance businesses beginning in August 2021.
 Greater capital availability for the capitalintensive insurance sector would result in greater
distribution reach to under/unserved areas, more
innovative product formulations to meet citizens’
diverse insurance needs, efficient service delivery
through improved distribution technology, and
higher customer service standards.
Capital Requirement in Government Companies:
The public sector general insurance businesses,
which are now mandated to be 100% government
controlled under the General Insurance Business
(Nationalisation) Act of 1972, can now issue capital.
 This would provide them with more funding for
company growth in rural industries and increased
competitiveness.
 The Government of India will retain a minimum of
51% shareholding.
Consumer Welfare:It would better serve customers’
interests by including rules such as those providing
for sanctions against intermediary organisations for
misbehaviour and prohibiting multi-level marketing
of insurance goods to reduce the practice of misselling.
 The revised Law has multiple provisions for
imposing increased fines ranging from one crore
to twenty-five crore for different infractions such
as mis-selling and misrepresentation by agents/
insurance firms.
 The revisions simplify the procedure of paying
the policyholder’s nominee because the insurer is
relieved of its legal obligations once the payment
is paid to the nominee.
 According to IRDAI rules, insurance firms are now
required by law to underwrite third-party motor
vehicle insurance.
 The modified legislation preserves insurers’ rural
and social sector commitments.
Robust Appellate Process:SAT will hear appeals
against IRDAI rulings since the new statute allows any
insurer or insurance intermediary who is dissatisfied
with an IRDAI judgement to file an appeal with the
Securities Appellate Tribunal (SAT).
Empowerment of IRDAI:The Act gives insurers the
responsibility of appointing insurance agents and
allows IRDAI to regulate their eligibility, qualifications,
and other aspects.
 It allows agents to work more broadly across
companies in various business categories, with
the safeguard that IRDAI will not allow a conflict
of interest through appropriate regulations.
Insurance Sector
IRDAI has the authority to oversee essential parts
of insurance company operations such as solvency,
investments, costs, and commissions, as well as
to develop laws for commission payment and
management expense control.
 It gives the Authority to control the functions,
code of conduct, and so on of surveyors and loss
assessors.
 Additionally, it expands the definition of an
insurance intermediary to cover brokers of both
types of insurance, as well as brokers of reinsurance,
consultants in the field of insurance, corporate
agents, third-party administrators, surveyors,
loss assessors, and any other businesses that the
Authority may from time to time notify.
 Furthermore, properties in India can now be
insured with a foreign insurer without the consent
of the Central Government, which was previously
required.
Strengthening of Industry Councils:The Life
Insurance Council and General Insurance Council have
now been empowered to draft bye-laws for elections
and meetings, and charge and collect fees, among
other things, from its members.
 The inclusion of representatives from self-help
organisations and insurance cooperative societies
on insurance councils has further broadened the
representation on these Councils.
Reforms to the Capital Market: The IRDA published
new initial public offering (IPO) criteria for insurance
companies wishing to dispose of stock via the IPO
route in March 2019. Insurance firms can now invest
up to 10% in extra Tier 1 bonds issued by banks.
 As a result, the modifications include enhancements
to insurance legislation that are in line with the
growing insurance sector scenario and regulatory
practices throughout the world.
 The reforms will allow the regulator to develop an
operational framework for increased innovation,
competition, and transparency to address people’s
insurance needs in a more comprehensive and
subscriber-friendly way.
 The modifications are intended to allow the
industry to reach its full growth potential and
contribute to overall economic growth and job
creation.
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13.28 FAVOURABLE POLICY MEASURES
TO PROMOTE INSURANCE SECTOR
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FEMA: Foreign Exchange Management Act Amendment
(FEMA) The government revised the Foreign Exchange
Management (non-debt instruments) Rules, 2019,
in August 2021, to increase the foreign direct
investment ceiling in the insurance industry to
74%.
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‘Ayushman Bharat PMJAY SEHAT’: The government
introduced the ‘Ayushman Bharat Pradhan Mantri Jan
Arogya Yojana (AB-PMJAY) SEHAT plan in December
2020 to provide health insurance coverage to all
citizens of Jammu and Kashmir.
‘COVID-19’ Insurance Policy:The government
extended an `. 50 lakh (US$ 66.85 thousand) insurance
coverage plan for healthcare professionals in India till
June 2021. Uttarakhand declared its intention to sell
international visitors the ‘COVID-19 Insurance Policy’
in December 2020.
National Export Insurance Account (NEIA) scheme:
The government authorised the continuance of the
National Export Insurance Account (NEIA) plan and a
grant-in-aid (corpus) payment of `. 1,650 crores (US$
221.30 million) for the next five years in September
2021 (from FY22 to FY26).
Pradhan Mantri Jeevan Jyoti Bima Yojana:In
November 2020, India Post Payments Bank (IPPB)
announced the start of the Pradhan Mantri Jeevan Jyoti
Bima Yojana (PMJJBY) for consumers in conjunction
with PNB MetLife India Insurance Company.
Union Budget: A budget of `. 16,000 crores (US$
2.20 billion) has been earmarked for crop insurance
schemes in the Union Budget 2021. In the fiscal year
2020, there was an increase in health insurance
coverage. In Bihar, Assam, and Sikkim, the proportion
of families with health insurance grew by 89% in FY20
compared to FY16.
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13.29 COMMITTEES TO REVAMP AND
REFORM THE INSURANCE SECTOR
Malhotra Committee:
Reforms in the Insurance Industry The Malhotra
Committee, led by former Finance Secretary and
RBI Governor R.N. Malhotra, was created in 1993
to assess the Indian insurance market and provide
recommendations for its future direction.
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The Malhotra committee was formed to supplement
the changes made in the banking industry.
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The reforms intended to create a more efficient and
competitive financial system fit for the needs of
the economy while keeping in mind the structural
changes now ongoing and recognising that insurance
is an essential aspect of the entire financial system
where comparable improvements were required.
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The committee delivered its findings in 1994, and
among the primary recommendations were:
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Recommendations:
 Regulatory Body:
 The Insurance Act needs to be amended.
Regulatory authority for insurance should be
established. The Controller of Insurance, which
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
is part of the Finance Ministry, should be given
independence.
Structure:
 The government’s stake in insurance companies
will be reduced to 50%.
 The government should take over GIC and
its subsidiaries so that they can operate as
independent enterprises.
 All insurance firms should be allowed more
leeway in their operations.
Competition:
 Private companies with at least `.1 billion in
paid-up capital should be permitted to enter
the market.
 A single company should not be involved in
both life and general insurance.
 Foreign firms may be permitted to enter the
industry in conjunction with native firms.
 Postal Life Insurance should be permitted to
operate in rural areas.
 Each state should only allow one State Level of
Life Insurance Company to operate.
Customer Support:
 UC should pay interest on payments that are
more than 30 days late.
 Unit-linked pension plans should be pushed
by insurance firms. In the insurance sector,
activities will be computerised and technology
will be updated.
 The committee emphasised that businesses
should be opened up to the competition to
improve customer service and expand insurance
policy coverage.
 At the same time, the committee recognised the
need to be cautious since any failure on the part
of new participants may undermine public trust
in the business.
 As a result, it was decided to enable limited
competition by imposing a minimum capital
requirement of `.100 crores.
Mandatory Investments:
 The percentage of government securities held
by the UC Life Fund will drop from 75% to 50%.
 GIC and its subsidiaries are only allowed to own
5% of each company; their current holdings will
gradually be reduced to this amount.
#OpinionMatters
v
In recent years the Insurance sector has seen an
applaudable growth but despite that why is the
penetration of the insurance sector low in India? Do
you think development of curated insurance products
will improve insurance penetration in India?
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Indian Economy
14
Financial Market in India
14.1 CONCEPT OF FINANCIAL SYSTEM
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The phrase ‘Financial System’ refers to a collection
of complex and intertwined instructions, actors,
procedures, markets, transactions, claims, and
liabilities in the economy.
The study of money, its nature, creation, behaviour,
rules, and administration are known as finance. Thus,
the Financial System encompasses all financial
operations that are organised into a system.
The financial system is critical to the running
of the economy because it permits resources to be
transferred from savers to investors.
Elements of Financial System: Financial institutions,
financial markets, financial instruments, and the
services supplied by the banks make up the financial
system.
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14.2 CONCEPT OF FINANCIAL MARKET
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A financial market is a place or process where
financial assets are bought and traded.
Financial market transactions may take place at a
specific platform, such as a stock exchange, or through
a specific method, such as a telephone, telex, or any
other electronic media.
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It has two separate segments today, one catering to
the needs of short-term funds and the other to the
requirements of long-term funds.
Financial markets make it possible to trade financial
assets.
These items are also known as financial instruments
or securities. Financial assets, unlike commodities
or services, are not consumed.
These are claims against money that allow their
holders to get consumable products or services
upon disposing of the claims.
Because financial assets are not consumed, what is
purchased and sold is their usage for a specific period.
Other marketplaces trade products and services
through pricing processes.
Similarly, the cost of using investible money in the
financial markets is the interest paid on a loan.
The amount of interest payable is determined by
a variety of criteria, including the size of the fund, the
length of the loan, the risk involved, and so on.
Thus, the interest rate, also known as the discount
rate, is the cost of obtaining present money in
exchange for future funds.
Financial Market
Money Market
Primary
Market
Call Money
Market
Capital Market
Secondary
Market
Treasury
Bills Market
Commercial
Bills Market
Other the
Counter
(OTC)
Primary
Market
Short
Term
Loan
Market
Stock
Exchange
(SE)
Secondary
Market
Stock
Market
Debt
Market
Mortgage
National
Stock
Exchange
(NSE)
Mutual
Market
Time Cash
14.3 ROLE OF FINANCIAL MARKETS
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All countries, regardless of their level of
development, require funding for economic
development and progress.
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These funds are gained in the economy from
savers or “surplus units,” which might be household
persons, business enterprises, public sector units,
Central governments, State governments, Local
governments, Semi-governments, and so on.
Certain investors or deficit units have spending or
investment that exceeds their current income. As a
result, financial markets play an important role
in transferring this surplus from savers to borrowers
(investors), this is called the ‘transmission mechanism.’
The transfer of excess cash from surplus units to
deficit units is critical in an economy for achieving
national goals and priorities. As a result, this flow
must be directed in the appropriate direction and for
production goals.
The financial markets provide a platform for such
flow by allowing each saver to identify and exchange
good financial assets according to their needs. The
process of allocating funds is known as financial
intermediation.
The financial markets not only aid in the rapid
expansion of industry and the economy, but they
also contribute to the well-being of society and the
rising quality of life. Thus, financial markets should
expand rapidly. They should also be more efficient
and diverse.
14.4 FUNCTIONS OF FINANCIAL MARKETS
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Price determination and discovery: Financial
Markets also play an important role in the pricing
of various assets. Essentially, demand and supply in
financial markets, as well as investor engagement,
influence pricing.
Mobilization of funds: Among the many roles
performed by Financial Markets, one of the most
important is the mobilisation of savings. Financial
markets also invest these savings for constructive
purposes, adding to capital and economic growth.
Ensures liquidity: Liquidity is required for the
proper operation and movement of tradable assets.
This is yet another function of the Financial Market
that helps ensure the smooth operation of a capitalist
economy. It enables investors to not only easily sell
their securities and assets, but also to easily convert
them into real money.
Saves time and money: Financial markets provide
useful information on the securities that are traded.
It saves time, effort, and money that would have been
spent by both buyers and sellers of a financial asset
trying to discover each other.
Ease of Access: Financial markets also offer effective
trading since they bring traders together in one place.
As a result, interested buyers and sellers do not have
to expend any resources, whether financial or time.
Furthermore, it gives required trading information,
which decreases the work that interested parties must
put in to complete their trades.
14.5 TYPES OF FINANCIAL MARKETS
Financial markets are divided into two types:
Organised Markets:
 These are financial markets that function in line with
government-enacted laws, rules, and regulations
that are controlled by the country’s central bank
(RBI) or another regulatory organisation.
 Organised financial markets are further classified
as follows:
 Money Markets: The money market focuses on
short-term credit transactions.
 Capital Markets: are focused on medium and
long-term credit and financial transactions.
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Unorganised Markets:
 Moneylenders, local bankers, and other individuals
who offer credit to the general public typically make
up unorganised markets, which are controlled or
regulated by the central bank.
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MONEY MARKETS:
The debt market is commonly believed to include the
money market, which includes short-term debt
with maturities of one year or less, and the capital
market, which includes long-term debt.
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In a money market (for 364 days or less), short-term
financial assets that are close substitutes for cash are
bought and sold.
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The maturity time of short-term financial assets is
less than a year. Treasury bills, certificates of deposit,
and other similar instruments are examples.
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Indian Economy
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This market is distinguished by the purchase and sale
of products with high liquidity (easily convertible to
cash) and short maturities (less than a year).
Objectives and Functions of Money Market:
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Providing short-term financing to borrowers such
as private investors, governments, and others at a fair
cost.
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It allows lenders to convert their idle capital into
productive ventures.
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The RBI oversees the money market, as a
consequence, it helps regulate the economy’s liquidity
level.
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The money market assists such businesses that
lack the working capital
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It is a major source of government funding for both
domestic and foreign trade.
Purposes of Money Market:
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It is described as a market for money and money
alternatives.
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In general, the money market is required to serve
three primary purposes 1. It should provide an equilibrating mechanism to
balance the supply and demand for short-term
cash.
2. It should serve as a focal point for central bank
intervention in the economy to influence liquidity
and the general level of interest rates.
3. It should provide suppliers and consumers of
short-term funds appropriate access to meet their
borrowing and investment needs at an efficient
market clearing price.
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The money market is a vital component of the financial
market because it provides an outlet for equilibrating
lenders’ surplus funds and borrowers’ demand for
short durations ranging from overnight to a year.
Characteristics of Money Market Transactions:
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Nature’s Short Term
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Transaction costs are quite cheap.
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There are no transactional complications.
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Extremely high quantities
India’s Money Market Evolution Since the mid-1980s:
Recognizing the need for reforms in India’s financial
system, the Reserve Bank of India established a
committee to Review the Working of the Monetary
System in 1985, chaired by Shri Sukhamoy
Chakravarty.
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RBI established a Working Group on Money Markets,
chaired by Shri. N.Vaghul, which issued its report in
1987.
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Based on the recommendations, the RBI implemented
a variety of initiatives to broaden and deepen the
money market in the 1980s.
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Financial Market in India
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The main initiatives were:
 In 1988, the Reserve Bank of India, public sector
banks, and financial institutions established the
Discount and Finance House of India (DFHI) as a
money market institution to provide liquidity to
money market instruments and aid in the growth
of the secondary market for these securities.
 In 1988-89, Commercial Paper, Certificates
of Deposit, and Inter Bank Participation
Certificates were launched to broaden the variety
of money market products.
 Beginning in October 1988, the interest rate
ceiling on call money was gradually removed to
allow for price discovery.
 In 1988, DFHI’s operations in the call/notice
money market was freed from the interest rate
ceiling, and in May 1989, the interest rate ceiling
was completely removed for all operators in
the call/notice money market and on interbank
term money, allowing risk-free rediscounting of
commercial bills and Inter Bank Participation
Certificates.
Money Market And Monetary Policy In India:
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Linkage: It is critical for the financial development
of emerging countries such as India that the money
market and monetary policy are linked.
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RBI: India’s central bank, influences monetary
conditions by managing liquidity through a variety of
mechanisms.
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Mechanism: It exerts control over the money supply
and financial markets using a variety of direct and
indirect mechanisms.
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Liquidity: The cost, availability, and flow of funds are
directly influenced by the Central Bank of India.
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Market force: However, in deregulated and liberalised
economies, interest rates are determined by market
forces; even in such cases, direct intervention by the
apex monetary maker is required to influence the
money supply in the economy. The success of indirect
instruments is dependent on the existence of a
vibrant, liquid, and efficient money market that is well
connected with financial markets like the government
and foreign exchange markets.
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Transmission: Such an integrated and efficient
market is required for monetary policy impulses
sent via money market intervention to be reflected in
monetary conditions via the transmission of general
interest rates.
Instruments of Money Market:
Call/Notice/Term Money Market:
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Commercial banks can borrow and lend money on the
call money market for short-term periods (typically
up to 14 days, but occasionally longer).
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It is a telephonic market, which means that
transactions are made over the phone and reported
to the RBI.
Commercial banks frequently suffer temporary
funding shortfalls to satisfy CRR and SLR standards,
as well as abrupt outflows of capital or temporary
surpluses.
 When a bank is short on finances, it borrows from
another bank that is flush with cash.
Borrowing for one day (overnight) is referred to as
“Call Money.” This is also called the overnight cash
market.
If the maturity of the borrowing (or loan) is more
than one day but less than 14 days, it is referred to
as “Notice Money.”
“Term Money” is money borrowed (or lent) for more
than 14 days but less than one year. The majority of
transactions in the Indian money market include call
money and notice money.
Commercial banks and main dealers can borrow and
lend in this market, while financial institutions and
mutual funds can only lend.
 Borrowing in this market might take place with or
without securities.
The interest rate in this market ‘glides’ with the
‘repo rate’ of the moment, but the idea is simple—the
longer the period, the higher the interest rate.
Scheduled commercial banks and cooperative
banks can operate in this market as both borrowers
and lenders, but LIC, GIC, Mutual Funds, IDBI, and
NABARD can only operate as lenders.

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Repos and Reverse Repos:
In a repo transaction, also known as a ready-forward
contract, one party borrows cash for a set length of
time (known as the repo period) against the collateral
of particular assets at a predetermined rate (known
as the repo rate).
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Although the primary goal is to borrow cash, the legal
title of the security changes as well.
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In other words, the first party sells the security to the
second party and agrees to buy it at a certain price at
a later date.
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In practice, the first party who sells the security gains
access to cash throughout the repo period, which is
the time between the asset’s sale and its repurchase.
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Similarly, a party that needs to invest temporary
surplus cash or increase its holding of securities (e.g.,
banks required to meet SLR obligations) will engage
in an opposite type of transaction with another party
- it will buy the security and agree to sell it back at a
predetermined price at a later date.
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This is referred to as a reverse repo deal. In other
words, from the standpoint of the seller, it is a repo
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transaction, and from the standpoint of the buyer, it
is a reverse repo transaction.
Depending on who started the transaction, it may be
referred to as a repo or a reverse repo.
Repo is essentially a method of borrowing against
the collateral of securities that are sold now and
purchased back at a later date, whereas reverse repo
is a method of lending against the collateral of security
that is bought now and sold back at a later date.
Apart from the Reserve Bank of India, only scheduled
commercial banks, excluding regional rural banks and
primary dealers, are permitted to participate in repo/
reverse repo transactions in India.
Through reverse repo, non-bank participants such
as financial institutions can only lend money to
qualifying participants such as the RBI, commercial
banks, and PDs.
Companies registered on Indian stock exchanges have
been allowed to lend their excess cash in the repo
market since April 2005, to broaden the market’s base.
Central and state government securities, including
treasury bills, are listed as securities suitable for
repo/reverse repo transactions.
Treasury Bills
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Treasury bills are short-term (up to 364 days)
securities issued by the Central Government.
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Treasury notes are now issued with three
maturities: 91 days, 182 days, and 364 days.
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The Treasury Bills instrument was present since
Independence but got organised only in 1986.
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Treasury bill yields serve as standards for most other
short-term rates since they are devoid of default risk.
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Treasury notes are sold for less than their face value.
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With effect from October 27, 2004, the RBI altered
this norm, and the yield is now calculated based
on 1 year = 365 days.
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The Discount and Finance House of India (DFHI) was
founded in November 1986 to create a secondary
market for treasury bills and a variety of other money
market instruments.
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In January 1993, a method of auctioning 91-day
Treasury notes was implemented.
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Banks, primary dealers, financial institutions,
provident funds, insurance companies, NBFCs, FIIs,
and state governments are among the investors in
treasury bills.
Commercial Paper
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Commercial papers (CPs) are short-term (up
to one year) unsecured borrowings facilitated by
the issuance of financial instruments known as
commercial papers by big, reputable, and financially
sound corporations with good credit ratings.
Indian Economy
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Non-financial corporates, main dealers, and All
India Financial Institutions with a certain level of net
worth and a strong credit rating can issue commercial
papers for any duration ranging from 7 days to 1 year.
Certificate of Deposits (CDs)
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CDs are commercial banks’ short-term borrowing
vehicles. CDs can be issued by all scheduled commercial
banks, excluding RRBs and cooperative banks, for a
minimum of 15 days and a maximum of one year in
values of `. 5 lakh and multiples of `. 1 lakh afterwards.
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CDs issued by All India Financial Institutions (AIFIs)
can also be considered money market instruments for
maturities ranging from one to three years.
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CDs are similar to bank fixed deposits, with the
exception that CDs are freely transferred by
endorsement, but bank fixed deposits are not.
z
CDs, like treasury notes, are issued at a discount to
face value.
z
The issuer and the purchaser can freely negotiate the
discount rate or yield on CDs.
z
Individuals, businesses, trusts, and investment firms
can all get CDs.
Bills Rediscounting/Commercial Bill/Bill of Exchange
Under the Negotiable Instruments Act 1881, a bill
of exchange is defined as an instrument in writing
containing an unconditional order.
z
A bill of exchange is used in the sale of products when
the buyer prefers to make the payment later and the
seller prefers to get the money sooner.
z
In this case, the seller or drawer draws a bill on the
buyer of a certain maturity and sends it to the buyer.
z
The buyer then approves or accepts the bill, indicating
that he agrees to pay the amount on or before the
indicated future date, and returns it to the seller.
z
The seller, who needs funds as soon as possible,
delivers this acknowledged bill to his bank and
receives payment from the bank against it.
z
The bank buys the bill from the drawer for a slightly
lower price than the amount shown on the bill. This is
referred to as bill discounting by the bank. When the
drawee makes the payment, the bank gets the money.
z
The bank gains the difference between the purchase
price (or discount price) and the bill amount, which is
also the cost to the bill’s drawer for receiving payment
before the drawee (buyer).
z
A bank can also put its own discounted bills with
the central bank and get funds to utilize in its
lending activities. This is known as the central bank’s
rediscounting of banknotes.
z
Money Market Mutual Fund (MF):
This money market instrument, also known as Mutual
Funds (MFs), was introduced/organized in 1992 to
provide individuals with short-term investment
opportunities.
z
Financial Market in India
z
z
The initial parameters for the MF were liberalised
several times. Since March 2000, MFs have been
subject to SEBI’s scrutiny in addition to the RBI’s.
At the moment, a wide range of financial organisations
and firms, including commercial banks, public and
private financial institutions, and private sector
companies, are permitted to establish MFs.
#OpinionMatters
Do you think the Indian financial market is procronyism? Can Crpto trading be allowed at the stock
exchange?
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the Indian economy, consider the
following statements:(2020)
1. ‘Commercial Paper is a short-term unsecured
promissory note.
2. ‘Certificate of Deposit’ is a long-term instrument
issued by the Reserve Bank of India to a corporation.
3. ‘Call Money ‘is a short-term finance used for
interbank transactions.
4. ‘Zero-Coupon Bonds are interest-bearing shortterm bonds issued by the Scheduled Commercial
Banks to corporations.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 4 only
(c) 1 and 3 only
(d) 2, 3 and 4 only
2. Consider the following statements:(2018)
1. The Reserve Bank of India manages and services
Government of India Securities but not any State
Government Securities.
2. Treasury bills are issued by the Government of
India and there are no treasury bills issued by the
state Governments.
3. Treasury bills are issued at a discount from the par
value.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 3 only
(c) 2 and 3 only
(d) 1, 2 and 3
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 Deposits
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
187
Cash Management Bill (CMB):
Since August 2009, the Government of India, in
consultation with the RBI, has decided to issue a new
short-term instrument known as Cash Management
Bills to fulfil the government’s temporary cash flow
shortfalls.
z
Cash Management Bills are unique, discounted
instruments with maturities of less than 91 days.
z
CMBs have the generic character of Treasury Bills.
z
They are marketable and qualify for ready-forward
facility and bank investment in them is deemed a
qualified investment in government securities for SLR.
z
It should be noted that existing Treasury Bills serve
the same purpose, but because they were placed under
the WMAs (Ways & Means Advances) regulations by
the Government of India in 1997.
z
They no longer serve as a discretionary route for
the government in meeting its short-term funding
requirements at will. CBM is not covered by the same
WMA provisions.
Unorganized Money Market:
z
Before the government began the organised growth of
the money market in India, it existed in an unorganised
form since ancient times—a relic of which is still there
in the country.
z
Their operations are not controlled in the same way
that the organised money market is, but they are
acknowledged by the government.
z
Some of them have been included in the regulated
organised market in recent years.
Type of unorganised money market:
z
Unregulated Non-Bank Financial Intermediaries:
Chit funds, Nidhis, and lending firms are examples of
unregulated non-bank financial intermediaries.They
charge extremely high interest rates and, as a result,
are exploitative in character, with a selective reach in
the economy.
z
Indigenous bankers: They accept deposits and lend
money in the capacity of an individual or a private
enterprise.
 Marwari Kayas: They primarily operate in Gujarat,
with a little presence in Mumbai and Kolkata.
 Chettiars: They are present in Chennai and the
southern Indian ports.
 Gujarati Shroffs: They have operations in Mumbai,
Kolkata, and other industrial, trading, and port
cities around the region.
 Multani or Shikarpuri Shroffs: They have
businesses in Mumbai, Kolkata, Assam tea gardens,
and North Eastern India.
 Money Lenders: They are India’s most localised
form of money market and operate in the most
exploitative manner.They occur in two varieties:
188
Professional money lenders that lend their own
money as a business to earn interest.
 Non-professional money lenders may be
businessmen who lend money to make interest
revenue as a side-line.
Reason for Unorganised section:
 The Indian money market is still in its youth.
 Lack of penetration and presence of organised
money market instruments.
 There are many needy money market customers
who are currently beyond the purview of the
organised money market.
 Customers’ access to the organised money market
is restricted, with small businessmen barred.

z
z
Capital Market:
The capital market is “a set of channels through
which the community’s savings are made accessible
for industrial and commercial firms, as well as
governmental bodies.”
z
The capital market is where investment products such
as bonds, stocks, and mortgages are exchanged.
z
The Indian capital market, like the money market, is
divided into organised and unorganised sectors. The
unorganised sector of the capital market consists of
indigenous bankers and money lenders.
z
This is a market for long-term loans. It offers fixed
and working capital to industry and funds the medium
and long-term borrowings of the federal, state, and
municipal governments.
z
This market’s primary duty is to invest in shareholders
who have surplus cash to those who are experiencing
scarcity. The capital market offers both long-term and
short-term funding.
z
The capital market also allows for the distribution
of firm ownership and the reallocation of financial
resources among corporations and industries.
Significance of capital market:
z
z
z
z
z
z
Funds: Individuals and financial intermediaries
provide funds to the capital market, which are
absorbed by businesses, industry, and government.
National Income: It enables the flow of capital to be
employed more efficiently and profitably to increase
national income.
Capital Formation: The capital market incentivizes
saving with interest or dividends and distributes cash
to investors. As a result, capital formation takes place.
Productive Initiatives: The capital market serves as
a market tool for people with savings as well as those
in need of funding for productive initiatives.
Productive Investments: It shifts resources away
from inefficient and unproductive channels like gold,
Indian Economy
z
jewellery, real estate, and conspicuous spending into
productive investments.
Value Booster: A well-organized and mature capital
market with experienced banking and non-banking
intermediaries boosts the value of stocks and
securities.
Participants In Capital Markets:
z
z
Speculation: It accomplishes this by giving finance
to the needy at fair interest rates and assisting in the
reduction of speculative activity.
Direction: The many institutions that function in the
capital market provide quantitative and qualitative
direction to the flow of cash as well as efficient
resource allocation.
Participants in Financial Market
Money Market
Participants
Capital Market
Participants
Central Commercial Indegenous Discount Acceptance
Bank
Bank
Financial Houses
Houses
Agencies
Commercial
Bank
Investment
Banks
z
Cooperative
Bank
Regional
Rural
Banks
Merchant Investment
Banks
Companies
Development
Banks
Only financial institutions and other agencies that
actively participate in the capital market or facilitate
the capital market process are discussed in this
section. It is divided into two types:
1. Banking Institutions:
z
Banking institutions are basically banks that receive
long-term deposits from the general public and
subsequently lend to the borrowing community.
z
Commercial banks, cooperative banks, land
development banks, foreign banks, regional rural
banks, and other types of banking institutions exist.
z
Banks take long-term deposits from the general
people, allowing them to invest their resources.
z
Furthermore, these commercial banks now satisfy
the long-term funding needs of all sorts of company
ventures, including micro, small, medium, and big
units.
z
They also offer long-term financing to transport
operators, traders in various commodities, farmers,
professionals, and self-employed individuals, among
others.
2. Non-Banking Financial Institutions (NBFI)
z
Other non-banking financial entities do a significant
amount of capital market activity.
Financial Market in India
Land
Development
Banks
z
z
z
Banking Non-Banking
Institution Financial
Institutions
Foreign
Banks
Finance
Insurance Pension
Companies Funds Companies
They actively engage in the transition of capital in an
economy from savers to investors.
They raise funds by collecting deposits from individuals
and others and lending them to businesses, industries,
governments, and so on.
They acquire and sell instruments as well as design
new ones to meet the demands of the savers.
A. Investment Banks:
z
An investment banking institution is a financial
intermediary that is in charge of collecting the savings
of prudent individuals and channeling this money into
commercial activity.
z
These investment banks’ primary tasks include:
 Long-term financing of corporate ventures
 Marketing of shares and debentures
 Serving as security intermediaries
 Advising on the marketing of an issue
 Acting as an insurer rather than the direct
acquisition of security, and so on.
B. Merchant Banks:
Merchant banks are essentially financial organisations
that provide particular services such as bill acceptance,
corporate issue management, portfolio management
z
189
services, project counselling and financing, corporate
restructuring, and so on.
z
Needless to say, the scope of commercial banking
operations is far too broad, and more and more issues
are ahead.
z
Merchant banking is an institutional structure that
provides financial advising and intermediary services
to corporations.
z
A merchant banker may specialise in only one
activity while also engaging in other supportive or
complementary activities.
The function of Merchant Banks:
z
z
z
z
z
z
z
z
z
Business restructuring: Another key service provided
by merchant banks is an external reorganisation
for the overall improved functioning of corporate
divisions. Merger, acquisition, amalgamation, takeover,
alliances, reconstruction, and other similar options
might be considered among interested entities.
Project Counselling: This involves producing
economic, technical, financial, and feasibility studies.
It also discusses project feasibility and procedural
requirements for execution.
Capital Restructuring: The primary goal of capital
restructuring is to advise the unit’s management on
how to build its capital structure in order to maximise
the potential of its financial resources.
Issue Management: The primary goal of issue
management is to make all preparations for mobilising
resources from the capital market for its clients
through the issuance of securities such as equity
shares, preference shares, debentures, and so on.
Working capital finance: Merchant banks support
their clients in obtaining working capital finance.
They advise on prospective sources of working capital
funding and, on occasion, they are able to improve
cash credit arrangements for their clients.
Credit Bills Discounted: After contacting acceptance
and discount houses, they create agreements to
provide bill discounting services to their clients.
Corporate Counselling: A merchant banker’s main
duty is to counsel corporate sector units on different
concerns such as finding areas/activities of growth
and diversification, assessing product lines, and
forecasting future trends.
Portfolio Management: Merchant bankers provide
specialised assistance to their customers on portfolio
management issues.
Credit syndication: Merchant bankers create credit
procurement and project financing agreements for
their client units.
C. Investment Companies:
Investment firms are entities that gather cash from
the public through a specific financial instrument,
such as a unit, share, or debenture.
z
190
z
z
z
The pooled money is subsequently invested in
appropriate securities based on the scheme’s
objectives.
In general, the primary goal of such investment firms is
to maximise the benefits of vast and pooled resources
through low risk and competence.
Investment trusts, mutual funds, commercial bank
common trust funds, management investment
companies, unit trusts, and other similar entities are
examples of big investment-type corporations.
D. Insurance Companies:
These firms are grouped into three types:
1. Life insurance companies,
2. General insurance companies,
3. Marine insurance companies.
These companies cover the danger of fire, accidents,
and natural disasters for human lives, automobiles,
residences, durable products, fixed assets, and so on.
z
E. Development Banks:
z
Development banks, which emerged after World War
II, are currently among the most active participants in
global financial markets.
z
Their major goal is to accelerate the speed of
industrialisation by providing essential development
components such as finance, expertise, and business
skills.
z
As a result, a development bank is a hybrid entity
that combines the goals of a finance company and a
development corporation.
z
Development banks, often known as financial
institutions, are primarily responsible for providing
long-term financial support to industrial units of all
types.
z
Financial support is given in numerous forms, such
as extending term loans, subscribing to shares and
debentures, underwriting capital issues, guaranteeing
term loans, guaranteeing deferred payments by
importers, and so on.
z
Major development banks in India:
 Industrial Finance Corporation of India (IFCI)
 State Financial Corporations (SFCs)
 State Industrial Development Corporations (SIDCs)
 Industrial Reconstruction Bank of India (IRBI)
F. Pension Funds:
Pension funds and retirement plans of various kinds
have recently emerged as significant investors and
market players.
z
These are large investible funds that demand a careful
selection of investment outlets based on the needs of
a certain fund or strategy.
z
Indian Economy
z
z
Private pension plans or corporate pension funds
became a substantial component of the capital market
in industrialised nations in the second part of the
twentieth century.
A pension plan provides pension holders with a
defined sum in a certain currency each month, which
is frequently calculated as a multiple of the number
of years spent in that company.
z
z
z
G. Finance Companies:
People’s money is collected by these firms through
shares, debentures, fixed deposits, and short-term
loans from banks and other corporate units.
z
It has been seen in certain circumstances that they
raise funds at an extremely high rate of interest. As
a result, the liability and capital structures of these
organisations differ significantly from those of other
public financial institutions.
They have a substantial amount of equity capital.
They borrow in both the money and capital markets,
therefore bridging the gap between both markets
and the connection between long-term and shortterm interest rates. Unfortunately, the performance
of these organisations has lately been discovered to
be unsatisfactory in India.
14.6MONEY MARKET VIS-VIS CAPITAL MARKET
Money Market vis-vis Capital Market
Point of Distinction
Definition
Money Market
Capital Market
The money market is a part of the economy Capital Markets are a specific type of financial
that provides short-term funds.
market where company or government securities
are created and bought and sold to establish longterm financing to match the required capital.
Period/Term
Risk Involved
Deals in short-term funds.
Long-term funds.
Commercial banks, NBFS, chit funds etc.
Stockbroker the underwriters, mutual funds,
individual investors, financial institutions
Money markets have low risk.
Riskier in comparison to money markets.
Instrument Dealt In Deals in securities like treasury bills, Deals in securities like shares, debentures, bonds
commercial paper, bills of exchange, and government securities.
certificates of deposits etc.
Participants
Regulatory body
Functions served
RBI
Increasing liquidity of funds in the Stabilizing economy by an increase in savings
economy
Types of Capital Market:
1. PRIMARY MARKET
The primary market is where shares, debentures, and
other securities are offered for the first time to raise
long-term capital.
z
This market is preoccupied with novel concerns. As
a result, the main market is also known as the fresh
issue market.
z
Because the flow of funds in this market is from savers
to borrowers (industries), it directly contributes to
the country’s capital formation.
z
The money received from this market is often utilized
by businesses to enhance plants, machinery, and
structures, expand operations, and form new business
units.
Features of Primary Market:
z
z
SEBI
The term “Initial Public Offer” refers to when a firm
offers new shares or debentures.
Financial Market in India
z
z
The primary market is not a specific location, but
rather the action of bringing in fresh concerns.
It has multiple Floating Capital Methods.
Methods of Floating Capital
z
z
Public Issue: The corporation releases a prospectus
and encourages the general public to acquire shares
or debentures using this strategy.
Offer for Sale: In this procedure, new securities
are originally sold at a predetermined price to an
intermediary (generic companies of stock brokers).


z
They then resell it to the wider population.
The advantage of this strategy is that the issuing
firm is relieved of the time-consuming task of
creating a public issue.
Private Placement: Instead of selling securities
to the public at large, the corporation sells them to
institutional investors or brokers. They then sell these
assets at a higher price to the chosen clients. This
191
strategy is suggested since it is a less expensive way
to gather donations than a public problem.
Right Issue: Companies that have previously
issued their shares employ this strategy. When an
established firm issues new shares, it first asks its
current shareholders to participate. This is known as
the correct problem. In this instance, the shareholder
has the option of accepting the offer for himself or
assigning some or all of his interests to another
individual.
Electronic Initial Public Issue (e-IPOs): Companies
use this procedure to issue securities via electronic
means (i.e. internet). A contract is entered into
between the entity issuing securities through this
medium and a Stock Exchange.
z
z
Benefits of Primary Market:
z
Price manipulation is less severe, making primary
market investing safer.
z
There is no need to time the market because investors
receive the share at the same price.
z
It is secure since primary research data is gathered
directly by the research institution.
z
The money is received by the corporation, and fresh
security certificates are issued to the investors.
Primary Market Application:
Appointing merchant bankers
z
Pricing of newly issued securities
z
The issue’s communication/marketing
z
Credit risk information
z
z
z
z
z
z
z
Making issues public
Money collection
Subscription requirements
IPO on the stock exchange(s)
Securities allotment in Demat/physical method
Keeping records
2. SECONDARY MARKET
The secondary market is the market for purchasing
and selling previously issued securities.
z
Secondary market transactions are often conducted
through the stock exchange. The secondary market’s
primary goal is to provide liquidity in assets.
Features of Secondary Market
z
It generates liquidity.
z
It has a specific place after the primary market.
z
It encourages new investments.
Benefits of Secondary Market
z
Investors can recoup some of their assets if their
economic situation changes.
z
In such instances, investors may choose not to make
long-term investments.
z
By investing over a longer length of time, an investor
can earn a lot of money.
Secondary Market Application
z
Securities trading
z
Risk administration
z
Trade clearing and settlement
z
Securities and money delivery
z
14.7PRIMARY VIS-A-VIS SECONDARY MARKET
Primary vis-a-vis Secondary Market
Point of Distinction
Primary Market
Traded By
z
Intermediaries
z
The flow of Funds
z
Buy/Sell
z
Determination of
Price
Location
192
z
z
Secondary Market
Sale of securities by new companies or
further.
z
The flow of funds is from savings to
investors.
z
It was decided by the company's
management.
z
The company sells securities directly to
the investor (or through a middleman).
z
The primary market only permits the
purchase of securities but does not
allow for the sale of securities.
z
It doesn't have any fixed geographic
location.
z
Only the existing shares can be traded.
Investors exchange ownership of existing
securities. The company is not involved in
any way.
Increases share encash-ability (liquidity),
implying that the secondary market
indirectly promotes capital formation.
The stock exchange allows for both the
buying and selling of securities.
Prices are determined by the security's
demand and supply.
Located in specific locations.
Indian Economy
14.8 INSTRUMENTS OF CAPITAL MARKET
z
Investors’ savings are often raised through a variety
of complicated financial products known as capital
market instruments, such as shares, Debentures,
bonds, or any other marketable assets of a similar
sort issued by any corporation, and so on.
z
Shares
z
z
Equity
Shares
z
z
Preference
shares
z
z
z
Shares
of sweat
equity
z
A company's capital is split into
a defined number of indivisible
pieces. These are referred to as
shares. According to Section 43 of the
Companies Act of 2013, a company
limited by shares' share capital can
be of two types:
1. Equity share capital
2. Preference share capital.
The goal of corporate stock
instruments is to raise capital for the
companies.
The holders of this stock have voting
rights on corporate affairs due to
their stake in the company.
However, if the firm suffers
significant losses and goes bankrupt,
the holders of common stock are
the last to get their money behind
creditors, bondholders, and preferred
stockholders.
Preference shares are a form of share
issued by a firm that delivers a preset
payout to the bearer, as opposed
to the dividend to equity owners,
who get a dividend based on profit
achieved.
Although preferred stock pays higher
dividends, it does not have voting
power in business concerns.
In the event of a company's demise,
preference shareholders have the
right to repurchase their shares
before common stockholders.
Sweat equity shares are equity shares
offered by a firm at a discount to its
workers or directors in exchange for
delivering know-how or a comparable
value to the company.
Sweat equity is a type of remuneration
provided by a company to its
owners and employees. It is an
acknowledgement of a partner's
labour commitment to a project,
whereas financial equity is a capital
input.
Financial Market in India
Debt Instruments:
z
z
z
A debt instrument is used by businesses or
governments to raise financing for capital-intensive
projects that may be obtained through the main or
secondary market. The connection under this kind
of instrument ownership is that of a borrowercreditor and hence does not indicate ownership in
the borrower’s company.
The contract is for a set amount of time, and interest
is paid at regular intervals.
Bonds, Debentures, and Government Securities (G Secs) are all examples of debt instruments.
Debentures
z
A debenture is a long-term financial instrument used to
raise capital by governments and major corporations.
z
It is a loan agreement certificate that bears the
company’s stamp and guarantees that the debenture
holder will receive a specified return and the principal
amount when the debenture matures.
z
In contrast to equity capital, which has variable
income, debentures have fixed income but no voting
rights.
z
Debentures are often freely transferable by the holder.
Bonds
z
It is debt instruments issued by corporations and
governments. Bonds are mostly issued by governments
(Treasury bonds in the United States, gilts in the United
Kingdom, and bonds in Germany) and corporations.
Some corporate bonds are secured against the assets
of the issuing firm, whilst others are unsecured.
z
An investor who purchases a bond loans money for a
certain length of time at a fixed interest rate. Investors
receive semi-annual or annual interest payments
throughout this period.
z
Because contractual interest payments must be made
to the borrowers, issuing a bond increases the bond
issuer’s debt load.
z
Bonds can be of the following types:
 Government Bonds
 Municipal Bonds
 Institutions Bonds
 Corporate Bonds
z
Yield on bonds:
 Interest yield (or running yield): The return on
a bond calculated only on the coupon payments.
 Yield to maturity (or redemption yield): The
return on a bond after deducting coupon cash
flows and capital gain or loss at redemption.
z
Green Bond:
 Green bonds create funds to support ‘green’
initiatives such as renewable energy, emission
reductions, and so on.
193
The World Bank issued the first Green Bond in
2007.
 In 2007, international organisations (European
Investment Bank and World Bank) issued the first
green bond.
 Yes Bank issued India’s first green bond in 2007.
 EXIM bank issued India’s first $500 million dollardenominated green bond in 2015.
 The Indian Renewable Energy Development
Agency Ltd has issued green bonds to finance
renewable energy.
Blue Bonds:
 It’s a kind of green bond that focuses on
infrastructure and water management that is
climate resilient.
Masala Bonds:
 Masala bonds are rupee-denominated bonds
issued in the world’s markets by Indian firms to
raise capital.
 Masala bonds were named after the International
Finance Corporation (IFC), a World Bank
investment arm that issued them to fund
infrastructure projects in India.
 In contrast to external commercial borrowing
(ECB), which must be raised and repaid in dollars,
they shield investors from exchange rate swings.

z
z
Derivative instruments:
 A derivative instrument is one that has a value
that depends on one or more underlying assets,
which can include commodities, precious metals,
currencies, bonds, stocks, stock indices, and so on.
 Futures, options, Forwards, and swaps are the four
most prevalent types of derivative products.
 The goal of these securities is to provide producers
and manufacturers with the ability to hedge risks.
 Using derivatives, both parties agree to sell at a set
price at a later date.
 Derivatives market can be divided into two as
follows:
 Exchange-traded derivatives
 Over-The-Counter derivatives.
How are Bonds Different to Debentures?
z
z
194
Bonds are more secure than debentures. On
the bonds, a guaranteed interest rate is paid that
does not alter in value regardless of the company’s
profit.
Debentures are less secure than bonds.
The security for the loan is provided by the
company. Furthermore, in the event of liquidation,
bondholders will be paid off first, followed by
debenture holders.
z
Debenture holders have no collateral against the
corporation in the event of bankruptcy. Companies
compensate for this by paying greater interest rates
to debenture holders than to bondholders.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the Indian economy, consider the
following statements:(2020)
1. ‘Commercial Paper’ is a short-term unsecured
promissory note.
2. ‘Certificate of Deposit’ is a long-term instrument
issued by the Reserve Bank of India to a corporation.
3. ‘Call Money’ is a short-term finance used for
interbank transactions.
4. ‘Zero-Coupon Bonds’ are the interest-bearing shortterm bonds issued by the Scheduled Commercial
Banks to corporations.
Which of the statements given above is/are correct?
(a) 1 and 2 only
(b) 4 only
(c) 1 and 3 only
(d) 2, 3 and 4 only
14.9 DIFFERENCE BETWEEN DEBT AND
EQUITY
Difference Between Debt and Equity
Basis for
Comparison
Debt
Definition
Monetary Funds
owed by the
company towards
another party is
known as Debt.
The funds that
the business
raises through the
issuance of shares
are known as
Equity.
Obligation
Ownership
Issued By
Status
Risk
Nature of
return
Payoff
Regulator
Companies
registered with
SEBI
Less
Equity
Companies,
governments
High
Fixed and regular Variable and
irregular
Lender of Debt
Shareholders
get
gets an interest
dividends/profits on
income along
their shares.
with the principal
amount.
SEBI
RBI and SEBI in case
of corporate bonds
Indian Economy
14.10 FORWARD CONTRACT VIS-A-VIS FUTURE CONTRACT
Basis for Comparison
Forward Contract
z
Definition
Regulation
z
Collateral
z
z
Default
Traded on
z
Customization
z
Settlement
z
Maturity
z
Size of the contract
z
Risk
z
Futures Contract
It is a customized contract
between two parties to buy or
sell an asset at a specified price
on a future date.
Self-regulated
z
Over the counter, i.e. there is no
secondary market.
z
As they are private agreements,
the chances of default are
relatively high.
z
It is a tailor-made contract.
z
On maturity date.
z
As per the terms of the contract.
Depends on the contract terms.
High
z
Angel Investors viz-a-viz Venture Capitalist
Support
Type
An
angel A Venture capitalist
investor operates is a company or a
independently.
firm.
Angel investors offer Venture
capitalist
mainly
financial seeks
a
strong,
assistance.
competitive product
or service and a
wide-ranging market
potential.
Angel investors are Venture capitalists,
specialized in early- who choose the
stage companies..
venture
capital
Speciality
business, participate
in early-stage firms
and more mature
businesses.
Control
Angel
Investors
don't have huge
control over the
institute.
z
z
z
z
State governments in India, like individuals, manage
their finances.
In these budgets, state expenditures may sometimes
exceed receipts.This results in a fiscal deficit. SDLs are
Financial Market in India
z
z
z
A legal contract to buy or sell a specific
commodity asset, security, or timeshare at a
predetermined price and time in the future.
By stock exchange
Initial margin required.
No such probability.
Organized stock exchange.
It is a standardized contract.
Daily.
Predetermined date
Fixed
Low
bonds issued by state governments to help finance the
budgetary deficit.
Each state may borrow up to a certain amount.
SDLs pay interest at half-yearly intervals and return
the principal amount at maturity. Usually, they are
typically valid for 10 years.
These SDLs are managed by the RBI. The RBI also
ensures that SDLs are serviced by monitoring interest
and principal payments.
However, this does not imply that the RBI guarantees
SDLs. SDLs, like the government bond market, are
traded online.
Banks, mutual funds, insurance firms, provident funds,
and others are among the participants.
Benefits State Development Loans:
z
Venture capitalists
have a huge influence
on the firm and
institution.
14.12 STATE DEVELOPMENT LOANS (SDL)
z
z
Not required
14.11 ANGEL INVESTORS VIZ-A-VIZ
VENTURE CAPITALIST
Operator
z
z
Lesser Risk: These have lower risks with the sovereign
guarantee than AAA Corporate bonds. SDL securities
are seen to be preferable to corporate bonds or
mobilisation loans. The RBI has the authority to make
SDL repayments from federal government allocations
to states. The RBI maintains a fund to cover contingent
liabilities resulting from borrowings by state-owned
enterprises. As a result, it may establish an implicit
presumption that RBI assures SDLs, which is incorrect.
Possibility of higher yields: These papers’ yields may
be greater than the central government’s benchmark
yield. They may offer a greater yield than government
bond rates. Auctions are used for trading, much like
they are for bonds issued by the Central Government.
195
z
z
On September 22, eleven states collected a total
of `. 14,298 crores through an auction of State
government securities or State development loans
(SDLs).
From April 7 to September 22 of the current
fiscal year, 27 states and two union territories
raised a total of `. 3.26 lakh crore through market
borrowings, a 45% increase over borrowings in the
previous fiscal year.
14.13 EXCHANGE TRADED FUNDS (ETF)
It is a pooled investment asset that functions similarly
to a mutual fund.
z
ETFs often track a specific index, sector, commodity,
or another asset, but unlike mutual funds, ETFs may
be bought and sold on a stock market in the identical
manner that a conventional stock can. It can be
designed to track anything from a single commodity’s
price to a huge and diversified group of commodities
which can even be designed to follow certain investing
strategies.
z
An exchange-traded fund (ETF) is a collection of
assets that trade on a stock market in the same way
that stock does.
z
Its share prices fluctuate throughout the day when
the ETF is purchased and sold, as opposed to mutual
funds, which only trade once a day after the market
closes.
z
ETFs can hold a variety of investments, such as
commodities, bonds, and stocks; some are restricted
to the United States, while others are global.
z
An ETF is a form of vehicle that owns numerous
underlying assets, as opposed to just one, like a stock,
does. Because an ETF contains several assets, it can
be a popular choice for diversification. ETFs are thus
capable of holding multiple types of investments,
such as equities, commodities, bonds, or a mix of
investment kinds.
z
An ETF might own hundreds or thousands of equities
across many industries, or it can be limited to a single
industry or sector.
z
An ETF is a marketable investment, which means that
its share price permits it to be purchased and sold
on exchanges throughout the day, and it may be sold
short.
Types of ETFs:
z
Passive and Active ETFs
 Exchange Traded Funds are classified as either
passive or actively managed.
 Passive ETFs seek to imitate the performance of a
wider index, such as the S&amp; P 500, or a more
specialised focused sector or trend.
z
z
z
196
Actively managed ETFs do not normally track a
stock index; instead, they let portfolio managers
decide which assets to include in the portfolio.
Bond ETFs
 Bond ETFs are utilized to give investors with
consistent income.
 Bonds income distribution is influenced by the
performance of the underlying bonds.
 Bonds by Government, corporate, state and local
bodies, known as municipal bonds, can all be
included.
Stock ETFs
 It is ETFs that include a basket of stocks to track
a single industry or sector.
Industry/Sector ETFs:
 Industry or sector ETFs are funds that invest in a
certain industry or area.
 Companies engaged in the energy industry, for
example, will be included in an ETF.
ETFs for commodities
 Commodity ETFs, as the name suggests, invest in
commodities such as crude oil or gold.
 Commodity ETFs provide various advantages.
 They diversify a portfolio, making it easier to
hedge against downturns.
Currency ETFs
 Currency ETFs are pooled investment vehicles
that follow the performance of currency pairings,
which include both local and foreign currencies.
Currency ETFs serve a variety of purposes. They
may be used to speculate on currency values
depending on a country’s political and economic
trends.

Current Status in India
z
z
z
14.14 EXTERNAL COMMERCIAL
BORROWINGS
A loan obtained by an Indian entity from a foreign
lender is known as external commercial borrowing
(ECB).
z
They are commonly used in India to provide access
to foreign funds by Indian firms and public sector
enterprises (public sector undertakings).
z
The majority of these loans are made available by
international commercial banks and other entities.
z
ECBs, like FDI and FII, have emerged as key forms of
foreign capital in the post-reform period.
External Commercial Borrowings in India:
z
z
The Ministry of Finance’s Department of Economic
Affairs, in collaboration with the Reserve Bank of India,
supervises and regulates ECB rules and regulations.
Indian Economy
As part of its development philosophy, India has
traditionally encouraged capital inflows. Unlike China,
the private corporate sector owns the majority of
India’s foreign debt.
ECBs have emerged as a key route for improving
India’s corporate debt market.
The major reason for using ECBs to obtain cash has
changed over time, with refinancing being the most
common in recent years.
The government has a well-designed ECB policy in
place, with a cap on the total quantity of ECBs that
may be received by all Indian enterprises through the
ECB route in a given year.
There are also limitations on how the money can be
spent. The RBI has liberalised the ECB standards by
expanding the window to include new sectors.
z
z
z
z
z
The Sahoo Committee, 2015
z
In 2013, the Sahoo Committee was formed to
establish a system for gaining access to local and
international financial markets.The Committee
assessed the currency risk posed by Indian
enterprises undertaking ECB. The Committee
highlighted that mandating enterprises that borrow
in foreign currency to hedge their exchange risk
exposure can reduce the potential of market failure.
securities provide interest and equity pays dividends,
but neither is guaranteed.
Structure of Security Markets:
Although they are extremely closely connected, the
securities market may be divided into three primary
divisions.
z
The primary market is the sector of the market in
which securities are issued by firms as either a fresh
issue or an offer for sale.
z
Secondary markets are where these securities are
really traded.
z
The derivatives market is where futures and options
are traded. Unlike stocks, which represent ownership,
derivatives are just contracts that are used to control
the risk underlying the security.
Functions of Securities Market:
z
z
z
z
14.15 SECURITY MARKET IN INDIA
The securities markets offer a regulated framework
for the efficient flow of money (equity and debt) from
investors to businesses in the financial market system.
z
Securities markets are essentially a vehicle for
allocating funds to investments.
z
The securities market, like any other market, brings
buyers and sellers together.
z
The main distinction is that the securities market, in
addition to providing liquidity and price discovery,
also contributes to capital formation.
Characteristics of Securities:
z
z
z
z
z
z
Securities are terms of exchange for money between
two parties, in this instance the buyer and seller.
Securities can be issued by borrowers/equity funders
to obtain funds at a fair cost and provide investors
with security ownership.
Businesses use a regulated contract and a controlled
and monitored system to issue securities to obtain
money from investors with surplus finances.
Securities are essentially categorised as either stock
(risk participation) or debt (risk absorption) (claim
on cash flows).
Unlike debt securities, which are issued for a set
period, equity securities are permanent. Debt
Financial Market in India
z
z
Securities markets are a barometer of the economy’s
health and resilience, as well as the investment
environment. Here are some of the primary purposes
of the securities markets.
They allow for the effective deployment of financial
capital. The securities market directs cash from
individuals prepared to accept risk for the sake of
returns to businesses that require capital to expand
by bringing together investors, savers, and issuers.
Securities markets harness millions of small investors’
diversified deposits into long-term wealth growth. As
a result, savings are put to good use, allowing small
investors to participate in economic growth.
The securities market serves a vital role by providing
liquidity to stocks and bonds that would otherwise
be illiquid. The presence of a liquid securities market
also encourages investors and issuers to engage more
confidently.
Securities markets are an essential price discovery
tool. Equities are far more difficult to price, and
securities markets manage to combine the intelligence
of analysts, traders, investors, and arbitrageurs to
determine the true value of an asset.
Participants in Security Markets:
z
z
z
Individuals or institutions having excess cash who
wish to acquire securities are referred to as investors.
The goal of investors is to turn their resources into
financial investments. These investors might be either
retail or institutional.
Issuers are companies or organisations that want to
raise funds by selling securities.
They issue securities to meet the company’s short and
long-term capital needs. Companies, governments,
financial institutions, PSUs, mutual funds, and other
entities that issue securities are examples of issuers.
197
Aside from the key participants, issuers and investors,
there are a variety of intermediaries who ensure the
proper operation of the securities market.
Key Intermediaries in Security Market: SEBI in 2008,
classified intermediaries as follows
z
AMCs / Portfolio Managers: Manage a securities
portfolio and sell units representing membership in a
money pool They assist investors in risk diversification
and wealth creation.
z
Investment banker: Investment bankers or lead
managers oversee IPOs, rights offerings, debt raising,
FD raising, institutional placement, syndication, and
corporate advising services.
z
Underwriters: Guarantee the sale of an IPO and
provide reassurance to issuers by agreeing to buy
back shares that are not sold. For this service, they
are compensated with an underwriting charge.
z
Brokers: Brokers are registered trading members
of stock exchanges who conduct secondary market
transactions. They also advertise IPOs and provide
clients with suitable guidance.
z
Clearing members: Clearing members are stock
exchange members who are in charge of clearing and
settling deals on a daily basis on the stock exchange.
z
Depository Participants: Depository Participants
(DPs) serve as the intermediary between the
depository (NSDL/CDSL) and the investors. They keep
the shares of investors in electronic form.
z
Trustees: When beneficiaries are unable to personally
oversee whether the money invested is being managed
effectively, trustees are appointed. Trustees oversee
mutual funds and debentures.
Regulatory Framework For The Securities Market:
z
The Securities and Exchange Board of India, the
primary regulator, has imposed regulations (SEBI).
Furthermore, the securities markets are governed
by the RBI, the Ministry of Finance’s Department of
Economic Affairs (DEA), and the Ministry of Corporate
Affairs (MCA). Aside from SEBI, the stock exchanges
and depositories also conduct first-level securities
market regulation.
The RBI also regulates exchange-traded currency
futures.
Corporate Affairs Ministry
 The Ministry of Corporate Affairs (MCA) governs
how the corporate sector operates.
 It includes company formation, operation, auditing,
and control.
 Securities issuing is also governed by the
requirements of the Companies Act of 2013.
Ministry of Finance
 The Department of Economic Affairs of the Ministry
of Finance (MOF) supervises markets.
 It controls capital markets and their players
extensively, as well as initiating reform debates and
overseeing the execution of numerous regulating
statutes.
z
Securities and Exchange Board of India (SEBI)
The SEBI was established as a statutory body in
the year 1992 and the terms of the Securities and
Exchange Board of India Act, 1992 (15 of 1992) came
into force on January 30, 1992.
z
SEBI is the primary securities market regulator,
with three primary goals:
 promoting capital market expansion
 protecting the interests of small investors
 ensuring market integrity.
z
The Reserve Bank of India
 The money market section of the securities market
is regulated by the RBI.
 RBI is the issue manager for government debt
since it manages the government’s borrowing
programme.
z
198

z
z
Issuers in the Indian Security Market:
Companies and other organisations that are listed
on the stock exchange are known as issuers. Stock
exchanges allow trading in equity shares, corporate
bonds and debentures, as well as government
securities (G-Secs and treasury bills).
Types of issuers of securities:
z
The federal and state governments use G-Sec,
Treasury Bills, Dated Securities, State Development
Loans (SDLs), and other instruments to raise
money.
z
Public Sector Units (PSUs) generate funds through
issuing shares, bonds, tax-exempt bonds, tax-free
bonds, and so on.
z
Companies in the private sector raise capital in the
market through issuing stock or debt securities,
preference shares, CPs and convertible instruments.
z
Banks, DFIs, and NBFCs raise capital through the
issuance of equity shares, preference shares, bonds,
convertible bonds, commercial paper, certificates of
deposit, and securitized paper.
z
Mutual funds issue unit NFOs in domestic markets
as well as through closed-ended funds and interval
funds.
z
The portfolios of real estate or infrastructure project
pools are also used as collateral for the issuance of
pass-through securities by REITs and INVITs.
z
Retail Direct Scheme
z
z
z
Retail investors will be able to open retail direct
gilt accounts (RDG) with the central bank under
the RBI's recently announced Retail Direct Scheme.
Goal: To encourage retail investment in government
securities by giving Retail Direct Gilt (RDG) account
holders prices and quotes that will allow them to
buy and sell securities through the RBI Retail Direct
Scheme.
Accounts can be formed under RDG schemes using
a specific online portal, which would give registered
users access to NDS-OM and the primary issue of
government securities.
Indian Economy
z
z
Registered users will have access to the Negotiated
Dealing System-Order Matching system and
the principal issuance of government securities
through a dedicated online portal (NDS-OM).
NDS-OM refers to RBI’s electronic order matching
system based on screens for government securities
trading in the secondary market.
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to India, consider the following
statements:(2021)
1. Retail investors through Demat account can invest
in ‘Treasury Bills’ and ‘Government of India Debt
Bonds’ in the primary market.
2. The ‘Negotiated Dealing System-Order Matching’
is a government securities trading platform of the
Reserve Bank of India.
3. ‘Central Depository Services Ltd’ is jointly
promoted by the Reserve Bank of India and the
Bombay Stock Exchange.
Which of the statements given above is/are correct?
(a) 1 only
(b) 1 and 2
(c) 3 only
(d) 2 and 3
14.16 STOCK EXCHANGE IN INDIA
z
z
z
z
z
z
The Stock Exchange is the market where securities are
exchanged. The country now has 23 stock exchanges.
The Bombay Stock Exchange (BSE) is India’s oldest
and most important stock exchange. The National
Stock Market (NSE), with its extensive network across
the country, has emerged as the country’s leading
stock exchange during the previous decade.
‘Over the Counter Exchange of India (ICEI)’ is another
new national exchange.
In India, the stock exchanges are organised as either
voluntary non-profit organisations or as public limited
companies limited by shares or by guarantees.
The stock exchange will be registered with the Central
Government and will operate under the Securities
Contracts (Regulation) Act of 1956. (SCRA).
This Act oversees the establishment, management,
membership, and operation of stock exchanges.
Furthermore, the Stock Exchange is controlled by its
own set of regulations and by laws.
Role Of Stock Exchanges:
z
Promoting industrial progress: The availability of
capital is critical to a country’s industrialization. This
is assured by stock exchanges, which allow the general
people to invest directly in firms.
Financial Market in India
z
z
z
Defending the interests of investors: The stock
exchanges establish criteria for listed businesses’
operations. These standards must be scrupulously
maintained by firms in order to preserve the interests
of investors who have funded the activities.
Secondary Markets: Stock exchanges will assist
bondholders, such as sovereign gold bonds (SGBs),
in selling their holdings before the lock-in period or
maturity date.
Determining a reasonable price: The stock
exchanges aid in the discovery of reasonable values
for publicly traded securities. The constant trading of
securities aids in setting the price of listed securities.
Stock Exchange Trading System:
Traditionally, dealing in securities at the Stock
Exchange has been done on the trading floor of the
Stock Exchange. This conventional approach has been
mostly supplanted with a computerised online trading
system.
z
System of Traditional Trading:
Only trading in listed securities is authorised on
a stock exchange. The phrase ‘listing of securities’
denotes that the security in question has been added
to the list of securities that can be traded on the Stock
Exchange.
z
On a stock exchange, only listed stocks may be
exchanged. As a result, while making a public offering,
corporations state that the security in question has
either been listed or created for that reason.
z
There are two types of listed securities:
1. Cash List: It includes ready delivery
2. Forward List: It allows for forward trade.
On-Line Trading System:
z
z
z
z
With the development of the online trading system,
which has supplanted the previous method, a
significant revolutionary change has occurred.
This technology, known as Bombay Stock Exchange
On-Line Trading, was introduced by the Bombay Stock
Exchange (BOLT).
Trading floor transactions have been eliminated under
the On-Line Trading System.
Settlement Procedure For Traded Securities:
Securities are classified into two categories for settlement
purposes:
(i) Specified Securities: They actively traded shares of
major, growing corporations. Only a small number of
shares come into this category, yet they account for a
significant amount of the capitalization in the Indian
Stock Exchange.
(ii) Non-Specified Securities: These are securities that
are not specified. Transactions in specified securities
can be settled in two ways:
199


Carry Forward System:
 Transactions are finalised at the conclusion of
each settlement period, which is typically two
weeks, beginning on Friday and finishing on
Thursday of the following week.
 The
members determine whether the
transaction is resolved or to be carried forward
at the end of the settlement period on Friday.
The carrying forward of transactions is referred
to as ‘badla.’
 On December 13, 1993, the Badla System,
also known as the Carry Forward System, was
discontinued.
 SEBI implemented a modified carry forward
method in October 1997.
 Finally, on July 2, 2001, SEBI outlawed ‘badla.’
Rolling Settlement System
 SEBI implemented a rolling settlement system
on the Stock Exchanges on a voluntary basis in
January 1998 for securities qualified for Demat
trading.
 All scrips are now traded in rolling settlement
mode.
 The rolling settlement was initially on a T + 5
basis, but as of April 1, 2002, the settlement
cycle for all securities has been reduced to a T
+ 3 basis. It indicates that payment and delivery
of securities must be completed within three
days after the transaction date.
Securities Dematerialisation (D-MAT):
z
z
z
z
z
z
z
200
Dematerialisation means that securities do not
exist in their physical form, i.e. in the form of share
certificates, but are only recorded in the records of an
organisation known as a Depository.
When a shareholder transfers his shares to another
person, he notifies the Depository, which records the
transaction in its books.
Thus, the transfer procedure is expedited and made
watertight while avoiding the different downsides of
physical share transfers.
The Depository Act of 1996, enacted in July 1996, and
the notice of the SEBI (Depository and Participants)
Regulations, 1996, established a legal framework for
recording ownership facts in a book entry form.
This will assist in lowering settlement risks and
addressing some infrastructure bottlenecks.
The dematerialised securities will be fungible, which
means they will have no distinguishing number or
particular identifier.
The National Securities Depository Limited (NSDL)
was established following the announcement of the
SEBI (Depository and Participants) Regulations, 1996.
z
z
The NSDL, which was supported by IDBI, UTI, and the
NSE, began operations in October 1996.
NSDL leverages cutting-edge technology and
competent management and has brought worldwide
securities handling norms and practices to the Indian
capital market.
14.17 INTERNATIONAL STOCK EXCHANGE
Bombay Stock Exchange (BSE):
z
z
z
z
z
z
An Indian stock exchange with its headquarters on
Dalal Street in Mumbai is called the Bombay Stock
Market (BSE), also referred to as BSE Limited.
It was established in 1875 by Jain industrialist and
cotton merchant Premchand Roychand, making it the
tenth-oldest stock market in the world and the oldest
in Asia.
Only 1.3% of Indians, compared to 27% in the US and
10% in China, invest in the stock market, according to
a study by the Bimal Jalan Committee.
The BSE was the first stock exchange registered by
the Indian government under the Securities Contracts
Regulation Act on August 31, 1957.
The BSE created the S&P BSE SENSEX index in 1986,
offering the exchange a way to gauge its overall
performance.
On December 30, 2016, the BSE launched India INX.
INX is the country’s first international exchange.
National Stock Exchange (NSE):
z
z
z
z
The NSE is one of India’s largest and most
technologically advanced stock exchanges.
In 1991, the Pherwani Committee suggested that
India create a National Stock Exchange (NSE).
The Government of India approved IDBI to launch
this exchange in 1992. The National Stock Exchange
of India was founded in 1992 by significant financial
institutions. Later on It was designated as a stock
exchange in 1993. NSE began operations in 1994. It
is located in Mumbai.
The National Stock Exchange was founded by the
following financial institutions:
 India’s Industrial Development Bank (IDBI).
 India’s Industrial Finance Corporation (IFCI).
 India’s
Industrial Credit and Investment
Corporation (ICICI).
 India Life Insurance Corporation (LIC).
 India’s General Insurance Corporation (GIC).
 SBI Capital Markets.
 India’s Stock Holding Corporation Limited
 Limited Financial Services and Infrastructure
Leasing
Indian Economy
z
z
The National Stock Exchange of India’s top index for
major companies is the Standard & Poor’s CRISIL NSE
Index 50, also known as S&P CNX Nifty - Nifty 50 or
simply Nifty. The Nifty is an index of 50 stocks that
represents 21 economic sectors.
The CNX Nifty Junior is an index for firms listed on
India’s National Stock Exchange. It is made up of 50
firms listed on the National Stock Exchange of India.
z
z
z
Calcutta Stock Exchange (CSE):
The CSE, which began under the Neem Tree in the 1830s,
has gone a long way since then. It is one of the country’s
oldest stock exchanges and was formerly considered one
of the largest.
z
z
The Government of India awarded it permanent
approval in 1980 under the applicable sections of the
Securities Contracts (Regulation) Act, 1956.
CSE also had an index known as CSE-40.
Metropolitan Stock Exchange (MSE):
z
z
On December 21, 2012, the Ministry of Corporate
Affairs designated the Exchange as a “Recognized
Stock Exchange” under the Companies Act.
MSE goods are comparable to those of any other
stock market. It provides options on futures, currency
derivatives, and debt market products.
India International Exchange (India INX):
z
z
z
It opened in January 2017 becoming India’s first
international stock exchange, INX.
It is also a subsidiary of the BSE and is based in Gujarat
at the International Financial Services Centre (IFSC),
GIFT City.
Currently, INX only offers debt instruments like
masala bonds and foreign currency bonds, as well
as derivative products like stock, currency, and
commodity derivatives.
NSE IFSC:
z
z
A wholly-owned subsidiary of the National Stock
Exchange (NSE), NSE IFSC Limited (NSE International
Exchange) was established on November 29, 2016,
and its headquarters are in Gujarat at the International
Financial Services Centre (IFSC), GIFT City.
India INX’s product offerings are comparable.
14.18 SECURITIES AND EXCHANGE
BOARD OF INDIA (SEBI)
z
z
The SEBI regulates India’s capital markets.SEBI was
created in 1988 and given legislative status in 1992
via the Parliamentary Act, SEBI Act 1992 to regulate
and grow the capital market.
SEBI controls stock exchanges and intermediaries like
stock brokers and merchant bankers, grants approval
Financial Market in India
z
z
z
for mutual funds, and registers Foreign Institutional
Investors who want to trade Indian scrips.
According to Section 11(1) of the SEBI Act, it is the
Board’s responsibility to defend the interests of
investors in securities.
SEBI’s headquarters are in Mumbai, with regional
offices in New Delhi, Calcutta, and Chennai.
SEBI encourages investor education and the training
of securities market intermediaries.
It forbids fraudulent and unfair trade activities
in securities markets, as well as inter-dealing in
securities, and imposes monetary penalties on erring
market intermediaries.
It also governs the major acquisition of shares and
takeover of firms, as well as requesting information
from, inspecting, conducting inquiries, and auditing
stock exchanges, intermediaries, and self-regulatory
bodies in the securities market.
SEBI’s powers were expanded in 2002, with the SEBS
board expanded to nine members from six, and three
full-time directors appointed, strengthened powers to
undertake searches and seizures, and so on.
SEBI and the Reforms:
The 1992 Stock Exchange Scam (Harshad Mehta)
and the 2000 Scam (Ketan Parekh) prompted the
government to take a number of steps to protect the
interests of small investors.
z
SEBI implemented changes such as increased
transparency, computerization, legislation against
insider trading, prohibitions on forward trading, and
the implementation of the T + 2 settlement system,
among other things.
z
The limitation and abolition of forward or contract
trading, known as ‘Badla’ in India, is a bold effort to
combat market speculation and manipulation.
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SEBI has also taken the following initiatives to
improve markets:
 SEBI reformed stock exchange governing bodies,
established capital adequacy standards for
brokers, and established regulations to increase
client/broker transparency.
 SEBI
enforces
corporate
transparency
requirements.
 Insider trading is prohibited.
 Retail investors are protected.
 SEBI has the authority to register and regulate
mutual funds.
 Creating a code of behaviour for all credit rating
firms in India.
 Clause 49 of SEBI’s listing agreement requires that
all listed businesses have half of their directors
serve as independent directors.
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market, like the stock market, has yet to establish
itself.
SEBI Rules, 2009
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The SEBI has authorised the “Anchor Investor”
concept, which allows an investor to subscribe to
up to 30% of the institutional quota in an initial
public offering.
Under the revised guidelines, an anchor investor
would pay 25% of the total investment when
applying for the initial public offering, and the
remainder within two days after the issue’s
conclusion.
Such anchor investors would be subject to a
one-month lock-in term from the date of share
allocation.
Bimal Jalan Committee
SEBI created a committee chaired by Dr Bimal Jalan
(former Governor of the Reserve Bank of India) in January
2010 to evaluate and suggest reforms in the ownership
and governance of Market Infrastructure Institutions
(‘MIIs’) such as stock exchanges, depositaries, and
clearing organisations.
14.19 COMMODITY EXCHANGES
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Commodity exchanges are entities that provide a
trading platform for commodity futures, similar to
how stock exchanges provide a trading platform for
stocks and their derivatives.
As a result, they play an important part in price
discovery, where several buyers and sellers interact
to establish the most efficient price for the commodity.
A variety of commodities are traded in ‘commodity
futures’ on Indian commodity markets.
The Forward Markets Commission now enables
futures trading in over 120 commodities.
In the country, there are two types of commodities
exchanges: national and regional.
Important Commodity Exchanges are as follows:
Indian Commodity Exchange (ICEX):
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ICEX is an Indian commodities derivative exchange.
It’s a permanent exchange that’s registered with SEBI
and the only exchange that enables futures trading in
diamond contracts.
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Aside from diamond contracts, ICEX also provides
agricultural derivatives such as spices, oilseeds,
plantations, and cereals.
Multi-Commodity Exchange (MCX):
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The MCX is one of the country’s biggest commodities
exchanges.
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These are mostly utilised by hedgers, traders,
merchants, and even corporations, but the commodities
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National Commodity and Derivatives Exchange (NCDEX):
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NCDEX, the country’s second major commodities
exchange, began operating at about the same time as
MCX.
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NCDCEX, unlike MCX, solely trades agricultural
products.
14.20 COMMODITY MARKETS
Trading in commodity markets includes the purchasing
and selling of numerous commodities and their
derivative products.
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Any raw resource or basic agricultural product that
may be purchased or sold, such as wheat, gold, or
crude oil, is considered a commodity.
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If you trade commodities, you may diversify your asset
portfolio.
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In commodities markets, physical trading and
derivatives trading might include spot prices, forwards,
futures, and options on futures.
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For generations, farmers have used a crude form
of derivative trading on the commodities market to
manage price risk.
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There is a large disparity between the trading volume
of commodities and the real worth of commodities in
physical form due to hedging by numerous parties.
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SEBI, the regulator, presently permits futures trading
in over 120 commodities.
Types of Commodities: Broadly divided into two
categories: hard and soft.
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1. Hard commodities:
 Hard commodities are those that have to be taken
from the ground.
 This category includes metals and minerals such
as gold, copper, and others.
 Crude oil is classed as a hard commodity as well.
2. Soft commodity:
 Food grains, edible oil, meat, and cattle are
examples of soft commodities.
Commodity trading list:
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Mustard seed, cottonseed, soybean oil, and other
edible oilseeds
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Wheat, Gram, Bajra, Maize, and other cereal grains
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Metals such as gold, silver, copper, and zinc
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Turmeric, pepper, jeera, and other spices
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Cotton, jute, and other fibres
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Others include sugar, gur, rubber, natural gas, crude
oil, and so on.
Indian Economy
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The most often traded commodities include gold,
crude oil, silver, copper, natural gas, lead, soy oil, zinc,
soybeans, and castor seed.
Commodity Markets – Regulation & Reforms:
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While the FMC (Forward Markets Commission) has
supervised commodities markets since 1952, it was
commonly considered as lacking the capacity to curb
extreme price movements and other anomalies.
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As a result, in 2015, FMC merged with SEBI (a
regulatory body for the industry with a reputation
for being superior in terms of surveillance, riskmonitoring, and enforcement mechanisms).
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Following that, SEBI implemented several reform
measures, including:
 Letting stockbrokers deal in commodity derivatives
(common broking businesses for equities and
commodities);
 Enabling the NSE and BSE to begin commodity
trading;
 Permitting FPIs to participate in commodity
derivatives contracts traded on stock exchanges
subject to certain conditions;
 Enabling Category III Alternative Investment
Funds (AIFs) to trade in commodity markets.
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Experts believe that India’s commodities trading
business is undergoing a metamorphosis, with
significant developments taking place in areas such
as logistics, transportation, infrastructure, and so on.
Benefits of Commodity Markets:
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Diversification:
 The link between commodity returns and other
asset returns is poor.
 Commodities may be utilised to diversify your
investment portfolio as an individual asset class.
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Hedge Against Inflation:
 Commodities are regarded as an excellent inflation
hedge since their prices rise during periods of high
inflation.
 This helps to keep buying power parity in place.
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Protection from event risk:
 Commodity prices may rise as a result of supply
disruptions caused by a natural disaster, an
economic crisis, or a conflict.
 Commodity trading, on the other hand, may assist
you to safeguard against loss by deliberately
leveraging price movements.
14.21 STRATEGIC DISINVESTMENT
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It entails the selling of a public-sector enterprise to
a non-government company or, more broadly, to the
private sector.
Financial Market in India
Strategic disinvestment encourages private sector
participation, making PSUs more efficient and
lucrative.
The government engages in strategic disinvestment
to relieve itself of the burden of running a nonperforming/loss-making public entity.
It is classified into the following categories:
 Minor disinvestment: It occurs when the
government gives up a portion of its investment
(minority stake) but keeps a majority stake,
preferably at 51%, to retain managerial control.
 Major disinvestment: It occurs when the
government sells the majority of its investment in
the firm while keeping small stakes.
 Complete
privatisation: The government
relinquishes total management of its interests to
a private player.
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Disinvestments: A Historical Overview:
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For the first four decades following independence,
India adopted a development path that relied on the
public sector to drive prosperity.
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However, the public sector grew too big and its
shortcomings began to show up in low capacity
utilisation and low efficiency due to overstaffing, low
work ethics, overcapitalization due to significant time
and cost overruns, inability to innovate, making quick
and timely decisions, large interference in decisionmaking processes, and so on.
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As a result, in 1991, the decision was made to adopt
the road of disinvestment.
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The change of process in India began in the year 199192 when 31 selected PSUs were disinvested for `.3,038
crore.
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The Disinvestment Commission, led by G V
Ramakrishna, was established in August 1996 to
provide guidance, supervise, track, and promote the
progressive disinvestment of Indian PSUs.
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In December 1999, the Agency of Disinvestment was
established as a separate organisation. In September
2001, it was renamed the Ministry of Disinvestment.
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The Department of Disinvestment was then transferred
to the Ministry of Finance on May 27, 2004.
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The Department of Disinvestment was renamed
the Department of Investment and Public Asset
Management (DIPAM) on April 14, 2016, and has been
designated as the nodal department for the sale of
strategic stakes in Public Sector Undertakings (PSUs).
National Investment Fund (NIF)
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It was established in November 2005 to channel
the earnings of the disinvestment of Central Public
Sector Enterprises.
203
Benefits of Strategic Disinvestment:
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It would contribute to the reduction of the government’s
debt and budget imbalance.
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It will support higher social expenditure with an
emphasis on social welfare and ensuring that resources
are available to the general people.
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Strategic disinvestment funds can be used to finance
large-scale infrastructure development, invest in the
economy to boost consumption and invest in social
services such as health and education.
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Government participation in non-strategic industries
affects competitive dynamics for private businesses,
causing consumers and taxpayers to suffer the burden
of inefficient PSU operations.
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Better work prospects will result from the expansion
of the private sector.
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It aids in the diversification of PSU ownership in order
to improve the effectiveness of individual enterprises.
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With the economy’s financial health degrading,
strategic disinvestment would provide income for the
government and therefore enhance fiscal health.
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It may encourage the use of creative managerial skills
and technology, and a strategic investor can help such
divisions flourish.
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It is believed that the strategic buyer/acquirer would
bring in new management/technology/investment
to help these firms expand and will employ creative
approaches to help them flourish.
Challenges with Strategic Disinvestment:
The emphasis has been on raising resources, as the
sale of PSUs that make money and pay dividends
would end in the government losing regular revenue.
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Loss of regular revenue from PSUs because the sum
acquired via disinvestment will be paid just once,
complicating the government’s method of receiving
regular income.
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If the government holds a majority stake, the public
businesses will continue to function with the previous
culture of inefficiency and loss.
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Privatization does not necessarily result in the
establishment of a competitive environment.
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The whole disinvestment process, from idea through
bidder selection, is influenced by bureaucratic control.
The sale of profit-making and dividend-paying PSUs
would cause the government to lose regular revenue.
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The strategic partner might engage in “Asset Striping.”
The majority of PSUs have valuable assets such as
plant and machinery, land and buildings, and so on.
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Vital disinvestment in oil PSUs is viewed as a danger
to national security by some analysts since oil is a
strategic natural resource and prospective foreign
ownership is incompatible with our strategic aims.
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Using disinvestment money to bridge the budget deficit
is a risky and short-term strategy. It is considered to
be the equivalent of selling “family silver” to address
immediate monetary needs.
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Why is the Government of India 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
14.22 REAL ESTATE INVESTMENT TRUST
(REITS)
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Complete privatisation may result in public monopolies
becoming private monopolies that will subsequently
employ their position to raise the costs of different
services while increasing profits.
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REITs are comparable to mutual funds. While mutual
funds enable you to invest in stocks, REITs allow you
to invest in income-generating real estate assets.
They are collective investment vehicles that handle
and manage property holdings while providing
investors with rewards. To raise funds, the Securities
and Exchange Board of India wants every real estate
investment trust (REITS) to be listed on markets and
conduct an initial public offering.
It’s akin to a group of people pooling their money to
acquire real estate, but on a much bigger scale and
with additional restrictions.
The basic principle behind REITs is that you own a
portion of the property and hence earn a portion of
the revenue after deducting an acceptable percentage
of expenditures.
Because the trust’s units are sold on exchanges, this
type of monetisation benefits developers by freeing
up capital for future real estate developments. It also
gives investors and unit holders liquidity.
REITs receive favourable tax treatment, such as
exemption from dividend distribution tax and
relaxation of the capital gains tax.
Working Mechanism:
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REITs collect money from a large number of investors
and invest it directly in income-generating real
estate holdings (which could be offices, residential
apartments, shopping centres, hotels and warehouses).
The trusts are listed on stock markets, allowing
investors to purchase units in the trust. REITs are
organised as trusts. As a result, an independent
trustee holds a REIT’s assets on behalf of unit holders.
Indian Economy
Type of REITs:
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1. Equity REITs - Acquire, hold, and manage incomeproducing assets.
Trustee
2. Mortgage REITs- Where companies lend money to real
estate owners directly or indirectly.
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3. Hybrid REITs- They are a cross between the first two.
Significance of REITs:
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Sponsor
Due to unsold inventories and limited demand, the
Indian real estate market has been experiencing
a liquidity crisis. REITs can assist cash-strapped
developers in capitalising on their existing property.
Rent and capital appreciation from the property
in the real estate industry are both affected by the
location, infrastructure, and industrial activity in the
surrounding region.
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REITs manage these risks by holding a diverse
portfolio of assets.
REITs can lessen the risk associated with your property
investments because 80% of the REIT’s value should
be in finished and rent-generating properties.
They must be operated by professional management
with the years of experience indicated by SEBI.
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Investment
Manager
14.23 INFRASTRUCTURE INVESTMENT
TRUSTS (INVITS)
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An InvITs is similar to a mutual fund in that it allows
small amounts of money to be invested directly in
infrastructure and receive a percentage of the revenue
as a return.
Because the units of the trust are sold on exchanges,
such monetisation benefits developers by freeing up
capital for future infrastructure investments.
The SEBI (Infrastructure Investment
Regulations of 2014 govern InvITs.
Investment Requirement:
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Trusts)
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
Every allocation lot must be at least `.1 lakh in
value.
Every lot should include 100 units.
Structure of InvITs:
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An InvITs is made following parts:
Financial Market in India
'Sponsor' refers to any organisation
or business entity having a capital of
` 100 crore that forms the InvITs and
is designated as such at the time the
application is submitted to SEBI.
Unless an administrative requirement
or concession agreement mandates
the sponsor to hold a certain
proportion,
promoters/sponsors
must jointly hold a minimum of 25%
in the InvITs for at least three years.
An investment manager is a business,
limited liability partnership (LLP),
or organisation that manages
and administers the assets and
investments of an InvIT.
InvITs
possess
infrastructure
assets that are both operational
and generate revenue, such as gas
pipelines, motorways, and electricity
transmission lines.
Long-term contracts with powerful
parties ensure that these trusts have
a steady supply of money.
They must also distribute 90% of their
net dividend cash flow to investors.
If the InvIT chooses to sell an asset, it
can reinvest the revenues in another
infrastructure project or distribute
90% of the proceeds to unitholders.
Risks Associated with InvITs:
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According to the SEBI Circular dated April 23, 2019,
the following are the minimum investment guidelines:

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It also gives investors and unit holders liquidity.
Additionally, InvITs receive favourable tax treatment,
such as a reduction in capital gains tax and an
exemption from dividend distribution tax.
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The trustee is the person who inspects
an InvIT's performance and is not
linked to the sponsor or manager.
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Investors are rarely fully aware of a project’s real
value. The growth of an InvIT can only be evaluated
by looking at its accounts since it is influenced by
how the corporation acquires concession assets via
a bidding procedure.
There is a chance of the project failing and being
passed on to the investors. For example, if the trust
begins a road project with toll collection as a source
of revenue, traffic estimations will be considered in
the estimates. However, if this does not occur, or if
the government constructs another toll-free road, the
project may fail with minimal or no profits.
InvITs may pose political and regulatory risks. The
government grants most of these trusts incentives on
infrastructure projects. These concessions might be
undone by a low demand and price-related risks.
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The benefit of InvITs:
At a time when private sector investment in the economy is declining, NHAI fund-raising and infrastructure
expenditure will not only offer a boost to the economy but will also crowd in private sector investment.
InvIT allows the government to tap into alternative sources of funding to increase public expenditure on roads and
infrastructure.
An InvIT also allows the corporation to meet its financial commitments more swiftly.
InvIT holders also benefit from favourable tax rules, such as exemption from dividend income and no capital gains
tax if they retain InvIT units for more than three years.
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14.24 DIFFERENCE BETWEEN REIT AND INVIT
Parameters
REITs
InvITs
Growth
It is visible to investors because the
corporation will remodel existing
properties, begin new construction, or
acquire new assets.
Its growth can only be determined
by looking at its books because it is
determined by how the firm acquires
concession properties through a bidding
procedure.
Minimum Requirement
Structure
Listing
Liquidity
Each allotment lot is worth at least Each allocation must be worth at least `.1
`.50000 & each lot should contain 100 lakh & each lot should include 100 units.
units.
It allows investment in the real-estate It allows investment in the
sector.
infrastructure sector.
It can be publicly listed, privately listed It must be publicly listed.
or privately unlisted
InvITs have a bigger trading lot size, thus They are more accessible to small
somewhat poor liquidity.
investors and have higher liquidity due
to lower unit prices and trading lots.
14.25 DEPOSITORY RECEIPTS (DR)
A DR is a negotiable certificate issued by a bank that represents shares in a foreign business/corporation that are
exchanged on a local stock exchange.
The DR which used to be a tangible certificate allows investors to store equities in other nations and provides an
option to trade on an international market.
The American Depositary Receipt (ADR), which has been offering companies, investors, and traders with global
investment options since the 1920s, is one of the most prevalent forms of D`.
DR enables investors to diversify their portfolios by acquiring stock in firms from other markets and economies.
D` are easier and less expensive than buying equities in foreign marketplaces directly.
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American
Depositary
Receipts
(AD`)
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206
Investors in the United States can acquire access to overseas equities through AD`. AD` are exclusively
issued by US banks for international equities that are traded on a US exchange, such as the NASDAQ
(AMEX).
A US financial institution overseas, as opposed to a global institution, holds the actual underlying
security when an investor purchases an American depositary receipt, for instance, which is stated
in US dollars.
AD` are a great way to buy stock in a foreign company while earning capital gains and possibly
getting dividends, which are payments in cash made by companies to shareholders.
Capital gains and dividends are both paid in US currency.
Because AD` trade in US dollars and clear through US settlement channels, ADR holders are not
required to deal in foreign currencies.
Indian Economy
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Global
Depositary
Receipts
(GDR)
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Global Depositary Receipts (GD`), European Depositary Receipts (D`), and International D` are
available in many parts of the world.
GD` are frequently listed on European Stock Exchanges like the London Stock Exchange, whereas
AD` are traded on a national stock market in the United States.
Both AD` and GD` can be issued in Euros, though they are more frequently issued in US dollars.
A GDR operates in the same manner as an ADR, but in reverse. A GDR allows a corporation
established in the United States to have its shares listed on the London Stock Exchange.
The corporation situated in the United States enters into a depositary receipt agreement with the
London depository bank. In turn, the London bank issues shares in the United Kingdom depending
on regulatory compliance for both nations.
14.26 CREDIT DEFAULT SWAP (CDS)
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It is a financial derivative that allows one investor to
swap or offset his credit risk with that of another. To
mitigate default risk, the lender purchases a CDS from
another investor who pledges to compensate them
if the borrower defaults. The CDS seller shields the
buyer against the failure of a reference asset.
The majority of CDS contracts need a continuing
monthly payment, comparable to the usual payments
owed on an insurance policy.
A CDS is commonly used by a lender who is concerned
about a borrower failing on a loan to offset or swap
such risk.
Remember that the credit risk has not been eliminated.
It is instead transferred to the CDS vendor.
In the CDS market, a credit event is a trigger that
causes the protection buyer to terminate and settle
the contract.
In exchange for the chance of obtaining compensation
if the asset defaults, the CDS buyer pays the seller a
series of payments (the CDS “fee” or “spread”).
Bonds and other debt securities are subject to the
risk that the borrower may default on the debt or its
interest payments.
Anyone, including individuals with no direct insurable
stake in the loan, can acquire a CDS.
If the reference bond performs satisfactorily, the
protection buyer pays the seller quarterly installments
until maturity. If the reference bond fails, the protection
seller pays the buyer the bond’s par value, and the
buyer repays the seller.
Credit Events:
The credit event is the catalyst that forces the CDS
buyer to pay the contract.
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Credit events are agreed upon and included in the
contract when the CDS is acquired.
Financial Market in India
Significance of Credit Default Swap:
Reduces risk for lenders: CDSs can be acquired by
lenders as a type of insurance to protect the lender
while passing the risk on to the issuer.
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No underlying asset exposure: You are not obliged
to acquire underlying fixed-income assets.
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Sellers can spread risk: CDSs transfer the risk of
payment default to the issuer. They can also offer
numerous swaps to further spread risk.
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The following credit events are used as triggers
for the bulk of single-name CDSs:
 Inability to pay: Payments are not made by the
reference entity.
 Obligation
acceleration:
When
contract
obligations are pushed, such as when the issuer
has to pay debts sooner than expected.
 Repudiation: A disagreement over the legality of
a contract.
 Moratorium: A contract suspension until the
issues that caused the suspension are rectified.
 Restructuring of an obligation: Restructuring of
the underlying loans.
 Government intervention: Government actions
that have an impact on the contract.
 Payment failure: The reference entity fails to
make payments.
 Repudiation: A disagreement over the legality of
a contract.
 Moratorium: A contract suspension until the
issues that caused the suspension are rectified.
 Restructuring of an obligation: Restructuring of
the underlying loans.
 Government intervention: Government actions
that alter the contract.
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15
Public Finance
(Budget and Fiscal Policy)
Do You Know?
“Public finance is an investigation into the nature and
principles of the state revenue and expenditure”.
– Adam Smith
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15.1 MEANING OF PUBLIC FINANCE
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It is the branch of economics that assesses government
revenue and government expenditure as well as the
modification of one or the other to achieve desirable
effects and avoid undesirable ones. It is a much wider
term that is connected with public money.
Public finance is a wide topic that includes all matters
that are related to public money i.e.
 The money a government gets
 The money a government spends
 The money a government borrows
 The money a government lends
 The money a government raises or prints
Also termed as “Public economics”, i.e. finances of
the government, it does not only discuss the number
of a country’s resources the government should
acquire for its own use but also the ‘efficiency’ with
which the money should be used.
Components of public finance are:
 Public revenue: Tax, non-tax revenue and public
debt.
 Public expenditure: a tool to do welfare and
implement other policies.
 Financial administration: public budget, audit
etc.
 Federal finance: The three layers of government
and need to divide function and resources.
The role of public finance became much more
important post-WW2 period since the government’s
role in the economy started expanding because of the
rise of the public sector, the delivery of public goods,
law and order, defence, etc.
Market couldn’t fulfil all the needs as areas such as
law enforcement, defence, etc needed the presence of
the government.
Other major areas which needed government
presence were affordable or free healthcare,
education, social security measures, etc (as they were
not profit driven).
Arthashastra of Kautilya covers ‘treasury, sources
of revenue, accounts, and audit’ in a very detailed
manner. Public finance is mentioned in this ancient
text.
National Institute for Public
Finance and Policy
It is an independent body established in 1976.
The Societies Registration Act of 1860 governs its
registration. One of the main responsibilities of
the institute is to help the federal, state, and local
governments develop and reform public policies by
offering an analytical foundation, conducting research,
advocating for policies, etc.
15.2 MEANING OF BUDGET
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The word “Budget” originated in the mid-18th century
from the French word ‘Baguette’. It meant a leather
bag out of which the financial statement was presented
in the parliament.
It is an Annual Financial Statement of income and
expenditure that is generally used for a government,
but could also be used for a firm, company, corporation,
etc.
As per the constitution of India (Article 112), such
a document called the Annual Financial Statement
is to be presented in the Parliament before the
commencement of every new fiscal year.
It is popularly known as the Union Budget and similar
provision is there for the states.
Basic Facts of Union Budget
In India, the Union Budget is prepared by the Department
of Economic Affairs (DEA) of the Ministry of Finance.
Earlier the budget was presented in two categories.
1. Railway Budget
2. General Budget
Both categories merged in 2017.
Budget is a money bill (Art.110) introduced in Lok Sabha.
India did away with Plan and Non-Plan Expenditures:
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Plan Expenditure: All expenditures done in the
plan's name (i.e. Five Year Plans) were called
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Important Terminologies:
plan expenditures. For example expenditure
on electricity generation, irrigation, and rural
developments, construction of roads, bridges,
canals, etc.
Non-plan Expenditure: All expenditures other
than planned expenses were identified as nonplan expenditures. For example interest payments,
pensions, statutory transfers to state and Union
Territories governments, etc.
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Revised
Estimates
(RE)
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Quick
Estimate
(QE)
Do You Know?
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The first budget was presented by James Wilson
in 1860.
RK Shanmukham Chetty, India's finance minister,
delivered the country's first independent budget
on November 26, 1947.
John Mathai delivered the nation of India's first
Republican budget on February 28, 1950.
Annual Financial Statement (Budget): Art 112
 The term budget is nowhere used in the
Constitution.
 Budget is referred to as the Annual Financial
Statement in the constitution under 112.
 The Rail Budget was separated from the
General Budget on the recommendations of the
Acworth Committee in 1924.
 However, it was merged again in 2017 on
the recommendation of the Bibek Debroy
committee of the NITI Aayog.
 The budget is a summary of the government's
anticipated income and expenses for the fiscal
year that begins on 1 April and ends on 31
March.
 Those receipts and expenditures that relate to
the current financial year only are included in
the revenue account (also called revenue
budget).
 Those receipts and expenditures that concern
the assets and liabilities of the government
into the capital account (also called a capital
budget).
The Union Budget has 3 sets of data:
1. Actual data of the preceding year (meaning, one
year before the year in which the budget is presented).
E.g. If the budget is presented for the year 2023-24;
then the data given is of 2022-23.
2. Provisional data of the current year (2022-23)
presents provisional estimates for this year i.e. 202324 (denoted as PE).
3. Budgetary estimates of the following year i.e. one
year after the year in which the budget is presented
(denoted as BE).
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Advance
Estimate
Revised Estimate is a current
estimation of either the estimates
made in the budget (BE) or the
provisional estimates (PE). It shows
the current situation.
It is Interim data i.e. in the meantime.
A quick estimate is a type of revised
estimate that reflects the most recent
circumstances.
It is useful in making future projections
for some sectors or sub-sector.
It is also interim data.
Advance Estimate is similar to a quick
estimate but done ahead (in advance)
of the final stage when data should
have been collected. It is also interim
data
15.3CONSTITUTIONAL PROVISIONS
RELATED TO BUDGET
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Public Finance (Budget and Fiscal Policy)
According to Article 112 of the Indian Constitution,
the Union Budget of a year is referred to as the Annual
Financial Statement (AFS).
The President of India lays it before both houses of
Parliament as a statement of the estimated receipts
and expenditures of the Government in a financial
year.
No “demand for a grant” may be made unless the
President advises it.
Money from the Consolidated Fund of India can’t be
withdrawn except under appropriation made by the
law.
No tax can be levied or collected except under the
authority of law. The Parliament can reduce or abolish
a tax but it can’t increase it.
A vote for the “demand for grants” is an exclusive
privilege of the Lok Sabha and the Rajya Sabha can’t
vote on it.
The budget can have two kinds of expenditure
from the CFI:
 Charged upon the CFI: The expenditure charged
on the consolidated fund of India can’t be voted
upon by the Parliament but it can be discussed.
 Made from CFI: This is the votable part of the
budget.
The Budget also includes the following:
 Estimates of capital gains and revenue;
 Methods for increasing revenue;
 Estimates of the cost;
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
Details of the actual receipts and expenditure of
the closing financial year and the reasons for any
deficit or surplus in that year;
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15.4CONSTITUTIONAL PROVISIONS FOR FUNDS
The taxation proposals, revenue projections,
spending plan, and introduction of new
programmes or projects that will guide economic
and financial policy in the upcoming year.
Three types of funds mentioned in the constitution:
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Article 266 (1)Consolidated
Fund of India
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Article 267Contingency
fund of India
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Article 266 (2)Public Accounts
of India
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It is the only fund from which if the government spends money, it’ll need parliamentary
approval. (except the expenses charged on CFI).
It gets funded from:
 Money from direct and indirect taxes,
 Loans taken by the government,
 Principle or interest received from loans given by the government.
It is the largest and most important of all three funds.
This is audited by the CAG of India and the report is tabled in the Parliament and each state
legislature (for state CFI).
Each state has a similar fund for states with similar provisions.
Fund which is operated by the Finance secretary in the name of the President of India.
This is for unforeseen situations and the government can spend from this fund without any
Parliamentary approval.
It has a corpus of 500 crores and the states can have their own contingency funds as per the
constitution.
It includes money from bank savings of various departments, provident fund, National Small
savings fund etc.
Government can use this without Parliamentary approval.
Money from sources other than those mentioned for CFI goes into this account.
Each state can have a similar account and it is audited by the CAG and reports laid in the
Parliament or respective state legislatures.
Stages in Enactment of Budget:
The Budget goes through the following six stages:
Presentation of Budget.
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General discussion.
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Scrutiny by Departmental Committees.
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Voting on Demands for Grants.
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Passing of Appropriation Bill.
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Passing of Finance Bill.
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15.5 VOTE ON ACCOUNT
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It is a way for the government to withdraw money from
the CFI when the validity of last year’s appropriation bill
has ended (i.e. 31st march). This is done before passing
the appropriation bill for the next year’s budget.
The authority to withdraw money from the CFI as per
last year’s budget was up to 31st March.
However, there are routine expenses of the government
(phone, electricity bills etc) which need to be done
before the new budget is passed.
Thus, the government puts forward a motion for the
passage of a “vote on account”.
It is generally granted for 2 months and is usually onesixth the total budget estimation for next year.
Relevance: No longer needed because The constitution doesn’t mention a particular date
for the budget to be presented. Thus, from 2017,
the budget is tabled on the first working day
of February.
 All six stages of the budget presentation are
completed by the last week of March. Thus, no
need for a “vote on account”.
 Although, in the 2019 “interim budget”, the
government placed a motion for “vote on account”
as it wanted to place the full budget after the
general elections.
15.6 INTERIM BUDGET
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There is no constitutional definition of an Interim
Budget.
During the election years, the ruling party/coalition
government may go out of power.
The new party/coalition government may have a
different vision for the country and hence would have
needed a different kind of budget.
Indian Economy
Thus, it is improper for the present government to
pass a full budget with major changes or provisions
in the election year before the election is conducted.
Thus, the interim budget is presented without any
major announcements although the process is still
the same- i.e. three documents (annual financial
statement, finance bill and appropriation bill) are
presented in 6 stages.
It is valid for the whole financial year; but if there is
a new government, it can pass a new general budget
with changed provisions.
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15.8 VARIANTS OF BUDGETS
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15.7OBJECTIVES OF GOVERNMENT
BUDGET
Redistribution: The government sector determines
the personal disposable income by making certain
transfers and collecting taxes. Distribution based on
the social and economic conditions of the country
happens by this process.
Contribution towards Economic Growth: The
budget focuses on generating adequate resources for
investing in the public sector and helps to raise overall
investment and savings thus creating economic
growth.
Management of Public Enterprises: Many public
sector industries in India are for the welfare of the
people. The Budget makes provisions for operating
such businesses and imparting financial help.
Economic Stability: The Budget focuses on expanding
or reducing demand to keep prices stable and create
jobs.
Proper resource pool allocation: Identifying areas
of weakness helps allocate resources in a useful and
sustainable manner. It’s important to ensure that
funds reach where it’s required the most. It helps in
implementing welfare policies.
Growth of business and trading: The government
can encourage business owners to revise their
policies as per the budget allocations and contribute
to economic prosperity.
Administering Operation of PSUs: A budget aids the
PSUs by introducing policies and schemes to aid their
growth.
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Golden Rule of Budget
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It is a guideline for the operation of fiscal policy,
especially in countries that use large borrowings
to run the budget.
The government should only borrow money to
finance investments during an economic cycle, not
to pay for current expenditures (routine operating
costs).
In layman’s terms, this means that the government
should borrow to finance investment that benefits
future generations.
Public Finance (Budget and Fiscal Policy)
Balanced Budget: A budget in which estimated
revenue of the government in a given year is equal to
its anticipated expenditure.
 Total budget expenditure = Total budget
receipts.
 For Example - If the budget expenditure is ` 2 lakh
crore and the budget receipts are also ` 2 lakh
crore. Then it is called a balanced budget.
Unbalanced Budget: The budget in which income &
expenditure are not equal to each other is known as
Unbalanced Budget. It is of two types:
1. Surplus Budget:
 When the financial year’s predicted revenues
exceed planned expenditures, the budget is
called a surplus budget.
 Total Budgeted Receipts > Total Budgeted
Expenditure.
 For example, if the budget expenditure is ` 2
lakh crores and the budget receipts are ` 2.8
lakh crores, then it is called a surplus budget.
 The government’s financial stability is shown
by the surplus budget.
 During too much inflation, the government can
pursue a surplus budget strategy by reducing
public expenditure, which lowers aggregate
demand.
2. Deficit Budget:
 A budget in which expected government
spending exceeds expected revenue. The budget
is said to be a deficit if expenditures surpass
revenue.
 Total Budgeted Receipts < Total Budgeted
Expenditure
 For example, if the budget expenditure is ` 2.4
lakh crores and the budget receipts are ` 2 lakh
crores. Then we have a deficit budget.
 Typically, the shortfall is covered by public
borrowing or by taking money out of the
accrued reserve surplus.
 In certain ways, a deficit budget is considered
a government liability because it adds to the
weight of debt or diminishes the government’s
reserve stock.
 In developing countries like India, large sums of
money are required for economic growth and
development, and it is not possible to generate
these funds through taxation alone. Hence,
deficit budgeting is the only choice.
 This is used to finance planned development in
developing countries, and it is used as a stability
tool to limit business and economic swings in
developed countries.
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Outcome Budgeting:
It is the practice of creating budgets based on the
relationship between funding and anticipated results,
and it was first introduced in 2005.
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It evaluates how each ministry and department is
doing in terms of its budgetary outlay and work
completed.
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It consists of a list of the scheme- or project-specific
expenditures for all central ministries, departments,
and organisations for a given year, along with the
corresponding outcomes that must be met during
that year.
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It gauges how well each government programme has
advanced society.
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It also tells us whether the money has been spent
for the purpose it was sanctioned and the outcome
it produced.
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The methodology differs from country to countrydifferences in setting goals, such as whether output or
outcome should be used for assessment.
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Outputs are measures of the physical quantity of the
goods and services produced through government
schemes and programmes. For example, the
construction of dams, roads to rebuild, setting up
healthcare centres, etc.
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Outcome means a sign of progress achieved such as
a decline in disease, an increase in the literacy rate,
infrastructure improvement, etc.
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Need for Outcome-Based Budgeting
 Traditional budgeting focused on containing the
fiscal deficit, increasing outlays for each scheme,
program, etc.
 A developing country has huge targets that need
to be achieved in various social sectors.
 Public expenditure faces leakage, corruption, etc.
which can be checked through OBB.
 Makes the process of developing effective and
speedy and helps bring a greater population under
good human development parameters.
 Provides absolute improvements in performance
and helps in medium- and long-term planning.
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Advantages of Outcome-Based Budgeting:
 Increase transparency and participation in the
budgeting process. It enables people to match
funds allocated and proposed outcomes.
 Accountability: Checks the effectiveness of
various schemes proposed by the government,
therefore, improving accountability.
 OBB also assists in clarifying the roles and
responsibilities of politicians and civil servants
in achieving identified priorities.
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This method helps to reduce costs by redirecting
focus to priority areas where investments can be
more effective.
 It requires coordination and cooperation among
various departments and government agencies.
Disadvantages of Outcome-Based Budgeting:
 Complicated measures and involves a lot of
technicalities.
 Risks additional costs and confuses the entire
budgeting process.
 Project outcomes are influenced by a variety of
factors, not just funding.
 For a single budget to drive multiple outcomes, it
can be difficult to find a direct correlation between
resources given and outcomes achieved.
Outcome-based Budgeting in India
 First introduced in 2005-06 by finance
minister P. Chidambaram. It serves as a microlevel, performance-based finance planning and
management tool.
 Its aim was to bring transparency to the budgeting
process.
 The outcome and performance budget were
merged and presented to the parliament as a
combined document, in 2008.
 There are a few challenges:
 Its management requires a strong and
continuous process.
 There is institutional resistance to the
implementation of OBB.
 It is yet to emerge as a robust fiscal instrument
to influence public expenditure decisions.
 They lead to higher expenses as additional
analysis is to be done before allocating funds.

15.9VARIOUS APPROACHES OF
BUDGETING
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Performance Budgeting:
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A method of budgeting that provides:
 The goals and uses for which money is needed.
Outputs to be produced or services to be rendered
under
 Costs of programs and related activities.
 Outputs that must be created or services that must
be provided for each programme.
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The aim is to improve the efficiency of public
expenditure. It links the funding of public sector
organizations to the results they deliver.
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It results in improved prioritization of expenditure,
and in improved service effectiveness.
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Compared to traditional budgeting, performance
budgeting pushes for more flexible use of economic
resources and transforms focus from inputs to results.
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It changes the focus from detailed line items to broader
objectives and outcomes for public programmes and
allows more conversant budgetary decision-making.
Indian Economy
Program objectives
Improve quantity,
quality, and access
to education
services
Outputs
Achievement
scores,
graduation
rates, dropout rates
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Inputs
Intermediate Inputs
Educational
spending by age,
gender, urban/
rural; spending
by grade level,
and number of
teachers, staff,
facilities, tools,
books
Outcomes
Literacy
rates, supply
of skilled
professionals
Enrollment,
student teacher
ratio, class size
Impact
Informed
citizenry, civic
engagement,
enhanced
international
Reach
Winners and
losers from
government
programs
Factors in Performance Budgeting Reforms:
Budget Classification: This changes the focus of
resource allocation to public programs designed to
serve the strategic objectives of the government.
 Performance Measurement and Reporting:
A successful performance budgeting system
requires consistent performance measurement
and reporting.
 Output-focused
Performance Management
Paradigm for the achievement of performance
budgeting targets.
 Informed Budgetary Decision-Making: It brings
more economic value to budgetary decisionmaking.
Process of doing performance budgeting:
 Performance reporting budgeting: It provides
data on performance as part of the budget but it
is not used for resource allocation.
 Performance-informed budgeting: It takes
program performance into account but uses it only
as a minor factor in decision-making.
 Performance-based budgeting: It means that
performance information has a vital role in
resource allocation but does not assess the amount
allocated.
 Performance-determined budgeting: Here, the
allocation of resources is directly and explicitly
related to units of performance.
Advantages of Performance budgeting
 Enhanced communication between budget
makers and citizens: It makes clear program
goals/objectives. It presents companies and
employees with reasonable expectations for their
performance.
 Improved
management in government
agencies: It can assist program managers to
identify organizational goals, and program
performance, with a better understanding of
problems, operations and planning for the future,
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improving internal control, and communicating
program results.
 More informed budgetary decision-making:
It positively adds value to deliberations as
performance information is accounted for when
the level of funding is decided.
 Higher transparency and accountability: The
budget is a good way of government accountability,
to the legislative body and the public.
Drawbacks of performance budget:
 A fixed document does not allow new budget
allocations mid-year in response to changed
conditions.
 Each department has a budget request. When all
of the departments and activities have submitted
their budget requests, someone must set budget
priorities.
Gender-Based Budgeting:
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It is a potent tool for achieving gender main
streaming; to guarantee that development benefits
are distributed equally to men and women.
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This is not a balancing act. It is a process that
incorporates a gender perspective into the
development, implementation, and evaluation of
policies and programmes.
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It makes sure that budgetary commitments are made
in accordance with gender commitments.
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Special attention is paid to how government spending
affects the most marginalised groups of women.
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The need is caused by the fact that the allocation of
resources in national budgets has different effects on
men and women.
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Due to their vulnerability and lack of access to
resources, women, who make up 48% of India’s
population, deserve special attention. They also
perform worse than men on many social indicators.
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Rationale Behind Gender Budgeting:
 As per the 2011 census, women account for 48
per cent of the total population of the country.
 Women have less control over and access to
resources than men do.
 The majority of government spending and policy
concerns are in “Gender-Neutral Sectors.”
 The effects on women in the aforementioned
sectors are not acknowledged or recognised.
 Gender-responsive budget policies can help
achieve the objectives of gender equality, human
development and economic efficiency.
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Gender Budgeting in India:
 The first Gender Budget Statement (GBS) was
included in the 2005–06 Indian Budget. It consists
of two sections:
Public Finance (Budget and Fiscal Policy)
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Part A reflects Women Specific Schemes, with
100% allocation for women.
 Part B reflects Pro Women’s Schemes, with at
least 30% of the allocation is for women.
 India’s gender budgeting efforts stand out
globally because:
 Influenced expenditure and also revenue policies
(like differential rates for men and women
in property tax rates and reconsideration of
income tax structure)
 Have extended to state government levels.
 It encompassed four sequential phases:
1. Knowledge building and networking,
2. Institutionalizing the process,
3. Capacity building, and
4. Enhancing accountability.
 It is not confined to an accounting exercise. It
helped gender-neutral ministries to design new
programs for women.
 All Ministries and Departments must now establish
Gender Budgeting Cells (GBC) as an institutional
mechanism.
 GBCs conduct beneficiary needs assessments,
beneficiary incidence analyses, and genderbased impact analyses to determine where public
spending needs to be reprioritized and how to
improve implementation, among other things.
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Shortcomings:
 Budgetary allocations for advancing gender
equality and women’s empowerment have
decreased, and the size of the gender budget
relative to the Union Budget has shrunk.
 Nirbhaya Fund and the Beti Bachao Beti Padhao
campaign are two of the Ministry of Women and
Child Development’s (MoWCD) few “big budget”
women-only programmes.
 lack of devoted personnel to carry out the
interventions suggested by the GBCs.
 Without
a designated national monitoring
mechanism, monitoring continues to be one of the
weakest links.
Traditional Budgeting:
It is a technique that bases current-year budgeting on
spending from the previous year.
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It demands small increases over earlier budgets.
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It only examines recent expenditures. While zero-based
budgeting begins at zero and requests justification for
both new and existing recurring expenses.
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It is very common since it saves time.
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Advantages:
 Provides a strong framework: It is simple to
manage because it is based on a reference point
(the data points from the previous year).
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Promotes decentralisation: The concept
becomes decentralised because everyone can
review last year’s spending and determine the
budget for the upcoming year.
 Since it is the most simple method, traditional
budgeting becomes ingrained in organisational
culture.
Disadvantages:
 Chances of human errors are higher: It’s natural
to err and make mistakes.
 Time-consuming: It takes a lot of time to sort
things out, and to compare the previous year’s
spending with the expected expenditure by adding
inflation and other factors.
 It doesn’t encourage expected behaviours: In
this budgeting, the expected behaviours aren’t
encouraged as it depends on the previous year’s
spending.
 No alignment between spending and strategy:
strategies need to change every year as conditions
change. But this is not possible here.
 Inaccurate predictions: Since it takes the
preceding year’s data points as base points, the
budget predictions for next year can’t be accurate.

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Zero-Based Budgeting (ZBB):
first made public by Edward Hilton Young in 1924.
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It alludes to creating the Budget from scratch, also
known as “Zero Base.” In contrast to a traditional
budget, which is based on prior budgets, it is different.
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At the start of every fiscal year, the process entails
reviewing and justifying each ministry’s expenditure.
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There are no pre-committed expenses or balances
that can be carried forward.
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All expenses are evaluated each time a budget is
made and expenses must be justified for each new
period.
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While traditional budgeting calls for incremental
increases, ZBB puts pressure on spenders to justify
expenses each time and may reduce costs.
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ZBB was rejected by policy experts. However, after
the global financial crisis of 2008, ZBB came back
into focus for its emphasis on judicious spending.
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Advantages of Zero Based Budgeting:
 Profitability Analysis: since each and every
activity has to be justified, it gets easier to eliminate
the ones that are not performing or generating an
adequate return.
 Resource Intensive: It does an accurate review
and justifies every budget element rather than
modifying an existing budget.
 Tracking of expenses: The focus is on both the
factors - ‘How much a unit will incur’ and ‘why it
is incurred’.
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Indian Economy
Minimizing redundancies: It leads to finding
opportunities and more economical ways by
removing all the unproductive or irrelevant
activities.
 Control of the budget: Every penny spent has to
achieve something under the zero-based budgeting
method as it controls mindless spending effectively.
 Coordinated: Zero-based budgeting promotes
taking initiative and responsibility so that your
spending gets coordinated.
Disadvantages of Zero Based Budgeting:
 Reward Short-Term thinking: It can reward
short-term thinking by allocating resources in the
direction of areas that will produce assets soon
rather than later.
 Too much Paperwork: It is a major shortcoming
and said to be responsible for the failure of ZBB.
The process requires too much paperwork, which
makes it laborious for the organizations.
 Complex and Expensive: Zero-based budgeting
can be very costly, as well as time-consuming
and complicated, to implement. Thus, smaller
governments and departments may struggle.
 High Manpower Requirement: since it involves
making an entire budget from Zero. Many
departments may not have the proper time and
workforce for the same.
 Lack of Experience: Explaining every tiny item
and cost is a difficult task and requires trained
experienced managers.
Zero-based budgeting in India:
 In India, the Department of Science and Technology
adopted the ZBB concept in 1983.
 The ZBB system was adopted by the Indian
government in 1986 to determine the expenditure
budget.
 All ministries were required by the government to
review their activities and programmes and create
expenditure estimates based on the ZBB concept.
 The seventh Five-Year Plan promoted the
concept of ZBB. But, at present there is limited
application of the concept in India.

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Traditional Budgeting
Inflation and expense Projects are allocated funds
of
new
programmes based on their relevance.
overlapped on previous
year expenses.
Lower
response
generated.
A simple method.
It refers to previous years It doesn’t refer to previous
making allocations for years for expense or
expenditure.
allocation.
An
accounting-oriented A decision-based way to
way of making a budget.
make budgets.
A complicated method.
Sunset Budgeting:
Same as zero-based budgeting.
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Every allocated fund, for every scheme/activity has a
pre-set deadline.
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15.10 ISSUES AND CHALLENGES WITH
INDIAN BUDGETING
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Unrealistic budget estimates: The amounts allocated
are often not realistic. Lack of proper estimates leads
to frequent revisions while on the other hand, there
are major unspent funds at the end of the year.
Hinder the implementation of projects: Resources
are limited and hence being spread thin. only token
provisions are taken in some cases, often leading to
inordinate delays in the execution of projects.
Inadequate adherence: to the plan made for spending
of the budget. If the plan is to achieve a goal in many
years; there needs to be consistency in allocation and
implementation.
Lack of correlation between expenditure and
actual implementation of the scheme for which the
money is allocated.
Improper expenditure: Many departments spend
the fund only in the last few months so as to lay a
claim for new funds. This spending is not qualitative.
Mis-statement of financial position: departments
park (keep) the money in non-government accounts
without knowing the fiscal health of that bank. This
puts the budget money at risk since only a fraction of
that amount is insured by DICGC.
Ad hoc project announcements: Projects are
announced outside the budget without worrying
about the money allocation.
15.11 COMPONENTS OF GOVERNMENT
BUDGET
Zero base budgeting
Last year is taken as a base Every budget involves the
while making the budget revaluation of activities
for the next year.
and expenses from scratch.
is Better
pictures
and
responses are generated.
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Public Finance (Budget and Fiscal Policy)
Revenue: Every form of money generation in the
nature of income, earnings are revenue for a firm or a
government which do not increase financial liabilities
of the government, i.e., the tax incomes, non-tax
incomes along with foreign grants.
Non-revenue: Every form of money production that
does not generate earnings for a firm or a government
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(i.e., money raised via borrowings) is considered a nonrevenue source if they increase financial liabilities.
Revenue Budget: The part of the Budget that
addresses the collection and use of revenue by the
government. Both income and expenditure are shortterm (less than one year). They DON’T CREATE
permanent capital assets like roads, bridges, canals
etc.
 This presents the annual financial statement of
the total revenue receipts and the total revenue
expenditure.
 if the balance is positive it is a revenue surplus
budget, and if it is negative, it is a revenue deficit
budget.
 It also shows anticipated revenue receipts and
expenditures of the government.
 Both tax and non-tax revenues are included in
the revenue budget. The two components are:
 Revenue receipts- These do not create
liabilities for the government and can be from
both tax (direct and indirect taxes) and non-tax
sources (grants received, profits etc). It DOES
NOT include borrowings from the government
as it would create liability in terms of debt to
be repaid.
 Revenue expenditure- That spending doesn’t
produce assets (like salaries, wages, interest
payments, subsidies etc). These are of shortterm or current nature and include maintenance
and repair costs. These do not create assets and
are day-to-day costs of governments.
Capital Budget: The portion of the Budget which deals
with the receipts and expenditures of the capital by the
government. It CREATES long-term and permanent
assets and raises receipts which may/maynot create
liabilities. E.g. roads, bridges, canals etc.
 Capital receipts- It includes loans raised from
the public, borrowings from the RBI and other
sources, loans from foreign bodies and recovery
of loans by the centre to states and UTs etc.
 Capital expenditure- It is spending on assets
(buildings, machines etc), investment in shares,
loans by the centre to states, UTs and others etc.
Receipts: It consists of  Capital Receipts: indicate the receipts which lead
to a decrease in assets or an increase in liabilities
of the government. It consists of:
 the proceeds from asset sales (or disinvestment),
such as the sale of shares of publicly traded
companies, and
 the money that the centre receives from states
as repayment of loans or as borrowings.
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Revenue receipts are sums of money that the
government receives that don’t directly affect
its assets or liabilities. It consists of the money
the government receives from both tax and nontax-related sources, including excise taxes, income
taxes, dividend income, and profits.
 Tax Revenue Receipts: This includes all money
earned by the government via the different taxes
the government collects, i.e., all direct and indirect
tax collections.
 Non-tax Revenue Receipts: This encompasses
every money earned by the government from
sources other than taxes. In India, they are:
 The revenue generated by the government’s
PSUs in the form of profits and dividends.
 Interests collected by the government from
all loans made by it, whether they were made
internally (internal lending) or externally
(external lending). It implies that this income
may be received in both local and foreign
currencies.
 Fiscal services also generate incomes for the
government, i.e., currency printing, stamp
printing, coinage and medals minting, etc.
 The provision of general services, such as
irrigation, banking, insurance, and community
services, also generates revenue for the
government.
 fines and penalties that are paid to the
government.
 Grants that the governments receive are always
internal for state governments and always
external for the federal government.
Expenditure:
 It includes the Capital Receipts and Capital
Expenditure.
 Capital expenditure: It is used to create assets or
to reduce liabilities. It consists of:
 The long-term investments by the government
on creating assets such as roads and hospitals,
and
 The sum of money provided by the federal
government as loans to states or as repayment
for its borrowings.
 Plan expenditure of the government
 Capital expenditure on defence
 General services- railways, postal services,
water supply, electricity etc.
 Other liabilities- all the repayment liabilities of
the government on items of other receipts.
 Revenue Expenditure: It is the government’s
spending that does not impact its assets or
liabilities. For example, this includes salaries,

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Indian Economy
interest payments, pension, and administrative
expenses.
 Interest payment by the government on the
internal and external loans;
 Salaries, Pension and Provident Fund paid by
the government to government employees;
 Subsidies forwarded to all sectors by the
government;
 Defence expenditures by the government;
 Postal Deficits of the government;
 Law and order expenditures (i.e., police &
paramilitary);
 Expenditures on social services (includes all
social sector expenditures as education, health
care, social security, poverty alleviation, etc.)
and general services (tax collection, (etc.);
 Grants given by the government to Indian states
and foreign countries.
Plan vs Non-Planned Expenditure:
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No longer used as a concept since 2017-18 and
the classification now used is of “Capital and Revenue
Expenditure” because:
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The Rangarajan committee had recommended
ending the distinction between “planned and nonplanned expenditure’’ in 2011.
z
The decision was taken after the planning commission
had been abolished which was consulted wrt planned
expenditures.
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New classification establishes a transparent link
between earnings, expenditure and outcomes.
Plan expenditure
Expenditures that
are estimated by
the
concerned
ministries
and
(erstwhile) planning
commission.
(c) Large donations to political parties and growth of
regionalism
(d) Loss of revenue to the State Exchequer due to tax
evasion
2. In the context of the Indian economy, non-financial
debt includes which of the following?
(2020)
1. Housing loans owed by households
2. Amounts outstanding on credit cards
3. Treasury bills
Select the correct answer using the code given below:
(a) 1 only
(c) 3 only
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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
Primarily
government
spending
as
revenue
expenditure but also can be
capital expenditure.
It forms the majority portion
of the government’s total
spending.
E.g. defence spending, debt
and
interest
payments,
subsidies etc.
PREVIOUS YEAR QUESTION (MAINS)
1. Distinguish between Capital Budget and Revenue
Budget. Explain the components of both these Budgets.
(2021)
Capital Expenditure of a
Company (CapEX)
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PREVIOUS YEAR QUESTION (PRELIMS)
1. Which one of the following effects of the creation
of black money in India has been the main cause of
worry to the Government of India?
(2021)
(a) Diversion of resources to the purchase of real estate
and investment in luxury housing
(b) Investment in unproductive activities and purchase
of precious stones, jewellery, gold, etc.
(d) 1, 2 and 3
3. Which of the following is/are included in the capital
budget of the Government of India?
(2016)
Non-planned expenditure
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(b) 1 and 2 only
Public Finance (Budget and Fiscal Policy)
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Capex is the funds used by a company to acquire,
upgrade and maintain physical assets like property,
plants, buildings, technologies or equipment.
It is often used to take up new projects or
investments. E.g. purchase of land, vehicles or
heavy machinery, patents, furniture etc.
For items with less than 1-year life; it is not counted
under capex.
It is shown on a company’s balance sheet as an
investment rather than as an expenditure.
A capital-intensive industry will have high capex
vis-a-vis an industry that isn’t capital-intensive. E.g.
oil exploration, production, telecom, manufacturing
etc.
Capex = change in PP&E (property, plant and
equipment)+ current depreciation
In layman’s terms, this means that the government
should borrow to finance investment that benefits
future generations.
217
PREVIOUS YEAR QUESTION (PRELIMS)
1. With reference to the expenditure made by an
organisation or a company, which of the following
statements is/are correct?
1. Acquiring new technology is capital expenditure.
2. Debt financing is considered capital expenditure,
while equity financing is considered revenue
expenditure.
Select the correct answer using the code given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Expenditure Management
Commission (EMC)
Arun Jaitley, India’s finance minister, announced
the formation in the budget speech for the 2014–15
fiscal year.
It will serve as a recommending body, with its
main duty being to make major expenditure reform
recommendations that will help the government
control and manage its fiscal deficit at more
manageable levels.
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15.12 FINANCE MINISTRY AND ITS DEPT.
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The highest official in each of these departments is
a secretary-level official (usually an IAS). The senior
most among them are appointed as the finance
secretary and the one rupee note bears his signature.
Department of Economic Affairs:
DEA is responsible for the fiscal policy, Preparation
and presentation of the Union budget including the
Railway component of the budget.
It also makes budgets for Union Territories without
a legislature and for States under presidential rule.
It announces the Interest rates of small saving schemes
and assigns infrastructure status to a particular sector.
Related departments and organizations:
 Finance
commission under Article 280
(constitutional body).
 Insolvency and Bankruptcy Board of India
(statutory body under Min. of Corporate Affairs).
 Office of Chief Economic Advisor
 Security Printing and Minting Corporation of India
Limited (SPMCI).
PREVIOUS YEAR QUESTION (PRELIMS)
1. Which one of the following is responsible for the
preparation and presentation of the Union Budget
to the Parliament?
(CSE-2010)
218
(a)
(b)
(c)
(d)
Department of Revenue
Department of Economic Affairs
Department of Financial Services
Department of Expenditure
Department of Expenditure:
In this department, the Controller General of Account
(CGA) prepares the estimate of the money that will
have to be spent from the consolidated fund of India.
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It also deals with Pay Commission reports, Pension
Accounting office etc.
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Department of Revenue:
z
It looks into the matters of taxation.
z
Related bodies/organisations:
 Central Board of Direct Taxes, the Central Board
of Indirect Taxes and Customs, various tribunals
and appellate bodies related to taxation. (statutory
bodies)
 Enforcement
Directorate, Central Economic
Intelligence Bureau, Central Bureau of Narcotics,
Financial Intelligence Unit. (subordinate bodies)
 Goods and Services Tax Network (associated PSU
with 100% government ownership)
PREVIOUS YEAR QUESTIONS (PRELIMS)
1. Find correct Statement(s):
(2015)
1. The Department of Revenue is responsible for the
preparation of the Union Budget that is presented
to the Parliament.
2. No amount can be withdrawn from the Consolidated
Fund of India without authorization from the
Parliament of India.
3. All the disbursements made from Public Account
also need authorization from the Parliament of
India.
Select the correct answer using the Code given below:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 2 only
(d) 1, 2 and 3
Department of Financial Services:
Work related to various schemes for Financial
Inclusion, PSB supervision and recapitalization,
Public Sector Financial Intermediaries, including their
regulators (Except EPFO, ESIC etc.)
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Employee Provident Fund Organisation (EPFO) and
Employees State Insurance Corporation (ESIC).
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Related organisations/bodies:
 Bank Board Bureau (set up through gazette
notification).
 National credit guarantee trustee company
(NCGTC) provides guarantees for Mudra loans,
stand-up India loans and those related to skill
development and education.
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Indian Economy
Department of Investment and Public Asset
Management (DIPAM):
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It looks after disinvestment targets in central public
sector enterprises.
15.13 CONCEPT OF DEFICIT AND ITS TYPES
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A deficit occurs in the financial sense when liabilities
exceed assets, imports exceed exports or expenses
exceed revenues. A deficit is synonymous with a
shortfall or loss and is the opposite of a surplus.
Revenue Deficit: It refers to the negative net of the
difference between the government’s total revenue
expenditure and revenue receipts.
 Revenue Deficit = Revenue expenditure –
Revenue receipts
 Only those transactions that have an impact on the
government’s current revenue and spending are
included in the revenue deficit.
 When the government experiences a revenue
deficit, it suggests that it is generating less money
than it is spending.
 It shows that the government is using up the
savings of the other sectors of the economy to
finance a part of its consumption expenditure.
 It can be shown in percentage terms (wrt GDP) as
well as in quantitative terms.
 Implications:
 Reduction of assets: The government has to
fill up the gap by drawing upon capital receipts
either by borrowing or by the sale of its assets
(disinvestment).
 Inflationary situation: can be created since
borrowed funds from a capital account are used
to meet the general consumption expenditure
of the government.
 More revenue deficit: Large borrowings
will increase the debt burden as liability and
interest payments grow.
 Debt repayment: A higher revenue deficit is
worse because it implies a higher repayment
burden in the future not matched by benefits
via investment.
 Measures to reduce Revenue Deficit (RD):
 Curtail its expenditure or increase its tax and
non-tax receipts.
 Raise the rate of taxes especially on rich people
and introduce new taxes wherever possible.
 Try to reduce unnecessary expenditure.
Effective Revenue Deficit (ERD):
 A concept introduced by the C. Rangarajan
committee in the Union Budget 2011-2012.
FRBM Amendment Act 2012 granted it statutory
status. It improves accounting
 ‘Effective Revenue Deficit’, which is the difference
between a Revenue Deficit and grants for the
creation of capital assets.
 The grants include: from the centre to the
states & UTs for the implementation of centrally
sponsored programmes such as Pradhan Mantri
Gram Sadak Yojana etc.
 Need: There are grants that are used to generate
financial assets and aren’t totally unproductive, but
are displayed under “revenue Expenditures’’. The
revenue expenditure by definition can’t produce
any productive asset. Thus a new ‘terminology’
was created. E.g. MGNREGA produces roads, ponds
etc.
 It helps in adjusting the capital expenditure and in
calculating the actual deficit in the capital account.
Capital Deficit:
 No such term exists. But we usually hear the use
of the terms “capital crunch, scarcity of capital’’
regularly.
 Basically, it means that the government is facing the
problem of funds/money/capital that it requires
for public expenditure. (expenditure could be of
revenue or capital kind)
 If there was a term to show this situation, it would
have been Capital Deficit.
Fiscal Deficit:
 It is the gap between the government’s total
expenditure (capital and revenue) and its total
receipts (capital and revenue) excluding the
borrowings during a fiscal year.
 This tells us about the borrowing requirements of
the government during the fiscal year. A surplus is
when the receipts are more than the expenditure.
 Fiscal Deficit = Total expenditure – (Revenue
receipts + Non-debt creating capital receipts).
 Similarly, the gross fiscal deficit is the excess of
total expenditure.
 Gross fiscal deficit = (Total Expenditure +
Loans Servicing) – (Revenue Receipts + NonDebt Capital Receipts)
 The gross fiscal deficit is a key variable in judging
the financial health of the public sector and the
stability of the economy.
 There can be a fiscal deficit without a Revenue
deficit when:
 The revenue budget is balanced but the capital
budget shows a deficit.
 The revenue budget is in surplus but the deficit
in the capital budget is greater than the surplus
of the revenue budget.

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Public Finance (Budget and Fiscal Policy)
219
The fiscal deficit is met by:
 Borrowing from domestic sources- e.g., public
and commercial banks, deposits in provident
funds and small saving schemes.
This is considered better than deficit financing
because it does not increase the money supply which
is the main cause of inflation.
 Borrowing from external sources- World
Bank, IMF and foreign sources.
 Deficit financing- it involves injecting money
in the economy by printing new currency notes.
By borrowing from the Reserve Bank of India (RBI).
Government issues securities that RBI buys in return
for cash from the government.
This cash is created by the RBI by printing new
currency notes against government securities.
Thus, it is an easy way to raise funds but it carries
with it adverse effects also.
It is inflationary and should be used as a last resort.
 Implications of fiscal deficit:
 Advantageous to an economy if it creates new
capital assets which boost productivity and
generate a future income stream.
 Detrimental for the economy if it is used just
to cover the revenue deficit.
 Debt traps: Borrowings create problems of
interest and loan repayments. Thus, liability
increases with higher borrowings. The payment
of interest increases revenue expenditure along
with the revenue deficit. If the borrowings are
too high, the government may be forced to
finance even the interest payment. Thus leading
to a debt trap.
 Inflationary pressure: due to deficit financing
which the RBI does by printing more money.
 Partial use: The part of borrowing that is used
to pay interest is not available for use. Only the
primary deficit (fiscal deficit-interest payment)
is available for financing expenditure.
 Retards future growth: Borrowing is a
financial burden on future generations. Thus it
retards the growth of the economy.
 Measures to reduce the fiscal deficit:
 Increase revenue
 Rationalize subsidies
 Focus on disinvestment
 Reducing public expenditure
 Tax base should be broadened
 Tax evasion should be effectively checked
 Austerity steps to curtail non-plan expenditure
 Increased focus on direct taxes to boost revenue

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220
Reorganisation and the sale of public sector
unit shares
 By being more vigilant and utilising new
technologies, prevent leaks
Primary Deficit:
 Primary Deficit equals a fiscal deficit of current
year minus interest payments of last year.
 This indicates the government’s borrowing
requirements excluding the interest payments
(whereas FD indicates borrowing requirements
with the interest payments).
 Zero primary deficit indicates that the government
needs to borrow only if it has interest payments
to make.
 Primary deficit = Fiscal deficit – Interest
payments
 Importance:
 It demonstrates the extent to which expenses
other than interest payments will be covered
by government borrowing.
 It is typically employed as a fundamental
indicator of financial irresponsibility.
 The government can only borrow money to pay
interest if there are no primary deficits.
 We must determine the primary deficit in order
to know how much we will need to borrow to
cover current expenses.

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PREVIOUS YEAR QUESTIONS (PRELIMS)
1. Consider the following statements: (2017)
1. Tax revenue as a percent of GDP of India has
steadily increased in the last decade.
2. Fiscal deficit as a percent 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
2. There has been a persistent deficit budget year after
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
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
Indian Economy
15.14 CONCEPT OF DEFICIT FINANCING
When the government finances or supports a deficit
budget by means of borrowing or minting a new fund;
it is called deficit financing.
When the total government income (Capital Account
+ Revenue Account) is less than its total expenditure;
this process can be followed.
The government does this by one or more of the
following:
 Internal borrowings- Borrowing from the public
in terms of bonds and other securities, central
banks, commercial banks or even ad-hoc T-bills.
 Printing currency- Asks the RBI to print more
money and borrow from it.
 External aid- They usually come with low or even
no interest rates.
 External borrowings- The benefit is that it does
not have a “crowding out effect” which occurs in
internal borrowings but it is considered an erosion
of the government’s power.
Need for deficit financing:
 To meet fiscal deficit targets, when the funds are
not enough to carry out normal economic activities.
 It is done when the need for growth is so much that
the inflation that will come with deficit financing
becomes the lesser evil.
 It also happens when the gap between total
income and expenditure increases rapidly due to
increased expenditure.
Impact
 It increases the aggregate expenditure which
increases the aggregate demand and thus there is
a risk of inflation.
 As there is more money to spend; economic growth
can happen.
 It helps in meeting the liquidity needs of the
economy.
 If done irresponsibly; it can cause instability
in the economy.
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15.15 DEFICIT FINANCING IN INDIA
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15.16 MONETIZED DEFICIT
Crowding Out Effect
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Governments that borrow must compete with
everyone else in the economy for the limited
amount of available funds.
It results in a reduction in the amount of money that
is available to meet the private sector’s investment
needs.
The real interest rate rises and private investment
declines as a result of this competition. This
phenomenon is called crowding out.
By the late 1960s, the government headed for deficit
financing.
From1970s onwards, India started having higher
fiscal deficits and became more and more dependent
on deficit financing with every fresh year.
We may classify deficit financing in India into
three phases:
 The First Phase (1947–1970): This phase had no
concept of deficit financing and the deficits were
shown as Budgetary Deficits.
 The Second Phase (1970–1991): India saw major
deficit financing, due to unsound fundamentals of
economics that finally ended in a severe financial
crisis by the year 1990–91. Major highlights of
this phase may be summed up as follows:
 Nationalisation
policy and emphasis on
expansion of the PSU.
 New PSUs increased the total expenditure of
the government.
 Existing PSUs increased the burden of salaries,
pensions and PF; many of them had started
fetching huge losses by this time.
 Huge population rise and mass employment
generation along with the burden of different
subsidies went on increasing
 Planned
development remained highly
centralised
 The plan expenditure was not based on sound
economics.
 The Third Phase (1991 onwards): started with
the initiation of the economic reforms process.
Highlights of this phase are:
 encouraging investment from the private sector
became the Government’s priority.
 Rationalizing expenditures of the governments
(centre and state).
 Raising its own tax and non-tax revenues.
 Strengthening and expanding financial markets,
etc.
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Public Finance (Budget and Fiscal Policy)
A new term which was adopted in India from 1997-98.
It means that part of the fiscal deficit is given by the
RBI to the government in a particular financial year.
Earlier, to finance the government’s expenditure;
the RBI had to compulsorily subscribe to the
government’s Treasury bills (short-term borrowings)
and G-securities (long-term borrowings).
The value of the investment made by the reserve bank
in these instruments was the monetized deficit.
221
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RBI started subscribing to T-bills voluntarily rather
than compulsorily from 1997 onwards when the Ways
and Means Advances were introduced.
Since 2013, RBI subscribed to 14 days, of ad-hoc T-bills
for meeting short-term demands for the government.
And since 2007, RBI no longer compulsorily subscribes
to G-secs. It just manages the government’s borrowing
programme.
Thus, technically; monetized deficit seems to be
outdated. But for regulating monetary policy; RBI
still buys and sells G-secs under the Open Market
Operations.
Today, most of government borrowings are financed
via the market.
This is done only when the government can’t
borrow from the market (Banks and other Financial
Institutions like LIC).
The money printed as a result of a monetized deficit
by the RBI is called high-powered money or reserve
money or monetary base.
There are two types of monetisation:
1. Direct Monetisation: RBI directly funds the
Central government’s deficit against government
bonds or securities until 1997.
2. Indirect Monetisation: Done when the RBI
conducts Open Market Operations (OMOs) and/
or purchases bonds in the secondary market.
Issues with monetization of the deficit:
 It spikes the inflation rates
 May increase the interest rates
 Poses a threat to the financial stability of the
economy.
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PREVIOUS YEAR QUESTIONS (PRELIMS)
1. Which one of the following is likely to be the most
inflationary in its effects?
(2021 and 2013)
(a) Repayment of public debt
(b) Borrowing from the public to finance a budget deficit
(c) Borrowing from the banks to finance a budget deficit
(d) Creation of new money to finance a budget deficit
2. 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 the foreign debt
15.17 FISCAL RESPONSIBILITY AND
BUDGET MANAGEMENT ACT
(FRBM), 2003
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The FRBM Act, 2003 sets a target for the government
to induce fiscal discipline in the economy, improve
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the management of public funds and reduce the fiscal
deficit.
Background:
 In the 1990s and early 2000s, India was among
the top capital borrowing countries.
 Our economic status was bad as it had a high fiscal
deficit, high Revenue Deficit, and high Debt-toGDP ratio (implies high chances to default on a
loan).
 In 2002-03, large borrowing continued and had a
bad impact on the economic status of our country.
 More than 50% of the borrowed capital was used
up in paying interest for past loans. Not much was
left for productive purposes.
 In the light of the above conditions, it was felt
important that the borrowings of the government
of India be regulated to an extent. Hence, FRBM
Act was passed in 2003.
The main objectives of the act:
 To introduce a transparent fiscal management
practice in the country.
 To implement a more equitable and manageable
debt distribution for the country over time.
 Long-term financial stability in the Indian economy
by reducing revenue and fiscal deficit.
 Furthermore, the RBI will be given the necessary
flexibility to manage inflation in India.
Salient features:
 Makes it mandatory for the government to
project four fiscal indicators to be projected in a
medium-term policy statement- revenue deficit,
fiscal deficit, tax revenue, and total outstanding
liabilities (all as a % of GDP).
 It sets targets for the fiscal and revenue deficit.
 Certain documents related to fiscal policy are to
be tabled in the Parliament along with the budget
documents annually.
 As an exception, the Act has an “Escape Clause”
to allow for deviation from fiscal deficit targets in
the event of special circumstances (used in 2020).
NK Singh committee recommendations:
 Replace FRBM Act with the Debt Management
and Fiscal Responsibility Bill 2017.
 The debt-to-GDP ratio should be 38.7% for the
centre and 20% for state governments by 2022-23.
 Fiscal deficit target should be 2.5% of GDP by FY
2022-23.
 Set up an autonomous fiscal council to deal with
the preparation of multi-year fiscal forecasts,
improve fiscal data quality, and could advise the
government on fiscal matters.
Indian Economy



Allow targets to deviate under certain
circumstances- national calamity, war, agricultural
collapse, etc.
The debt path for states will be based on their fiscal
health and prudence and should be recommended
by the 15th Finance Commission.
Both, monetary and fiscal policies, should
complement each other.
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PREVIOUS YEAR QUESTIONS (MAINS)
1. What are the reasons for the introduction of the Fiscal
Responsibility and Budget Management (FRBM) act,
2003? Discuss critically its salient features and their
effectiveness.(2013)
15.18 PUBLIC EXPENDITURE
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Public expenditure is the expenditure incurred by
the government to fulfil the demand for goods and
services by the people. It is a major GDP component.
Importance of public expenditure:
 By increasing or decreasing the public expenditure;
demand and inflation can be managed in an
economy.
 It can help in better income distribution and
allocation of resources.
 It helps in ensuring economic stability, generating
opportunities and increasing economic growth in
the following ways:
 Spending on welfare schemes, roads, railways
etc.
 Balanced regional growth
 Development of agriculture and manufacturing
sector.
 Exploitation and development of mineral
resources.
 Subsidies and grants to vital areas- agriculture,
food security etc.
 Through income distribution it can reduce poverty
and inequalities.
 When the private sector has a poor balance sheet;
public expenditure acts as a saviour.
 Private investment (FDI, FII and FPI) are volatile
and unstable.
Causes for increase in public expenditure in recent
times all over the world:
 Developmental work
 Rise in inflation
 8 billion global population
 Rise in welfare states
 Increased expenditure on internal and external
security
Increase in Urbanization
 Growth of public sector
 Economic measures to aid the private sector.
Public expenditure in India is restricted by fiscal
consolidation targets, It should be complemented
with private investment in key areas like health and
education.
Both, the quantity and quality of public expenditure
needs to be increased. The focus should be on raising
the tax-to-GDP ratio and bringing more private
investment.

15.19 PUBLIC DEBT/NATIONAL DEBT
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Public Finance (Budget and Fiscal Policy)
Public Debt is the total amount of loan by the
government of a country.
It includes both external and internal debt and also
the total liabilities of the government.
It is a debt that is to be paid from the CFI (Consolidated
Fund of India).
It can also be understood as the overall liabilities
of the union government paid from the CFI (under
Article 292 of the Indian Constitution). It excludes the
debt paid from the Public account of India.
However, India has one of the lowest debt-to-GDP
ratios of 170 per cent.
 In India, the household sector accounts for 36 per
cent debt to GDP, the non-financial private sector
has 88 per cent of the debt to GDP size of the
country while the government debt is 82 per cent
to GDP.
 As per the economic survey 2022-2023: Public
debt in India is primarily contracted at fixed interest
rates, with floating internal debt constituting only
1.7 per cent of GDP in the end-March 2021.
A country’s ability to repay its debt is known by its
debt-to-GDP ratio. The concept helps investors make
the decision about whether to invest in a country or
not.
Debt-to-GDP ratio is also used to analyse the
government’s ability to service/repay its debt.
Large debt-to-GDP ratio of a major economy can fuel
a national/global economic crisis.
Public Debt is sourced from:
 Dated government securities or G-secs.
 Treasury Bills or T-bills
 External Assistance
 Short-term borrowings
Reasons For Borrowing/Public Debt:
 When the government has expenditures more
than income; it needs to borrow.
 A small share of taxes in the national income i.e.
very few people pay taxes.
223
Indirect taxation puts pressure on lower-class
strata and thus the government needs to reduce
their burden.
 A complex tax system allows evasion or motivates
people to not pay taxes diligently.
Classification of Public Debt:

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
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Public Debts
Public Debts According to
Maturity
Short-Term Debts
(a debt from three
months to one
year)
Medium-Term Debts
(a debt from one
year to five year)
Long-Term Debts
(a debt for five
year or more)

There is a misuse of public funds due to corruption,
wasteful projects, red-tapism etc.
Government needs to borrow for welfare schemes
and various initiatives important for growth and
development.
Public Debts According to
Resource
Internal Debts
(Resources of Internal Debts)
- Private individuals and
institutions
- Social Security Institutions
and economic organizations
- Commercial kinks and
insurance companies
- Central Bank
Voluntary Debts
Compulsory Debts
External Debts
-A
ccording to Maturity
* Short-Term External Debts
* Medium-Term External Debts
* Long-Term External Debts
- According to Usage
* Development Credits
* Technical Credits (Assistance)
* Defence Credits
* Donations
- According to Creditors
* Intergovernmental Borrowing
* Borrowing from International
Organizations
* Borrowing from Private Sources
- According to Debtors
* Public Sector External Debts
* Private Sector External Debts
- According to Repayment
* Foreign Currency Debts
* Local Currency Debts
Internal Debt:
Debt borrowed from within the country.
 Major sources are commercial banks and
financial institutions.
 It constitutes more than 93% of the overall
public debt.
 This can be further divided into two broad
categories -marketable and non-marketable
debt.
 Dated government securities (G-Secs) and
treasury bills (T-bills) are marketable debts
that are issued through auctions.


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Public Debts According to
Voluntariness

Non-marketable debt includes intermediate
T-bills (14-day maturities) issued to state
governments and public sector banks, as
well as special securities issued to the
National Small Savings Fund (NSSF).
External Debt:


Debt is taken from individuals and organizations
outside the country.
Government borrows from commercial
banks, governments or international financial
organizations and individuals.
Indian Economy
Both the principal and the interest, usually is
to be paid in the same currency in which the
debt was taken.
 It can include:
Public and publicly guaranteed debt
Non-Guaranteed private sector external debt
Central bank deposits
Loans from the IMF
 Productive Debt- Those debts that help generate
income from sources such as railway, plans for
electricity, irrigation, etc. The income generated
can be used for the payment of yearly interest and
principal. It puts pressure on the taxpayer and the
government.
 Unproductive Debt- Debts that are incurred on
assets that do not generate income. In these debts,
losses can be incurred on interests as well.
 Redeemable/Terminable Debt- The debt which
the government promises to pay back the debt on
a fixed date later.
 Irredeemable Debt/Perpetual Debt- Debts
taken without any promise of paying back on a
certain time.
 Funded Debt- Debts with a long term. Payment of
these debts is to be done beyond one year.
 Unfunded debts -Debts that are borrowed for
6-12 months.
 Short Term Debt - debts that are to be paid back
within a year.
 Long Term Debt - debts that are to be repaid after
a year.

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Advantages of Public Debt:
z
It provides money that facilitates various economic
activities in the country along with increasing
production and the standard of life.
z
It helps deal with various natural and man-made
disasters and crises.
z
It is helpful for developing countries in allocating
resources.
z
Public debts are considered a secure source of
investment for lenders.
z
It aides in various non-economic benefits like better
international relations.
Disadvantages Public Debt:
z
A large amount of the money is to be repaid as an
interest to others.
z
In case of default; there is a risk of going bankrupt.
z
Extravagant spending can happen with enough debt.
E.g. Greece in 2009 had a debt-to-GDP ratio of 160%.
z
There is always a risk of international interference in
domestic matters as the country is indebted. E.g. debt
trap diplomacy of China.
z
Ultimately the burden is shifted to the public for
repayment.
Public Debt Management in India:
z
As per the RBI Act of 1934, the Reserve Bank is the
banker as well as the public debt manager for the
Union government.
z
The RBI oversees all the money, remittances, foreign
exchange and banking transactions on behalf of the
Government.
z
The RBI takes cash balance deposits from the
government.
The NK Singh Committee on FRBM has suggested a debtto-GDP ratio of 40 per cent for the central government and
20 per cent for states. And a total of 60 per cent of general
government debt-to-GDP.
How to make public debt sustainable:
Privatisation of the loss-making PSUs.
z
Adherence to the Fiscal Responsibility Budget
Management (FRBM) Act 2003.
z
Leveraging of the Public Financial Management
System (PFMS).
z
PPP model in social sector schemes.
z
Investment in infrastructure.
z
Harmonisation of tax regime.
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Thrust on renewable energy to reduce import bills.
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PREVIOUS YEAR QUESTIONS (PRELIMS)
1. In the context of the Indian economy, non-financial
debt includes which of the following?
(2020)
1. Housing loans owed by households
2. Amounts outstanding on credit cards
3. Treasury bills
Select the correct answer using the code given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
15.20 FISCAL POLICY
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Public Finance (Budget and Fiscal Policy)
Fiscal policy is the use of government revenue
collection (primarily taxes, but also non-tax revenues
such as divestment and loans) and spending to
influence the economy.
The government of a country controls the flow of
tax revenues and public expenditure to navigate the
economy through fiscal policy.
If the government receives more revenue than it
spends, it operates in a surplus; if it spends more than
it receives in tax and non-tax receipts, it operates in
a deficit.
To cover additional expenses, the government must
borrow either domestically or from abroad.
225
Alternatively, the government could draw on its
foreign exchange reserves or print more money.
z
In India, fiscal policy is the guiding force that assists
the government in determining how much money it
should spend to support economic activity and how
much revenue it must earn from the system in order
to keep the economy running smoothly.
z
One of the key objectives of the Government of India’s
fiscal policy is to achieve rapid economic growth.
The difference between fiscal policy and monetary
policy:
z
Fiscal policy
Deals with the changes
in government
expenditure and tax
rates.
Monetary policy
Deals with the changes in
money supply and rate of
interest.
It is set by the
government (not RBI).
It is set by the country’s
central bank (RBI in India).
It can have an impact
on the budget and
borrowing.
It can impact the exchange
rates and real estate, loans
etc.
It does not have specific It has a specific target
targets (like inflation
(inflation targeting policy).
etc)
It is heavily influenced
by political decisions.
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It is usually independent of
political influence.
Objectives of Fiscal Policy
 Economic growth: Fiscal policy helps maintain the
economy’s growth rate so that certain economic
goals can be achieved. E.g. setting up heavy
industries like steel, fertilizers etc. The private
sector can’t take up such large expenditures thus
the government has to step in.
 Price stability: It controls the price level of the
country by regulating the supplies so that when
the inflation is too high, prices can be reduced.
Also subsidies on food, LPG etc.
 Full employment: Aims to achieve or near
full employment, as a tool to recover from
low economic activity. Through PSUs; jobs are
generated. Also, tax holidays and other incentives
promote the private sector to invest more and thus
create employment.
 To reduce income and wealth inequalities: This
is done by putting more tax burden on the rich and
less or no burden on the poor.
 To maintain equilibrium in the Balance of
Payments: the government promotes exports
through subsidies and incentives while reducing
226

imports through increased tariffs and other
barriers.
To promote effective administration: by
spending on police, defence, judiciary and other
goods and services.
Types of Fiscal Policy:
Expansionary Fiscal Policy  It seeks to increase economic activity by putting
more money into the market.
 Adopted in response to business cycle contractions
and to avoid economic recessions.
 Tax cuts and increased government spending are
two components of expansionary fiscal policy.
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Contractionary Fiscal Policy  It seeks to decrease economic activity by taking
out money from the market.
 It is designed to combat rising inflation.
z
Neutral Fiscal Policy  Govt. spending is equal to the Tax revenue
z
Importance of Fiscal Policy
z
In a developing country like India, fiscal policy plays
a significant part in increasing the rate of capital
formation both in the public and private sectors.
z
Through taxation, it helps mobilise large amounts of
resources for financing its numerous projects.
z
Fiscal policy can also help in elevating the savings rate
as the public can have more money to spend or save.
z
The fiscal policy by lowering taxes and other incentives,
gives adequate chances to the private sector to expand
its activities.
z
It aims to minimise the imbalance in the dispersal of
income and wealth.
15.21 FISCAL CONSOLIDATION
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It is the process of reducing the fiscal deficit of the
country.
Vijay Kelkar Committee presented a roadmap for
fiscal consolidation.
Steps Taken For Fiscal Consolidation:
 Implementation of the FRBM Act of 2003, the GST
Act, and the Insolvency and Bankruptcy Bill.
 Direct Benefit Transfer allows for more precise
targeting of government subsidies.
 Improving
Tax Collections through better
compliance mechanisms, expanding the tax base,
and increasing the country’s tax-to-GDP ratio
 The government has set a disinvestment target of
` 1.20 lakh crore for 2020-21.
15th Finance Commission recommendations:
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41% of the divisible pool to be given to states in
2020-21.
Indian Economy
z
z
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Horizontal devolution done based on three
criteria:
 Needs-based- population, area, forest and ecology.
 Equity based- income distance (the largest
percentage of weightage).
 Performance based- demographic performance
and tax efforts.
Three types of grants are recommended:
 Revenue deficit grants for states that have revenue
deficit.
 Sectoral grants for nutrition, health, education,
judiciary etc.
 Performance-based incentives on 6 broad criteria.
Empower local bodies:
 Grants to all tiers of PRI and allows them to pool
resources.
v
Grants to 5th and 6th schedule areas and
cantonment boards.
 Grants in critical sectors of sanitation and drinking
water.
 Account for urbanization and increase the share of
local bodies for grants in the medium term to 40%.
 4.3% or 90000 crores of the divisible pool to the
local bodies.
Disaster risk management:
 To promote local-level mitigation activities, set up
mitigation funds at the state and national levels.

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#OpinionMatters
v
Public Finance (Budget and Fiscal Policy)
Why is increased capex considered more important
than revenue expenditure? Do you think increasing the
capex achieve the targets of Amritkaal as envisaged by
the government?
v
227
16
Indian Taxation System
16.1GENERAL SCENARIO OF INDIAN
TAXATION
z
z
z
z
z
The term “tax” derives from the word “taxation,”
which means an estimate.
The direct taxation system that is currently in use has
existed in India in some form or another since ancient
times.
Governments levy taxes on their citizens to finance
initiatives that benefit the country’s economy and
raise the standard of living for its citizens.
The authority of the government to levy taxes in
India is derived from the Indian Constitution, which
delegated tax-levying authority to the Central and
State governments.
All taxes levied within India must be accompanied
by legislation passed by the Parliament or the State
Legislature.
z
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Tax is a compulsory payment and not a voluntary
payment or donation made by the taxpayers, failing
which is a punishable offence.
According to the Finance Ministry, India’s Direct Tax
Collections increased by 24.09% between April 1,
2022 and February 10, 2023, to Rs. 15.67 lakh crore.



16.2EVOLUTION OF TAXATION IN INDIA
Year
Committee
1991-93
Chelliah
2002
JHA Committee
Vijay Kelkar
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z
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Committee
2003
Corporate income tax increased by 19.33%, while
personal income tax increased by 29.63%.
The government anticipates a 10.5% increase in
corporate and individual income tax revenues to
Rs 18.23 lakh crore in the next fiscal year.
Impact
Committee
1986
After accounting for refunds, the net Direct Tax
collection was Rs. 12.98 lakh crore, 18.40% higher
than the net collections for the same period last
year.
The tax reforms began with Chelliah committee recommendations for reforming
India’s tax system
VAT introduced. Recommended the transforming of Union excise duties into a
modified value added tax (MODVAT)
Abolition of wealth tax. Abolish Minimum Alternative Task,
Kelkar Task
z
Force
z
2006
–-
z
2015
Asim Das
z
State Level VAT was introduced
z
Introduces 122nd Constitutional Amendment Bill 2014 in 16th Lok Sabha.
Committee
2014-16
—
z
Fiscal Responsibility and Budget Management (FRBM)
Recommended GST
Launch of GST was announced from 2010
Ultimately, it was passed & became the 101st Constitutional Amendment Act,
2016 → introduction of GST.
16.3 CONSTITUTIONAL DISTRIBUTION
OF TAXATION POWER
z
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The Central Government and the State Governments
in India levy taxes using powers granted to them by
the Indian Constitution. Local governments, such as
the Municipality, levy minor taxes as well.
The authority to levy a tax stems from the Indian
Constitution, which divides the authority to levy
various taxes between the Union Government and the
State Governments.
According to Article 265 of the Constitution, “no tax
shall be levied or collected except by the authority of
law,” which is a significant limitation on this power.
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16.4 DISTRIBUTION OF TAX REVENUES
Article
Levy
Collection
Appropriation
268
Centre
States
States
269
270
271
NA
Centre
Centre
Centre
Centre
State
State
Centre
Centre
States
Shared between
Centre and states
Centre
State
16.5CANONS OF TAXATION BY ADAM
SMITH
z
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Many years ago, the principles of good taxation
were established. Adam Smith claimed in The
Wealth of Nations (1776) that taxes should adhere
to four principles: equity, certainty, convenience, and
economy.
Canon of Equality:



Equality involves treating everyone equally, but in
this context, equality refers to the capacity to pay.
Assuming everyone is equal, the low-income group
would pay a big amount, whereas the high-income
group would pay the same amount, if not less.
Adam Smith proposed that taxes be proportionate
to income.
Indian Taxation System
As a result, each tax levied or collected must be
accompanied by a law passed by either the Parliament
or the State Legislature.
Article 246: Of the Indian Constitution, distributes
legislative powers including taxation, between the
Parliament of India and the State Legislature.
Schedule 7: gives these subject matters with the
use of three lists  List - I: Entails the areas on which only the
parliament is competent to make laws,
 List - II: Entails the areas on which only the state
legislature can make laws, and
 List - III: Listing the areas on which both the
Parliament and the State Legislature can make
laws concurrently.
Various Taxes
z
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z
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Stamp duties on shares, cheques, promissory notes,
insurance etc.
Taxes on interstate trade and commerce.
Revenues do not form part of the consolidated fund
of India.
All taxes in the union list –income tax(other than
agricultural income), corporate tax, etc.
Surcharge on taxes under Art 268, 269, 270.
Sales tax, excise duty on liquor and Narcotics, octroi,
professional tax (max of Rs 2500 – limit kept by the
constitution)
Canon of Certainty:
 He said that “the tax that an individual is obligated
to pay should be certain and arbitrary.”
 The amount of tax, the method of payment, and the
person to whom it is to be paid must be specified
so that the individual is aware of the amount that
will be imposed as a tax well in advance. If the tax
system is uncertain, a person may face harassment.
 Canon of Convenience

“Every tax needs to be charged at the time or
in the way most likely to be convenient for the
donor to pay it,” he says.
 The payment and method of payment of the
taxable amount must be easy for the individual
paying it.
 If the tax collecting method is complicated, the
contributor will be frustrated and dissatisfied.
229
Canon of taxation:
 A good tax system is one in which the expense
of collecting the tax is little in comparison to the
amount collected.
 To Adam Smith, “any tax should be devised so that
it takes and keeps as little as possible out of the
wallets of the people over and above what it brings
into the public purse of the State.”
OTHER CANONS OF TAXATION:
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Canon of Simplicity:
 A straightforward tax structure must bring in or
produce more income for the government.
 When the entire tax system is straightforward, it
eliminates confusion and is simple to grasp.
z
Canon of Productivity:
 The tax amount should not be arbitrarily
established and levied on the individual in order
to discourage additional investment.
 However, this does not preclude the implementation
of a tax in favour of the country’s top brass.
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16.6 TYPES OF TAXES
Basis
The government must levy the tax in such a way
that it is productive, i.e. generates enough income.
Canon of Flexibility:
 The tax system must be adaptable enough to keep
up with economic development.
 When the average citizen’s income rises, the
government’s revenue rises as well.
 This is most relevant in the case of indirect taxes.
For example, levying a high tax on high-end or
luxury items and services. Similarly, as people’s
income falls, so should their tax.
Canon of Diversity:
 According to the Canon of Diversity, there must
not be a single tax with excessively high rates, but
rather multiple taxes with lower rates.
 This is because an individual paying a higher tax
rate would result in tax avoidance. The Canon of
Diversity also promotes investment and economic
prosperity.

Direct Taxes
Indirect Taxes
A direct tax is one that is levied on a
person’s income or wealth and is paid
directly to the government by that person
(or his office).
z
Indirect tax is levied on a person’s goods or
services and is collected from buyers by another
person (seller) and paid to the government.
z
z
It all comes down to the same person.
Imposed on the income of a person and
paid by the same person.
More income attracts more income tax.
Tax burden is progressive on people.
z
Various people are affected. Imposed on the
sellers but collected from the consumers and
paid by sellers.
Evasion
z
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Inflation
z
Tax evasion is possible.
Shift ability
z
Cannot be shifted to others
z
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Meaning
Incidence and
Impact
z
Burden
z
Examples
Direct tax helps in reducing inflation.
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Income Tax, Wealth Tax, Capital Gains Tax,
Securities Transaction Tax, Perquisites
Tax.
z
Rate of tax is flat on all individuals. Therefore
more income individuals pay less and lesser
portion of their income as tax. Tax burden is
regressive.
Tax evasion is more difficult
Indirect tax contributes to inflation.
Can be shifted to others
GST, Excise Duty.
16.7 METHODS OF TAXATION
Proportional Taxes:
Proportional taxes are those in which the tax rate remains constant while the tax base changes.
z
In this case, the tax base could be income, the monetary value of property, wealth, or goods, and so on. However,
income is regarded as the primary tax base because it determines a person’s taxable capacity.
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230
Indian Economy
Thus, in a proportional tax system, taxes vary in
direct proportion to income changes. When income
is doubled, so is the tax amount.
Progressive Taxes:
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Progressive taxes are those in which the tax rate rises
over time. Thus, in a progressive tax, the amount of tax
paid rises faster than the tax base or income.
z
Because the taxation amount is the product of
multiplying the base by the rate, and both rise in a
progressive tax.
z
As a result, a progressive tax extracts a greater
proportion of rising income.
Regressive Taxes:
z
Regressive taxes are those in which the tax rate
decreases as the tax base grows.
z
It should be noted that in regressive taxation, while
the total amount of tax increases with higher income
in absolute terms, the tax rate decreases with higher
income in relative terms.
z
As a result, the poor bear a disproportionately heavier
burden than the rich.
z
In general, necessary taxes are regressive because
they take a greater percentage of lower incomes than
higher incomes.
z
Regressive taxation is thus unjust and inequitable. It
does not follow the equity canon. It tends to amplify
income disparities in the community.
Digressive Taxes:
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Digressive taxes are those that are mildly progressive,
i.e. not very steep, so that high income earners do not
make the necessary sacrifice on the basis of equity.
z
A tax may be progressive up to a certain point in
regressive taxation, after which it may be charged at
a flat rate.
z
Thus, in regressive taxation, the tax payable rises at
a decreasing rate.
z
Specific Tax:
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A per unit tax, also known as a specific tax, is one
that imposes a fixed amount on each unit of a good or
service sold, such as cents per kilogramme.
Thus, regardless of price, it is proportional to the
specific quantity of a product sold. Excise taxes, for
example, fall under this category.
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When the quantities of the product or service
being sold are easily measured, per unit taxes have
administrative advantages.
z
Ad Valorem Tax:
Ad valorem is a Latin phrase that means “according
to value”. Ad valorem taxes are levied on the basis of
the item’s determined value.
z
Ad valorem taxation is a type of taxation that is based
on the assessed value of an item, such as real estate
or personal property.
z
The most common type of ad valorem taxation is
property taxes.
z
Ad valorem taxes, on the other hand, can be applied to
a wide range of tax situations, including import duty
taxes on goods from other countries.
z
Difference in Ad Valorem and Specific tax:
Ad Valorem
z
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Specific
Ad valorem taxation is based on the product’s assessed
value. ‘Ad Valorem’ is a Latin term that means “according
to Value.”
z
The tax is commonly expressed as a percentage. Example
GST in India has 5 tax rate slabs- 0, 5. 12, 18 and 28
percent.
z
They are progressive in nature.
z
Ad valorem taxes are levied based on the purchase price.
z
GST, property tax, and sales tax are a few examples.
z
Single Tax:
A single tax system is a taxation system that is based
mostly or entirely on one tax, often chosen for its
unique qualities, and is frequently a tax on land value.
z
In the 17th century, John Locke and Baruch Spinoza
independently suggested a single tax on land values.
z
Indian Taxation System
It is a flat-rate tax based on the number of units
sold.
It is assessed based on the quantity of the item
purchased.
The tax is usually expressed in monetary terms.
Example: Excise Duty on Petrol.
Excise duty on gasoline and alcoholic beverages,
for example.
They are regressive in nature.
Multiple Taxes:
A multiple tax system is one in which taxes are levied
on various items or bases.
z
A modern economy does not have a single objective
economy. It attempts to move forward at the same
z
231
time on the paths of growth, equitable distribution of
income and wealth, economic stabilisation, and so on.
Because no single tax can be expected to benefit the
economy on all fronts, a multi-tax system becomes
unavoidable.
Advantage of a multiple tax system is that it is effective
in detecting patterns of frequent tax evasion.
It enhances the government’s tax income. It is more
adaptable than a unified tax system.
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z
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16.8 DIRECT TAXATION SYSTEM
A tax that is imposed on an individual’s income and
wealth and paid directly to the government is known
as a direct tax; this tax cannot be avoided.
The tax is graduated. It is assessed based on the
individual’s ability to pay. The Central Board of Direct
Taxes (CBDT), which is part of the Ministry of Finance
in the Government of India, makes recommendations
on Direct Tax programmes and policies.
FY23 revenue from the direct tax, which includes
income and corporate taxes, is projected to grow by
over 17% to Rs 16.50 lakh crore from Rs 14.08 lakh
crore in FY22.
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16.8.1 Types and Variants of
Direct Tax
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Income Tax
 Individuals, Hindu undivided families, unregistered
businesses, and other groups of people are all
taxed on their earnings.
 In India, income tax is progressive. Income from
all sources is aggregated and taxed in accordance
with the individual’s income tax slabs.
 Income tax rates are calculated based on the
amount of net income.
 For example, if your net taxable income is between
Rs 5 and 7.5 lakhs, you will be charged 10%
income tax.
 It is important to note that agricultural income is
not subject to income tax. There is a 10% income
tax surcharge where the total income exceeds Rs
50 lakh but does not exceed Rs 1 crore.
Capital Gain Tax (CGT)
 Any profit or gain derived from the sale of a capital
asset is referred to as a capital gain. Profits earned
from the sale of capital are taxed.
 Capital assets include land, buildings, houses,
jewellery, patents, and copyrights. A short-term
capital asset is a financial asset that is held for
less than 36 months.
 A long-term capital asset has been held for more
than 36 months. The 36-month requirement for
232
z
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immovable property has been reduced to 24
months beginning in fiscal year 2017-18.
 Short-term and long-term capital gains are taxed
differently depending on the income earned.
Corporation Tax
 It is a tax levied on companies and commercial
enterprises’ earnings. It is also known as corporate
tax.
 For tax purposes, a business is considered a
separate entity and must pay a tax separate from
its owner’s personal income tax.
 Corporate tax is levied on both public and private
companies incorporated in India under the
Companies Act 1956.
 As of January 2023, the corporate tax rate is 22%
for all domestic enterprises.
Minimum Alternate Tax (MAT)
 The concept of MAT was launched to ensure that
companies with large profits and substantial
dividends to shareholders.
 The Income-tax Act provided exemptions that paid
a fixed percentage of book profit as MAT.
 According to the Income Tax Act, if a company’s
taxable income is less than a certain proportion of
its booked profits, that portion of the book profits
is automatically considered taxable income and
tax is due.
 MAT is now at 15% as of January 2023.
Securities Transaction Tax (STT)
 The STT is a tax on profits made on the domestic
stock exchange on securities such as stocks,
options, and futures contracts.
 The central government levies and collects it as a
direct tax. Former Finance Minister P. Chidambaram
suggested the STT in 2004.
Commodities Transaction Tax (CTT)
 In India, the CTT is levied on buyers and sellers
of exchange-traded non-agricultural commodity
futures.
 It is computed based on the amount of the contract.
 Metals (gold, silver, and copper) and energy goods
are among the commodities covered by CTT (crude
oil and natural gas).
Minimum Alternate Tax (MAT)
 AMT is what MAT is to companies and MAT is to
limited liability partnerships.
 Other forms of commercial organisations, such
as partnerships, sole proprietorships, and
associations of individuals, are exempt from this
tax.
Indian Economy
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Estate Duty
It originally appeared in 1953. When a person dies,
it is enforced on all of his or her possessions.
 The whole estate of a deceased individual is
considered his riches and is subject to taxes. The
tax has been repealed since 1985.
Wealth Tax
 It originally appeared in 1957.
 Individuals,
combined Hindu families, and
corporations with an excess of net wealth were
subject to it. The tax was repealed in 2015.
The Gift Tax
 It originally appeared in 1958.
 With the exception of charity organisations’
government and private companies, all
contributions were subject to the gift tax.
 The tax has been repealed since 1998.
Fringe Benefits Tax (FBT)
 Many businesses provide various bonuses to their
employees and maintain them below their input
costs in order to reduce profit on booked entries.
Profit is lowered as a result, resulting in lesser
government taxation.
 To address this, the government introduced the
Fringe Perks Levy (FBT), which is effectively a tax
that employers must pay in place of the benefits
granted to their employees.
 The fringe benefits tax was removed from India’s
Union budget in 2009.
Customs Duties
 When commodities cross international borders,
customs duty is levied as a levy or tax.
 Its mission is to protect the country’s economy.
 Customs laws apply many types of duties, including
Basic Duty, Countervailing Duty, Protective Duty,
Anti-Dumping Duty, and Export Duty.
 Import tariffs are used to control business as well
as create income for the government.
 Import tariffs in India are computed on an ad
valorem basis.
20%

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25%
30%
Tax
Rate
Current Income
Slab
Proposed Income
Slab
Nil
Up to Rs 2.5 lakh
Up to Rs 3 lakh
5%
10%
15%
Rs 2.5 lakh to Rs 5
lakh
Rs 3 lakh to Rs 6
lakh
Rs 7.5 lakh to Rs 10
lakh
Rs 9 lakh to Rs 12
lakh
Rs 5 lakh to Rs 7.5
lakh
Rs 6 lakh to Rs 9
lakh
Indian Taxation System
Rs 12 lakh to Rs 15
lakh
Above Rs 15 lakh
Above Rs 15 lakh
Rs 12.5 lakh to Rs
15 lakh
-
Income tax slabs for resident individual between
60 and 80 years of age (Senior Citizen)
Taxable
income
slabs
Up to Rs 3
lakh
Rs 3,00,001
to Rs
5,00,000
Rs 5,00,001
to Rs
10,00,000
Rs
10,00,001
and above
Income tax rates and cess
Nil
5% of (Total in taxpayers Rs
3,00,000) + 4% cess
Rs 10,000 + 20% of (Total income
minus Rs 5,00,000) + 4% cess
Rs 1,10,000 + 30% of (Total income
minus Rs 10,00,000) + 4% cess
Income tax slabs for resident for individual
above 80 years of age (Super Senior Citizen)
Taxable
income
slabs
Up to Rs 5
lakh
Rs 5,00,001
to Rs
10,00,000
Rs
10,00,001
and above
16.8.2 Various Income Tax Slabs
Current and proposed tax slabs
Rs 10 lakh to Rs
12.5 lakh
Income tax rates and cess
Nil
20% of (Total income minus Rs
5,00,000) + 4% cess
Rs 1,00,000 + 30% of (Total income
minus Rs 10,00,000) + 4% cess
16.8.3 Advantages Of Direct Taxation:
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Progressive

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Certainty

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Equity direct taxes are progressive, which means
that the tax rate varies with the tax base.
Direct taxes can assure the canon of certainty.
Elasticity:

Direct taxes also fulfil the elasticity canon. The
nature of income tax is income elastic. Tax revenue
to the government grows naturally as income
levels rise.
233
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Economic
 Direct tax collection is quite inexpensive. The tax
is paid directly to the state by the taxpayers.
Progressive
 It is connected to the idea of ability to pay. As a
result, it is a significant instrument for reducing
income and wealth disparities.
Equity
 In general, it is progressive. It is possible to force
the wealthy to pay more taxes than the poor.
Similarly, if necessary, low-income individuals can
be provided exemptions while the super-rich are
forced to pay more.
Important instrument
 In the event of significant inflation, the government
may raise the direct tax rate in order to reduce
money in people’s hands and thereby lower
consumer demand.
Volatility
 By applying the Tobin Tax, the Direct Tax aids in
international currency exchange rates.
Inflation
 During inflation, the government raises taxes to
limit the demand for goods and services, resulting
in a fall in inflation.
16.8.5 Issues Related Direct Taxation in
India
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234
Cross-border transactions: The source rule of taxes
for non-residents was tied to physical presence,
resulting in lengthy litigation, base erosion, and profit
shifting.
Synchronisation with the global economy: As
India becomes increasingly connected with the global
economy, differential treatment of foreign and local
enterprises in the nation should be phased away
progressively.
Narrow tax base: A larger and broader tax base will
assist to address the issue of possible revenue loss
owing to lower tax rates and a simpler tax structure.
Protracted tax lawsuit: In India, protracted tax
litigation not only burdens the Indian judiciary but
also costs the government exchequer.
Complex corporate tax rate structure: The existing
effective corporation tax rate disparity across
industries is relatively large. The corporation tax
breaks are not vertically fair.
Rationalization: The taxation system is convoluted,
and it urgently has to be rationalised and simplified.
Clarity: When it comes to complex taxation
arrangements, there is a lack of clarity.
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Tax litigation: India has the biggest number of
conflicts between tax administration and taxpayers,
with the lowest percentage of tax arrears recovered.
Tax evasion and avoidance: People in India attempt
to escape taxes by unlawful means or by exploiting
loopholes in the Indian tax system.
Outdated Income Tax Act: It contains measures
that are no longer necessary and outdated, or are
incompatible with changing time
The balance between direct and indirect taxes:
Increasing the percentage of indirect taxes in revenue
is concerning since indirect taxes are regressive,
causing poor people to suffer more.
16.8.6 Government Initiative in Direct
Taxation SYSTEM
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Project Insight and Operation Clean Money: They
were created to employ data analytics to increase tax
compliance and effectively utilise information in tax
administration.
Corporate Rate Cut: To stimulate industrial activity
and promote compliance, the corporate tax rate is
being decreased from 30% to 22%.
 The effective tax rate for all domestic corporations
is currently 25.17%.
 New manufacturing enterprises will be subject to
a 15% corporation tax rate.
Dividend Distribution Tax (DDT): To boost the
attractiveness of the Indian equity market, the Finance
Act of 2020 repealed the DDT.
Vivad Se Vishwas: Declarations for resolving
unresolved tax issues are now being submitted under
Vivad Se Vishwas. This will assist both the government
and taxpayers by raising timely money and lowering
increasing litigation expenses.
Encouragement of digital transactions: To aid in
the digitalization of the economy and the reduction
of unexplained transactions.
Monetary threshold: It has been increased from Rs.
20 lakhs to Rs. 50 lakhs for appeals before the Income
Tax Appellate Tribunal (ITAT).
 Rs. 50 lakhs to Rs. 1 crore for appeals before
the High Court, and Rs. 1 crore to Rs. 2 crore for
appeals before the Supreme Court.
Expansion of scope: In order to broaden the tax
base, various additional transactions were added to
the scope of Tax Deduction at Source (TDS) and Tax
Collection at Source (TCS) (TCS).
Concessional rate: The Finance Act of 2020 allows
individuals and co-operatives to pay income tax at
concessional rates if they do not take advantage of
specific exemptions and incentives.
Increasing Tax Compliance:
Indian Economy
To assist online filing of returns, the CBDT created
the E- Sahyog platform.
 CBIC created Project Saksham to assist with GST
implementation.
 As an expansion had been made in the Indian
Customs Single Window Interface for Trade
Facilitation (SWIFT).
GAAR: Effective from April 1st, 2017, as a collection
of regulations that assists revenue authorities in
determining whether a specific transaction has
commercial substance or not and the tax responsibility
connected with a genuine transaction.
Place of Effective Management (POEM): In the
fiscal year 2017-18, standards for determining the
residence of international enterprises were adopted.
If a company’s PoEM is in India, its international
revenue is taxed here.
Agreement on information sharing: India has also
entered into an agreement with the United States
under the Foreign Account Tax Compliance Act
(FATCA).

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16.8.7 Way Forward: Direct Taxation
System
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Arresting tax evasion: While the clause exempting
agriculture revenue is intended to help farmers, nonagricultural entities may utilise it to avoid paying taxes
by claiming agriculture as the source of their income.
Tax terrorism: Tax terrorism must be reduced by
increasing transparency in the country’s taxation
structure and lowering the tax department’s
discretionary powers.
A level playing field: Between giant corporations
and start-ups and fledgling firms. A complex tax
structure benefits major company organisations that
can manipulate the system with the assistance of
in-house tax professionals.
Reducing sectoral disparities: The tax system is not
horizontally egalitarian since the effective tax rate
disparity across sectors is extremely large.
Increasing Vertical Inequity: Corporate tax breaks
are not vertically equitable.
Reduction in the effective tax rate: India’s high tax
rate hinders investment and growth in comparison
to other Asian countries, and it also harms equity
investment.
Rationalising tax exemptions: Tax exemptions are
not granted based on established rules. Instead, things
are created by an opaque process.
Double taxation: The revenue from operations of
partnership businesses is taxed twice:
 First, the profits of the corporate entity are taxed
 Then the income of the individual owners is taxed.
Indian Taxation System
16.8.8 Direct Tax Reforms
Collection of taxes:
The preliminary figures for Direct Tax collections
up to March 10, 2023, show steady growth. Direct
Tax collections up to March 10, 2023, show gross
collections of Rs. 16.68 lakh crore, which is 22.58%
higher than gross collections for the same period last
year.
 Direct tax collection, net of refunds, stands at
Rs. 13.73 lakh crore, a 16.78% increase over
net collections for the same period last year.
 This collection represents 96.67% of total Budget
Estimates and 83.19% of Total Revised Estimates
of Direct Taxes for Fiscal Year 2022-23.
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In terms of gross revenue collections, the growth rate
for Corporate Income Tax (CIT) is 18.08%, while the
growth rate for Personal Income Tax (PIT) (including
STT) is 27.57%. After refunds are deducted, the
net growth in CIT collections is 13.62%, while the
net growth in PIT collections is 20.73% (PIT only)/
20.06% (PIT including STT).
 The Centre budgeted 20,000 crores in STT for
FY23, and at the current rate, it is likely to exceed
the target.
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Refunds totalling Rs.2.95 lakh crore were issued
from 1st April 2022 to 10th March 2023, which
is 59.44% more than refunds issued during the
same period the previous year.
Reforms of 2020-21:
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Simple returns: Measures to pre-fill the income tax
return have been launched, so that an individual who
chooses the new regime receives pre-filled income tax
returns and does not require the aid of an expert to
pay income tax.
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Without human contact: Practically all verification
and evaluation of returns selected for inspection
will be done electronically ‘without any personal
interaction’ between taxpayers and tax authorities by
2020-21.
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The Charter of Taxpayers: A taxpayers’ charter is
to be implemented in order for a tax system to run
effectively and accomplish the goal of compliance.
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Dividend Distribution Tax: To encourage increased
investment in the stock market, the government
eliminated the requirement for companies to pay
dividend distribution tax (DDT).
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Concessional Corporate Tax: A 15% corporation
tax rate has been established for newly registered
domestic electricity-generating enterprises.
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Sovereign Wealth Fund (SWC): The government
declared a 100% exemption on interest, dividend,
and capital gains income earned by foreign sovereign
wealth funds on investments in key areas.
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235
Start-ups: Employees’ tax on the sale of ESOP
(Employee Stock Option Plan) shares has been
postponed for 5 years, or until they quit the firm or
sell their shares, whichever comes first. This measure
is intended to strengthen the country’s start-up
ecosystem.
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Scheme Vivad se Vishwas: In 2020-21, the
government developed a new system called Vivad se
Vishwas to eliminate direct tax lawsuits.
Direct Tax Proposal in Union Budget 2023:
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Increased presumptive taxation limits for MSMEs
and professionals at Rs. 3 crores and Rs. 75 lacs in
turnover, respectively.
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Manufacturing cooperatives will benefit from a 15%
tax cut.
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TDS reduction on cash withdrawals in the cooperative
sector.
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Startups will be able to carry forward losses on
changes in shareholding for a period of ten years.
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Extends the date of incorporation for new businesses
for income tax purposes until March 31, 2024.
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Reducing income tax litigation - 100 joint
commissioners will hear pending appeals.
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The Rs.10,000 TDS threshold for online gaming will
be removed.
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Conversion of gold into electronic gold receipts and
vice versa is not subject to capital gains taxation.
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Important Personal Income Tax Announcements:
 In the New Tax Regime, the rebate limit has been
raised to 7 lakh INR.
 Proposes reducing the number of slabs to five and
raising the exemption limit to three lakhs (0-3
lakhs - NIL, 3-6 lakhs 5%, 6-9 lakhs 10%, 9-12
lakhs 15%, 12-15 lakhs 20%, and above 15 lakhs
30%).
 The highest surcharge will be reduced from 37%
to 25%, resulting in a 39% reduction in MMR.
 The new income tax regime will be the default tax
regime, but taxpayers will be able to continue to
benefit from the old regime.
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16.8.10 DIRECT TAXATION:
and Commission
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236
Committees
Kelkar Committee (2015): It was a committee
chaired by Vijay Kelkar that was formed to research
and assess the existing public-private partnership
(PPP) model in India.
Raja Chelliah Committee: In 1991, the government
formed the Tax Reforms Committee, chaired by Prof
Raja Chelliah, to draw forth a plan for restructuring
India’s tax system. This TRC issued three reports with
various measures in 1991, 1992, and 1993.
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z
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Y.V. The Reddy Committee: The Working Group on
Money Supply: The Working Group proposed that the
Reserve Bank of India, commercial and cooperative
banks, and the organised financial sector conduct
extensive analytical surveys at regular intervals.
Wanchoo Committee (1971): The Wanchoo
Committee suggested that rather than spreading
resources evenly yet consistently throughout all
backward areas, a few places be chosen and fiscal and
financial resources devoted to transforming these into
growth poles.
The Parthasarathy Shome panel: It was established
in 2012 by the Prime Minister of India to develop
final GAAR rules, primarily to bring about tax
certainty and address the concerns of international
investors. Instead of only FIIs, the panel was requested
to investigate concerns affecting all non-resident
taxpayers.
Akhilesh Ranjan Committee: The Central Board
of Direct Taxes (CBDT) established an e-commerce
Taxation Committee to investigate e-commerce
business models, which delivered its findings on
March 21, 2016. The Committee’s Report was received
by the Government of India and considered in the
development of the Finance Bill, 2016.
16.8.11 Direct Tax Code:
The government intends to streamline the framework
of direct tax regulations in India through the Direct
Taxes Code (DTC).
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The DTC would supersede the Income Tax Act of
1961 as well as other direct tax legislation such as
the Wealth Tax Act of 1957.
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Objectives:
 To simplify and combine all central government
direct tax legislation
 To improve the effectiveness and efficiency of the
tax system.
 To bring the integrated legislation on direct taxes,
namely income tax, dividend distribution tax,
fringe benefits tax, and wealth tax, into effect.
 To achieve horizontal fairness among various
taxpayer classes in accordance with the best
worldwide standards.
 Tax regulations must be straightforward, stable,
and resilient in order to promote compliance even
more.
 To reduce the number of tax exemptions and
deductions in order to broaden and deepen the
tax base.
It recommended the following features for the Direct
Tax Code:
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Litigation Management: Changes to Sections 147 and
148 of the Income Tax Act that allow the tax officer
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Indian Economy
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to revisit assessment cases based on predetermined
criteria. The I-T officer can examine the assessee’s
books of accounts for up to six years.
Raising the bar for filing cases: it is now Rs 1 lakh
and beyond. In addition, the pre-defined criteria for
selecting cases for review will be strengthened.
Anonymity: Assessment procedures should be made
anonymous, and the public should be able to request
clarification on tax concerns from the CBDT.
Reduced Tax Compliance Burden: Tax compliance
in accordance with worldwide trends and best
practices. This is supposed to promote transparency
among taxpayers while also broadening the tax base.
Artificial intelligence (AI): It is being used in the tax
compliance and administration process.
Personal Income Tax: Rates will be reduced from 5%
to 20%.
Currently, the personal income tax structure is divided
into three age groups: those under the age of 60, those
between the ages of 60 and 80, and those aged 80
and up.
16.8.12 GAAR – General Anti Avoidance
Rule
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GAAR is a part of the direct tax system that allows tax
inspectors to reject any corporation a tax advantage.
 Tax officials, on the other hand, have the authority
to violate certain provisions of the Income Tax Act
and the Double Taxation Avoidance Act.
key benefit:
 Significantly decrease tax evasion and DTAA
misuse.
 Round-tripping will be prohibited.
 Money laundering is being reduced.
Key disadvantages:
 It delegated authority to tax officers.
 Corruption may become increasingly prevalent.
 The degree of uncertainty will increase.
 Creditworthiness will deteriorate.
16.8.13 Minimum Alternate Tax (MAT)
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MAT is a provision in direct tax legislation that limits
tax breaks for firms and requires them to pay a
minimum amount of corporate tax to the government.
MAT, unlike a traditional company tax, is applied on
book profit rather than taxable earnings.
In 1988, MAT was used for the first time to bring zerotax firms into the tax net.
It was eventually repealed in 1990. However, it was
revived by the Finance Act of 1996.
The tax is levied on all entities operating in India,
whether they are owned by Indians or foreigners.
Indian Taxation System
Life insurance companies and shipping companies
subject to tonnage tax are prominent exceptions.
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Companies that do not have a permanent presence in
India are likewise excused from paying MAT.
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MAT was previously exclusively applicable to
companies, but it has gradually been expanded to
include all other taxpayers under the Alternative
Minimum Tax umbrella.
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In September 2019, the government reduced the
MAT tax rate from 18.5% to 15%, while concurrently
cutting the corporation tax rate from 30% to 22%.
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Furthermore, no MAT would be levied on any new
domestic manufacturing business (incorporated on or
after October 1, 2019).
Basic Provisions:
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According to MAT regulations, a company’s minimum
tax liability will be the greater of the following:
 A firm’s usual tax liability is computed in
accordance with the typical rules of Income-tax
legislation, with the taxable amount equalling the
tax rate applicable to the company.
 The tax rate is 15% of the book profit, including
surcharges and cess.
Calculation:
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Minimum Alternate Tax is imposed where the
taxable income computed under the Income Tax Act
provisions is less than 15% (plus surcharge and cess
as applicable) of the book profit calculated under the
Companies Act, 2013.
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16.9 TAX BUOYANCY
Tax buoyancy is the link between changes in the
government’s tax revenue growth and changes in GDP.
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It is related to how sensitive tax revenue growth is to
changes in GDP.
z
When a tax is buoyant, its revenue rises without the tax
rate rising. Tax elasticity is a similar-looking concept.
z
It refers to fluctuations in tax revenue as a result of
tax rate adjustments.
Tax buoyancy depends mainly on:
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The scope of the tax base
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Regime of tax administration
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The tax rates are reasonable and straightforward.
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16.10 LAFFER CURVE
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According to the Laffer Curve, if tax rates are raised
over a particular threshold, tax revenues may decline
because higher tax rates discourage individuals from
working.
Arthur Laffer developed the Curve to demonstrate
the link between tax rates and the amount of tax
revenue received by governments. The curve is used
237
to demonstrate Laffer’s point that lowering tax rates
can occasionally boost overall tax collection.
It is based on the idea that if tax rates are 0%, the
government receives no money.
Similarly, if tax rates reach 100%, the government will
get zero money because there is no use in working.
If tax rates are very high and later reduced, it can
encourage businesses to grow and people to work
longer hours. This boost to economic development
will result in increased tax receipts, including greater
income tax, corporate tax, and VAT.
The idea is significant because it gives an economic
foundation for the politically appealing policy of tax
cuts.
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Tax Revenue
Revenue maximising point The laffer curve
Region of
increasing
revenue
Region of decling
revenue
Growth
Maximizing
0
Point
100%
Tax Rate
Basis of Laffer Curve:
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The tax cuts have two impacts on the budget as
follows:
1. Arithmetic Effect:
 It is predicated on the assumption that lowering or
raising the tax rate would result in a proportionate
loss or rise in tax collections.
 The arithmetic impact is immediate and one-toone.
2. Economic Effect:
 When tax revenues increase/decrease in the
opposite way as tax rates change, it demonstrates
how raising taxes reduces revenue and decreasing
taxes raises revenue.
 The economic impact is long-term and has a
multiplier effect.
Tax Elasticity
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It refers to swings in taxing income caused by rate
changes. The elasticity may be seen in how revenue
changes when the government reduces corporate
income tax from 30% to 25%.
0%
16.11 TOBIN TAX
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A Tobin tax, proposed by Nobel Laureate in Economic
Sciences Economist James Tobin, was initially defined
as a charge on all spot currency changes.
The basic idea behind the tax was to penalise shortterm financial transactions into another currency.
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Instead of being paid by consumers, the Tobin tax
would be paid by market participants in order to
control the stability of a country’s currency.
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The Tobin Tax was designed to create a method
of managing exchange rate volatility. James Tobin
proposed two solutions to this problem:
1. Transition to a common currency, monetary and fiscal
policies, and economic integration
2. Make attempts to increase financial segmentation
across nations, allowing for greater financial policy
autonomy for central banks and governments.
Examples of Tobin Tax Across The World:
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Sweden introduced a 0.5% Tobin tax on share
purchases and sales but did not achieve the expected
outcomes.
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Belgium, Germany, Estonia, Greece, Spain, France,
Italy, Austria, Portugal, Slovenia, and Slovakia have
opted to charge a 0.1% tax on the exchange of shares
and bonds, and a 0.01% tax on derivative transactions.
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The Tobin tax has also been tried in Thailand, Brazil,
Chile, and Malaysia, with variable success.
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The Securities Transaction Tax (STT) is a variation of
the Tobin tax in India. It was implemented in 2004
and is charged on all transactions involving securities
listed on stock exchanges and mutual funds.
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16.12 PIGOVIAN TAX
Pigouvian taxes are levied on economic activity
that produce negative externalities, which result in
expenses paid by unconnected third parties.
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The expenses incurred as a result of negative
externalities are not accounted for in the ultimate
price of a product or service.
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In India, the Clean Energy Cess on coal is an example
of a Pigouvian tax.
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It raises the marginal private cost by the amount
created by negative externality, preventing market
inefficiencies. As a result, the ultimate cost represents
the whole societal cost of the activity on a country’s
economy.
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Pigouvian taxes can be applied to halt different
activities such as pollution, dangerous chemicals, and
traffic congestion.
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It seeks to return the cost of the negative externality
back to the producer or consumer.
Examples of Pigouvian Tax:
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Coal cess or clean environment cess in India is an
example of a Pigouvian tax.
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France imposes it as a noise levy on flights at its nine
largest airports. It varies between 2 and 35 euros
depending on the airport.
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Indian Economy
More than 40 nations levy a carbon tax on firms that
use coal, oil, or gas and emit greenhouse gases.
In order to safeguard pure drinking water for future
generations, the Netherlands levied a groundwater
levy on drinking water corporations.
To discourage the use of plastic and paper bags, a fee
on plastic and paper bags was implemented in Europe
to encourage people to carry their own reusable bags
from home.
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A tax surcharge on income is a significant source of
revenue for the government.
This money is collected and used for whatever purpose
the Union Government sees fit.
It’s important to note that it only applies to the tax
owed, not the whole revenue.
This money is transferred to India’s Consolidated
Fund and can be used for any purpose.
A 10% surcharge on a 30% income tax rate, for
example, increases the tax burden to 33%.
Individuals with a net taxable salary of more than Rs
1 crore face a 10% surcharge on their tax burden.
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Domestic companies are subject to a 5% surcharge
if their net income is between Rs 1 crore and Rs 10
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Foreign corporations are subject to a 2% surcharge
if their net income is between Rs 1 crore and Rs 10
crore.
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The surcharge is increased to 5% if the net income
reaches Rs 10 crore. Domestic and international
enterprises receive marginal relief if their net income
exceeds Rs 1 crore and Rs 10 crore, respectively.
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16.13 SURCHARGE
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crore. If the net revenue exceeds Rs 10 crore, a 10%
surcharge is charged.
16.14 CESS
In essence, a cess is a tax on tax.
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It is crucial to remember that a cess can only be used
for the purpose for which it was imposed.
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For example, the Indian government collects an
education cess and spends it completely on education.
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This tax is also levied on all taxpayers.
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Cess taxes are paid to the Indian Consolidated Fund.
Cess is normally assumed to be charged until the
government has completed its function and then to
become inactive.
A cess is distinct from other types of taxes in that it
is charged in addition to the present tax (tax on tax).
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Similarities and Differences Between Cess and Surcharge:
Differences
Cess
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Surcharge
Cess Rate is fixed.
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Cess is levied on everyone.
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Cess is aimed at public welfare.
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Authorities calculate the cess on the surcharge and
the total tax.
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Cess is used for a specific purpose only and cannot
be used for any other reason.
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It is calculated on the total tax amount only.
Only higher income brackets face a Surcharge.
It can be used for any reason.
Surcharge aims to tax high-earning individuals.
Similarities
The central government imposes both surcharge and a cess.
Both are collected and deposited in the Consolidated Fund of India.
State governments cannot share any of these.
6.15 ISSUE OF CESS AND SURCHARGE
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Its rate varies as per the brackets in which the people
fall.
As part of the division of authority and responsibilities
between the Union and states as stipulated in the
Seventh Schedule.
Under Article 246 of the Constitution, the Centre can
levy and collect both direct and indirect taxes under
the Union List.
Indian Taxation System
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This has resulted in a major resource mobilisation
imbalance, which has hampered governments’ ability
to meet their pledged social expenditure obligations.
Net tax income is derived by removing cesses and
surcharges from gross tax revenue, as well as the
cost of collection and transfer to the National Disaster
Response Fund (NDRF).
239
As a result, a bigger pool of cesses and surcharges
decreases the overall amount of divisible taxes,
resulting in less resource transfer to the states.
According to the 15th Finance Commission, states are
accountable for more than 62% of expenditures but
only 37% of revenue-raising capacity, whereas the
federal government has 63 percent of revenue-raising
power to spend on 38% of expenditures.
Despite a rise in cesses and surcharges from Rs
49,628.02 crore in 2010-11 to Rs 3,74,471.14 crore
in 2021-22, the benefits do not reach the states since
cess and surcharges are excluded from the divisible
pool.
States have regularly requested that the Union
administration either abolish cesses totally or, if they
are maintained for a longer period of time, include
them in the divisible pool.
As a consequence of this inclusion, states will get
a higher share of devolution from the Centre’s net
revenues, allowing them to satisfy their own social,
human development, and infrastructure duties.
The fourteenth and Fifteenth Finance Commissions
proposed that profits from cesses and surcharges
be included in the divisible pool by enacting a
constitutional change.
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16.16 INDIRECT TAXATION
An indirect tax is collected from the person who
bears the ultimate economic burden of the tax by an
intermediary.
Tax incidence and tax impact do not fall on the same
person in indirect taxes. Customs duty on import and
export, Excise duty on goods manufacturing, Service
tax on services, Sales tax, Value Added Tax (VAT), and
Goods and Services Tax are some examples of indirect
taxes.
Indirect taxes are managed by the Finance Ministry’s
Central Board of Excise and Customs (CBEC), which
was renamed Central Board of Indirect Taxes and
Customs in Budget-2018 (CBIC)
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16.16.1 Types and variants of Indirect taxes


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GST (Goods and Services Tax)
 It is an indirect national tax levied on the
production, sale, and consumption of goods
and services.
 It has substituted all indirect taxes levied on
products and services by the federal and state
governments.
Excise Duty
 Excise duty is a true commodities tax since it is
collected on the manufacture of items in India
rather than the sale of the product.
CGST has now taken its position.
 The Sales tax
 In India, a sales tax is a sort of government tax
applied on the sale or purchase of a certain item
inside the nation.
 IGST has now taken its place.
 Dividend Distribution Tax (DDT)
 A dividend is a payment made to investors by
a corporation from the company’s profits in a
particular year. Dividends are income in the
hands of shareholders and, ideally, should be
taxable.
 A DDT tax is a tax placed on Indian firms by the
Indian government depending on the number
of dividends paid to shareholders.
 DDT was initially used in 1997 and was governed
under Section 115 O of the Income Tax Act.
 The DDT was repealed by the Finance Minister
in Budget 2020.
 Dividend taxation has now been transferred
from corporations to individuals.
 Service Tax
 In India, all services are subject to a service tax.
 A service tax was levied on three services in
1994-95: telephone services, general insurance,
and stockbroking.
 Since then, the service net has grown by adding
more and more services each year. We now
have a ‘negative list’ exclusion criterion, which
means that some services are no longer taxed.
 The Goods and Services Tax took its place.
 VAT (Value Added Tax)
 The VAT is designed in such a way that
distortions are eliminated.
 As a consequence, all Indian states and union
territories have introduced VAT (except UTs of
Andaman Nicobar and Lakshadweep).
 The state sets the amount of the tax, which is
levied on a range of items sold in the state.
 SGST has now taken its place.
Important Terminology

Tax
Incidence
Tax
Impact
Tax
Shifting
Tax base
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It is the one who pays the taxes. The
true burden of a tax is determined by
incidence rather than impact.
It is the entity subject to taxation. The
entity is legally obligated to pay taxes.
Tax shifting occurs when the incidence
of a tax differs from the impact of the
tax.
Volume of goods and services subject
to taxation
Indian Economy
16.16.2 The Sources Of Non-Tax Revenue

Special assessment of betterment levy:
It is a type of special charge levied on members
of the community who benefit from specific
government activities or public projects.
 People in that neighbourhood, for example, may
see an increase in the value of their property or
land as a result of the construction of a public
park or road.
Gifts, Grants and Aids:
 In the contemporary day, a gift from one
government to another is a significant source
of cash.
 To carry out their tasks, the Centre government
distributes grants to state governments,
while state governments offer grants to local
governments.
 Foreign aid refers to grants from other countries.
 Other nations provide military help, nutritional
aid, technical aid, and so on to developing
countries.
Escheats:
 It refers to the claim of the state to the property
of people who die without legal heirs or
documented will.
Fees:
 Fees are another important revenue source for
the government.
 Public authorities charge a fee for providing a
service to citizens.
 In contrast to taxes, there is no compulsion in
the case of fees.
 The government provides certain services for
which fees are levied.
 Passports,
driving licenses, and other
documents, for example, are subject to fees.
Earnings from Public Enterprises:
 The government also receives revenue from
surpluses generated by public enterprises.
 Some
public-sector enterprises generate
significant profits.
 Profits or dividends received by the government
can be used for public purposes.
Central Sales tax





Source Of Indirect
Tax Revenues For The
Union
Source Of Indirect Tax
Revenue For The States
Customs Duty
Sales Tax
Central Excise Duty
Excise duty on alcoholic
liquors
Indian Taxation System
Service Tax GST
Taxes on luxuries,
amusements, betting,
entertainments and
gambling
Electricity Tax
16.16.3 Merits of Indirect Taxation:
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Elastic: It is pliable in nature. Because it is more
broadly applied, any little increase in taxation will
generate significant income.
Equitable: When a larger tax is placed on luxuries
consumed by the wealthy, the indirect tax meets the
canon of fairness.
Sin Tax/Consumption Control: It can be used to
dissuade the purchase of undesired items.
 For example, by levying taxes on luxury products
and increasing their prices.
Convenience: Indirect taxes are handy since taxpayers
(consumers) pay little amounts of tax.
Economic Cost: The economic cost of collection is
lower since manufacturers and merchants collect and
pay taxes to the government.
 Honorary tax collectors are traders.
Wider Coverage and Broad Base: The impact of
indirect taxes is felt by almost everyone in society.
 It must be paid (by both affluent and poor) when
they acquire taxed goods.
16.16.4 Demerit of Indirect Taxation:
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Uncertainty: An increase in indirect taxes raises
prices and diminishes demand for goods.
 As a result, the government is concerned about
revenue collection.
Civic Consciousness: There is no civic Consciousness
because the tax is disguised in the price, buyers are
unaware that they are paying tax.
Inelastic: When compared to direct taxes, indirect
taxes are less elastic. Because indirect taxes are
usually proportionate.
Unfair and regressive: Indirect taxes are sometimes
unfair and regressive since both affluent and poor
people must pay the same amount in taxes regardless
of their income level.
16.16.5 Issues with Indirect Tax
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List of exclusions: Petroleum items (crude oil and
natural gas), diesel, gasoline, aviation turbine fuel,
drinkable alcohol, and real estate, which account for
35-40% of indirect tax income, are exempt from GST.
Tax evasion: In the lack of a practical method of
matching invoices, the phoney invoice business has
evolved.
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High tax rate: High tax rates on autos and building
and construction materials have created an additional
slowdown in these industries at a time when demand
is constrained.
Agriculture: Farmers must pay GST for agrochemicals,
fertilisers, safety kits (eyewear, masks, and gloves),
drip irrigation systems, and so on, but they do not
obtain the input tax credit.
Tax compliance is difficult: The current four distinct
rates, several exclusions and cesses, separate rates
for gold, and so on undercut the final objective of
simplifying tax compliance and result in lost efficiency
benefits.
Multiple rate challenge: Such is the high expense of
auditing the categorization of items into tax slabs at
each stage and the lengthy litigation in the event of
a dispute.
Data security: The current GST implementation
needed massive registration for input-based tax
credits and the creation of a shared database of
registered traders to be administered centrally.
16.16.6 Indirect Taxation: Way Forward
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Minimizing tax interface: There is also a need to
enhance tax authorities’ interface with taxpayers,
making the procedure more user-friendly.
Efficient GST operational system: We need to develop
an efficient GST operational system and minimise the
disruption caused by the transition from the current
indirect tax regime to the GST.
Rationalising GST Rate: We should move gradually
towards fewer numbers and lower levels of rates.
Because the GST system would broaden the tax base,
we should be able to reduce tax rates without losing
income.
Eliminating the generation of black money:
Tax reform should be viewed as part of a bigger
government strategy to clean up the system so that
no black money is produced.
Expanding the tax base: A wider tax base, as a result
of tax changes, can also allow for lower overall tax
rates, promoting investment, expanding production,
and boosting economic growth.
Improvement in Custom clearances: There is room
for improvement in customs clearance operations. All
partner government agencies should have access to a
single window for customs clearance (SWIFT).
Dispute resolution strategy: Following the Tax
Administration Reform Commission’s (TARC)
recommendation, the CBDT and CBIC should each
establish a distinct dispute-handling vertical apart
from the tax collecting operations.
Tax officers’ performance evaluation: The
inclination of tax authorities to commence an action
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without the appropriate reason or evaluation is a
fundamental cause behind the growing number of
tax disputes.
Stable tax policy: Supporting investments through
a predictable and stable tax policy, which may be
achieved through simplifying tax rules and regulations.
Limit the discretionary powers granted to tax officials
by legislation.
Custom duty rationalisation: To the greatest degree
possible without breaking our WTO responsibilities,
we should unify all custom duties at 7%. Entrepreneurs
are always complaining about the inverted duty
structure.
16.16.7 Government Initiative In Indirect
Taxation
Trade Policy Measures:
The Customs Act is being changed to provide for
effective checks on imports under FTAs.
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For certain sensitive commodities, the Rules of Origin
must be evaluated.
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Provisions about safeguard duties should be enhanced
to allow for systematic regulation of such an increase
in imports.
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Provisions for preventing dumping and importing
subsidised products are being enhanced.
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Suggestions for reviewing customs duty exemptions
will be crowdsourced.
Excise duty
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Excise tax on cigarettes and other tobacco goods is
planned to be hiked, although bidi duty rates remain
unchanged.
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Anti-dumping tariff on PTA eliminated to assist the
textile industry.
Govt. Initiative In Indirect Taxation: Overall
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GST introduction: GST was adopted on July 1,
2017 (by the 101st Constitutional Amendment) as
the largest indirect tax reform, including around 17
indirect levies such as excise duty, VAT, service tax,
luxury tax, and so on.
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Turant Customs: Under the project ‘Turant Customs,’
the Central Board of Indirect Taxes and Customs has
implemented a faceless assessment of consignments.
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Administrative
Reforms:
Based
on
the
recommendations of the Tax Administration Reforms
Commission led by Parthasarathy Shome, the Revenue
Secretary established a Tax Policy Research Unit to
improve research competence on fiscal themes and
Tax Policy.
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16.16.8 Budget of 2023 and indirect tax
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Several customs duties have been changed.
Indian Economy
The amount of cess on a few items, such as gold,
platinum, and aeroplanes, has been increased,
with a corresponding decrease in customs duties.
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Budget 2023 includes indirect tax proposals that
emphasise tax structure simplification with fewer tax
rates to help reduce compliance burden and improve
tax administration:
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Except for textiles and agriculture, the number of
basic customs duty rates on goods has been reduced
from 21 to 13.
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Toys, bicycles, automobiles, and naphtha have had
their basic customs duties, cesses, and surcharges
slightly modified.
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Excise duty on GST-paid compressed biogas contained
in it has been waived to avoid tax cascading on blended
compressed natural gas.
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The duty-free importation of specified capital goods
and machinery required for the manufacture of
lithium-ion cells used in the batteries of electrically
powered vehicles (EVs) has been extended until
March 31, 2024.
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Subject to conditions, vehicles, specified automobile
parts and components, sub-systems, and tyres are
proposed to be exempt from customs duty when
imported for testing and/or certification by notified
testing agencies.
Key Proposals:
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The budget for 2023 proposes amending the CGST
Act in order to:
 Increase the minimum tax amount limit for
launching a GST prosecution from one crore
to two crore, except for the offence of issuing
invoices without supplying goods and services or
both;
 Reduce the compounding amount from 50 to 150
percent of the tax amount to 25 to 100 percent of
the tax amount;
 Decriminalise certain CGST offences or clauses,
such as obstructing and preventing any officer
from performing his duties, deliberately tampering
with evidence, or failing to supply information.
 Limit the amount of time you have to file returns
and statements to three years from the date they
were due; and
 Let unregistered vendors and composition
taxpayers sell goods within the same state through
E-Commerce Operators (ECOs).

16.17 GOODS AND SERVICE TAX (GST)
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It is a single tax on the provision of Goods and Services
throughout the entire product cycle or life cycle, from
manufacturing to consumer.
Indian Taxation System
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It can only be calculated during the “Value addition”
stage of commodities or services.
Rather than paying the entire supply chain, the
ultimate customer will only pay his portion of the tax.
It is a system of destination-based taxes.
The 101st Constitutional Amendment Act created it.
It is an indirect tax imposed on the entire country in
the spirit of “One Nation, One Tax” in order to make
India a united market.
The GST Council has the authority to rule on any GSTrelated issue, and its chairman is the finance minister
of the country.
16.17.1 Objectives Of GST
Documentation reduction: The government intends
to decrease the need for many documents under the
old taxing system by establishing a unified tax, such
as GST.
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Improving efficiency: The goal is to provide
businesses with a simple tax filing system that will
increase their efficiency and lower the total expenses
connected with company activities.
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Simplification: The major goal of this taxation system
is to simplify the entire process of paying taxes as well
as compliance.
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Common market: It contributes to the creation of a
common market in India through a unified taxation
structure.
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Input tax credit: It also provides for the deduction
of earlier taxes connected to the same transactions
through the use of the input tax credit. The GST tax
is solely levied on the net value added at each level
of the supply chain.
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Increase the tax base: One of the key goals of GST
is to increase the tax base in India. Most former
indirect taxes had registration threshold restrictions
depending on a company’s annual revenue.
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Surveillance system: The goal of GST is to create a
countrywide surveillance system to find defaulters
and tax evaders.
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Cascading effect: It eliminates the cascading effect of
indirect taxes on a single transaction.
16.17.2 Current rate structure:
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The percentage rates of tax levied on the sale of goods
or services under the CGST, SGST, and IGST Acts are
referred to as GST rates.
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A GST-registered firm must issue invoices containing
GST amounts levied on the value of supply.
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The GST rates for CGST and SGST (for intrastate
transactions) are nearly the same. In contrast, the GST
rate for IGST (for inter-state transactions) is roughly
equal to the sum of the CGST and SGST rates.
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16.17.3 Timeline of GST
244
Indian Economy
16.17.4 GST Revenues: Data and figures
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In the month of March 2023, the gross GST revenue collected is 1,60,122 crore, of which CGST is 29,546 crore, SGST
is 37,314 crore, IGST is 82,907 crore (including 42,503 crore collected on import of goods), and cess is 10,355 crore
(including 960 crore collected on import of goods). The gross GST collection has surpassed 1.5 lakh crore for the
fourth time in the current fiscal year, marking the second-highest collection since the implementation of GST.
 This month saw the highest IGST collection in history.
As part of the regular settlement, the government transferred 33,408 crore to CGST and 28,187 crore to
SGST from IGST.
After IGST settlement, the total revenue of the Centre and the States in March 2023 is 62,954 crore for CGST and
65,501 crore for SGST.
 The revenue for March 2023 is 13% higher than the revenue for the same month last year.
Revenues from imports of goods were 8% higher during the month, and revenues from domestic transactions
(including imports of services) were 14% higher than in the same month last year.
The number of returns filed in March 2023 was the highest ever.
 In February, 93.2% of invoice statements (in GSTR-1) and 91.4% of returns (in GSTR-3B) were filed until
March 2023, compared to 83.1% and 84.7%, respectively, in the same month last year.
Trends in GST Collection (Rs. in Crore)
1,80,000
1,60,000
1,47,686
1,17,010
1,43,612
1,12,020
1,48,995
1,44,616
1,16.393
60,000
92,800
80,000
97,821
1,40,885
1,00,000
1,39,703
1,20,000
1,67,540
1,40,000
40,000
20,000
0
Apr
May
GST Collection in FY 2021-22
16.17.5 Goods and Service Tax Network
(GSTN)
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GSTN is a not-for-profit corporation under the
Companies Act.
It was established to start and operate the GST’s
information technology backbone.
While the central (24.5%) and state (24.5%)
governments own 49% of the company, the remaining
51% is owned by five financial institutions: LIC Housing
Finance (11% share), ICICI Bank, HDFC, HDFC Bank,
and NSE Strategic Investment Corporation Ltd (10%
stake each).
Indian Taxation System
Jul
Jun
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Aug
GST Collection in FY 2021-22
Sep
GSTN had given the contract to Infosys Ltd to build
GST hardware and software.
GSTN was created to create an entity that is equidistant
from both the Central Government and the State
Governments since it will advise both the Centre and
the States on the information technology network.
16.17.6 National Anti-Profiteering.
Authority (NAPA)
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Section 171 of the Central Goods and Services Tax
Act of 2017 established the National Anti-Profiteering
Authority (NAA).
245
Its purpose is to guarantee that any decrease in tax
rates or the benefit of an input tax credit is passed on
to the receiver in the form of a price reduction.
Functions:
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The Authority’s primary purpose is to guarantee that
the advantages of the GST Council’s lowering in GST
rates on goods and services are realised.
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Proportional change in the Input Tax Credit passed
on to the final consumers and recipients, respectively,
through price reductions by suppliers.
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Composition: The National Anti-Profiteering
Authority would be led by a senior official with the
rank of Secretary to the Government of India, with
four technical members drawn from the Centre and/
or the States.
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16.17.7 GST Council
GST (Article 279A) The President will appoint a
council to manage and govern GST. Its Chairman is
India’s Union Finance Minister, and its members are
ministers chosen by state governments.
The council is structured so that the centre has onethird of the voting power and the states have twothirds.
Decisions are made with a 3/4th majority.
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16.17.8 Success of gst regime: 5 yrs
completed
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Promoting Ease of Doing Business: The government
has been proactive in producing circulars and
explanations to clear up any confusion about GST
taxation and to make conducting business easier.
Revenue Collection: The GST council has met 47
times and adopted actions that have resulted in Rs 1
lakh crore GST collection per month being the “new
normal.” Every month, the value is expected to reach
Rs 1.4 lakh crore.
 The average monthly gross GST collection has
increased from ₹0.90 lakh crore in FY18 to ₹1.49
lakh crore in FY23.
Faster Growth in State Revenues: Since the
implementation of GST, the total resource growth rate
for states has been 14.8% per year, compared to an
annual average growth rate of 9% between 2012 and
2015.
 As a result, states appear to be better off. When
compared to 2014-17, the GST share of state
revenue has grown somewhat in 2018-21.
Improving Compliance: The GST Network (GSTN)
serves as the indirect tax regime’s technical backbone.
 It has been employing artificial intelligence and
machine learning to provide updated data and
address income leaks.
246
The GST-to-GDP ratio increased from 5.8% in
2020-21 to 6.4% in 2021-22, demonstrating
improved compliance.
Avoiding Cascading of Taxes: It incorporated 17
local charges such as excise duty, service tax, and VAT,
as well as 13 cesses.
 In the pre-GST period, the combination of VAT,
excise, CST, and their cascading effects resulted in
31% of tax paid by a customer on average.
 With continuous adjustments to the different
tax rate levels, the effective GST rate has fallen
to 11.6% in 2019 from 14.4% when it was first
implemented.

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16.17.9 Challenges to gst
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Lack of Coverage: With petrol, diesel, and ATF exempt
from GST, a major portion of the economy remains
untaxed.
Compensation to states: Many states have relied on
GST compensation.
 Since the provision is about to expire, many states
are requesting an extension.
 The Union Government, on the other hand, looks
hesitant. Furthermore, as the economy began
to weaken in 2019-20, the Union Government
postponed GST payments to the states.
Multiple Tax Rates: India has multiple tax rates, unlike
many other economies that have established similar
tax structures. This impedes the implementation of
a single indirect tax rate for all commodities and
services in the country.
Hardships for Taxpayers: Taxpayers face considerable
challenges as a result of the unnecessary and excessive
issue of show cause notifications for financial number
reconciliation, registration grants, and so on.
Lack of proper implementation: Despite the
introduction of e-way bills and e-invoicing, real
receipts are not issued in all sectors of the economy.
 Fast-Moving Consumer Goods (FMCG) stores and
pharmacies, for example, get their supplies from
super stockists, who get them from distributors
chosen by the firms.
Inflation and Revenue Collections: According
to some economists, the present increase in GST
collections is related to excessive inflation.
 In real terms (adjusted for inflation), the growth
rate of GST collections is substantially lower; for
example, the year-on-year growth rate in GST
Collections in March 2022 was 14.7% in nominal
terms, but just 3.7% in real ones.
Frequent technical issues: It has resulted in the
suspension of forms GSTR 2 (a purchase return) and
GSTR 3 (an input-output return), and subsequently
Indian Economy
their abolition. The debut of the e-way bills was
plagued by technical difficulties.
16.17.10 Way Forward
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Reduced Harassment: To reduce needless harassment
of taxpayers, several checks can be integrated into
system-produced GST notices.
Analysis of Data: The GST system contains a large
database. The data may be analysed to offer helpful
insights into the economy’s health.
 Data-driven insights can aid in the formulation of
suitable policy initiatives.
Extending the scope: Governments should explore
putting petroleum and power into the GST purview
to assist minimise cascade and provide additional
consistency.
Extension of Compensation: The majority of states
have advocated an extension of the compensation
system.
A single source of authority: To make the process
easier for exporters, a new system for authorising and
processing GST refunds has been proposed.
 A single tax agency will assess, check, and sanction
refunds under the proposed change. Revenue
performance of the Composition Scheme:
 It must be enhanced by assuring more compliance
among small business owners.
GST Council: They will need the assistance of a robust
technical secretariat composed of administrators,
economists, accountants, and attorneys, among others.
 At the moment, the GST Council depends on the
analysis of the “fitment committee,” which is made
up of nominated officials from the Tax Research
Unit of the Central Board of Indirect Taxation and
Customs (CBIC) and officials from the commercial
taxes departments of several states.
Clarity: As technology advances, new asset classes
develop, such as virtual digital assets (VDA) or
cryptocurrencies.
Resolving AAR decisions: The government may
consider establishing a central authority to reconcile
conflicting AAR decisions between states.
 It may also explore eliminating anti-profiteering
regulations, allowing firms to determine their
rates.
 The Chief Economic Advisor has suggested
establishing a complaint-resolution system (a GST
Tribunal).
PREVIOUS YEAR QUESTION (PRELIMS)
1- What is/are the most likely advantages of implementing
‘Goods and Services Tax (GST)’?
(2017)
Indian Taxation System
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
(c) 1 and 3 only
(d) 1, 2 and 3
{REVIOUS YEAR QUESTION (MAINS)
1. Explain the rationale behind the Goods and Services
Tax (Compensation to States) Act of 2017. How Has
COVID19 impacted the GST compensation fund and
created new federal tensions? 2020
16.18 TAX TO GDP RATIO
It is used to measure how successfully a country’s
government controls its economic resources.
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The tax-to-GDP ratio compares the size of a country’s
tax revenue to GDP.
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The greater the country’s tax-to-GDP ratio, the
better its financial situation. The ratio represents the
government’s capacity to support its spending.
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A higher tax-to-GDP ratio suggests that the government
has the ability to cast a larger fiscal net. It assists
governments in becoming less reliant on borrowing.
India’s tax-to-GDP ratio:
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India’s overall tax collections increased by 34%
in 2021-22 to reach 27 lakh crore, raising the taxto-GDP ratio to an at least 23-year high of 11.7%, up
from 10.3% the previous year.
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India Tax revenue: % of GDP was reported at 7.8
% in Dec 2022. This records an increase from the
previous number of 7.7 % for September 2022.
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The tax revenues exceeded the Budget forecasts for
2021-22 by 5 lakh crore and even above the revised
estimates by 1.87 lakh crore, with direct taxes
increasing by 49% and indirect taxes increased by
20%.
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The latest budgeted projection was 22.17 lakh crore,
17% more than the previous year,” are now close to
27.07 lakh crore, a than 5 lakh crore rise.
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Corporation tax collections increased by 56.1%, while
personal income tax collections increased by around
43%, bringing total direct tax growth to 49%.
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247
Customs duty revenues increased by 48% as a result
of strong export-import growth.
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At 1.9, the present tax buoyancy ratio is considered
healthy. In 2021-22, the tax buoyancy ratio, which
measures tax growth compared to GDP growth, was
2.8 for direct taxes and 1.1 for indirect taxes. The
direct-to-indirect tax ratio improved from 0.9 in
2020-21 to 1.1 in 2021-22.
Reasons for the poor tax to GDP ratio:
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Large agriculture sector: Of India’s 25 crore families,
15 crores are in the agricultural sector, which is taxfree.
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Parallel and black economies: In many sections
of the parallel economy, unaccounted income and
expenditures go untaxed.
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Tax exemption: India’s high tax exemption rules have
benefited the country’s wealthier private sector.
z
Large Informal Sector: India has a comparatively
large informal/unorganized sector, and tax evasion
is more prevalent there than in the organised sector.
z
Basic concerns include: In India, low per capita
income and significant poverty keep tax receipts low.
z
High tax dispute: India has one of the greatest
numbers of tax administration-taxpayer disputes,
with the lowest proportion of tax arrears recovered.
z
Generous government policy: Due to different
political reasons, several central governments have
ignored the low tax-to-GDP ratio.
z
Zero tax liabilities: Because of individuals who
declare zero tax obligations, the real number of
persons who pay tax is fewer.
z
Indirect tax ratio: The direct-to-indirect tax ratio
in India is around 35:65. This is in contrast to the
majority of OECD economies, where the ratio is 67:33
in favour of direct taxes.
Implications of Low Tax to GDP ratio:
z
Tax burden: Widespread tax evasion remains
unpunished, stifling growth, and the majority of the
tax burden falls on high-productivity industries that
require expansion.
z
Social inequality: The uneven allocation of economic
resources in society is increasing social inequality.
z
Low spending capacity: As tax revenues decline, the
Indian State is unable to spend on national security,
the welfare system, public amenities, and so on.
z
Permanent deficit: Due to the government’s low tax
collection, there is substantial borrowing, resulting in
a permanent deficit tilt in fiscal policy.
z
Effective tax system: A system like this provides
political incentives for the government to borrow
money to purchase votes rather than focus on
constructing an effective tax system that will lead to
economic growth and progress.
z
248
16.19 ECO-SURVEY 2019: BEHAVIOURAL
ECONOMICS IMPROVE TAX
COMPLIANCE
z
z
z
z
Behavioural Economics is the study of the
psychological, social, emotional, and cultural
components of an individual’s economic behaviour, as
well as the deviations of these decisions from those
based on rational classical economics.
Behavioral economics studies how market decisions
are formed and what factors influence public choice.
This field of economics has gained pace in recent
years and garnered appeal among policymakers after
Richard H Thaler was awarded the Nobel Prize in
Economics in 2017 for his work on nudge theory.
Richard H Thaler conducted a considerable study
on the topic and wrote Nudge: Improving Decisions
About Health, Wealth, and Happiness.
16.19.2 Scope for Behavioural Economics
in India:
z
The economic survey advocated societal improvements
in the following areas using behavioural economics:
 From Beti Bachao to Beti Aapki Dhan Lakshmi and
Vijay Lakshmi (BADLAV).
 Sundhar Bharat to Swachh Bharat
 From “Give it up” for LPG subsidies to “Think about
it”
 Transitioning from tax evasion to tax compliance
16.19.3 Nudge Policies
z
z
z
z
z
z
z
India is a country where culture, tradition, and social
standards are extremely important.
Individuals’ economic decisions are influenced by the
social and cultural features of their surroundings.
To achieve social and economic transformation, the
government must implement behavioural changes in
society through social engineering.
This is critical, particularly for India, a country with
varied cultures and customs.
In recent years, economists and policymakers have
used new strategies known as nudge policies.
This is based on the nudge principle, which states that
people’s behaviour may be changed reliably without
restricting their options.
According to this view, people may be gently coaxed
towards making the proper decision by policies.
Indian Economy
z
z
These rules establish specific levers to affect
individuals’ good behaviour.
These policies can be used to encourage tax compliance,
prohibit social ills, promote environmentally friendly
infrastructure and technology, and encourage savings.
16.19.4 Limitations
z
z
z
z
z
It should be highlighted that behavioural economics
is not a panacea for all the country’s economic
difficulties.
There are several industries where it has not been
effective.
Certain policies may necessitate harsh measures to
be successful.
India is a land of many different ideas, cultures, and
customs. At the local level, a common shove from the
Centre will have little to no effect.
Infrastructure and education are critical components
of nudge policy. At the grassroots level, India suffers
from major deficiencies in each of these areas.
PREVIOUS YEAR QUESTION (PRELIMS)
1. A decrease in tax to GDP ratio of a country indicates
which of the following? (2015)
1. Slowing economic growth rate
2. Less equitable distribution of national income
Select the correct answer using the codes given below.
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Tax Morale
z
Tax morale measures taxpayer opinions and attitudes
regarding tax payment and evasion. Our research
on tax morale identifies various aspects that may
impact people’s desire to pay taxes, as well as policy
implications.
16.20 R
ECOMMENDATIONS BY CEA
SUBRAMANIAN K.
z
z
z
Highest taxpayers over a decade: Over a decade,
the highest taxpayers should have important sites
named after them, such as roads, railroads, schools,
universities, hospitals, and airports.
Ease of Paying Taxes: Pre-populated Income Tax
forms using simple words. Even if a person has no
tax due, he should be forced to complete an Income
Tax form.
Unpaid debt: Is regarded as a sin in Hinduism, Islam,
and Christianity. As a result, commercials should
emphasise how tax evasion violates such “spiritual/
religious ideals.”
Indian Taxation System
z
The top ten highest taxpayers: In a district should
be given VIP treatment, such as priority boarding at
airports, special “diplomatic” style lanes at immigration
desks, fast-lane on highways and toll booths, and so
on.
16.21 TAX EVASION
z
z
z
z
z
z
Tax evasion is an illegal attempt by individuals,
businesses, trusts, and others to avoid paying taxes.
Tax evasion sometimes involves the intentional
misrepresentation of the taxpayer’s circumstances to
tax authorities in order to decrease the taxpayer’s tax
burden.
Dishonest tax filing includes claiming less income,
earnings, or gains than earned and overstating
deductions.
Bribes are being used against officials in corrupt
countries, and money is being hidden in secret
locations.
Tax evasion is a common activity associated with the
informal sector.
The amount of unreported income (the “tax gap”) is
one indicator of the level of tax evasion (the difference
between the amount of income that should be declared
to the tax authorities and the actual amount recorded).
16.21.1 Reasons
z
z
z
z
z
z
z
Frequent changes in government and political
instability: Another factor for the failure to create
a well-defined tax system is the frequent changes in
government and political instability. Different nations
adopt different tax systems, making it difficult to keep
track of them all.
Changes in tax policy: The government of India
changes tax policies on a regular basis. It confuses
taxpayers and officials regarding the applicable
provisions.
Deficiencies in enforcing Penalty Provisions: This
leads to slack behaviour on the part of the taxpayer,
worsening the issue.
High taxation: A high taxing burden is imposed on
taxpayers. As a result, they seek ways to avoid paying
taxes.
Failure to prevent bribery: An efficient system
should be in place to prevent bribery and corruption
among authorities. They assist taxpayers in avoiding
tax by obtaining an agreed-upon percentage of the
earnings from avoided tax.
Lack of simple procedures: India’s tax structure is
complicated, and individuals find it difficult to travel
to multiple offices for a single issue.
Existence of several taxes: The existence of numerous
distinct types of taxes places a burden on taxpayers.
249
z
Complex tax rules and tax avoidance loopholes:
Indian tax law is complex. People can discover
provisions to avoid tax responsibility in the same
statute.
16.21.2 Initiatives of Govt
z
z
z
z
z
z
z
z
z
Operation Clean Money (2017): The Income Tax
Department verified substantial bank deposits made
following demonetization.
Project Insight 2017: Income Tax Department
commissioned L&T Infotech Ltd. to design an
integrated platform for data mining and tracing tax
evaders.
Tax (Evasion) Disclosure Schemes: Under these
amnesty programmes, a tax evader can reveal his
unreported income and pay the taxes and penalties. The
Income Tax Department will not prosecute him.
Income Declaration Scheme (IDS): The offer was
45% (30% tax plus a 7.5% surcharge plus a 7.5%
penalty). The government will seize a portion of the
concealed revenue.
Pradhan Mantri Garib Kalyan Yojana (PMGKY):
Introduced following demonetization; valid from
December 2016 to April 2017. The government would
seize around 50% of the undeclared revenue as tax
+ penalty + Pradhan Mantri Garib Kalyan Cess. The
initiative was not very successful, with just about INR
5000 crore declared.
PMLA-2002: This legislation establishes a structure
to fight money laundering, with cases adjudicated
by the PMLA Adjudicating Authority and the High
Court. It also gives the RBI, SEBI, IRDAI, and other
authorities the authority to create standards for banks
and NBFCs and to penalise violators.
Benami Transactions Prohibition Act (BTPA1988/2016): Benami refers to properties registered
in the name of a buyer’s kin, personal staff (Driver,
Gardner), or a non-existent/ fake person in order to
evade the notice of tax authorities.
Budget 2019 Sabka Vishwas Scheme (Legacy
Dispute Resolution): More than 3.75 lakh crore in
tax income is tied up in service tax and excise duty
litigation.
Chairman of the Supreme Court’s Special
Investigation Team on Black Money in 2014:
Retired Supreme Court Justice M. B. Shah, along with
top tax officers. They proposed different strategies
to combat black money concealed in India, offshore
banks, P-Notes, and so on.
16.22 TAX-AVOIDANCE
z
250
Tax avoidance is the legal use of a single territory’s
tax structure to one’s advantage in order to lower the
amount of tax owed using legal ways.
z
z
One sort of tax avoidance is a tax shelter, while tax
havens are jurisdictions that allow for lower taxes.
Tax avoidance should not be confused with criminal
tax evasion.
16.22.1 Method
z
Country of residence:


z






However, there are very few double-taxation
treaties with nations considered tax havens, once
where the income is generated and again in the
place of residence.
Personal taxes can be lawfully avoided without
moving one’s country of residence by establishing
a separate legal company to which one’s property
is given.
A separate legal entity is frequently a corporation,
trust, or foundation.
These can also be located offshore, as with many
private foundations.
Assets are transferred to the new business or trust
so that profits or revenue can be achieved inside
this legal entity rather than by the original owner.
Tax outcomes are determined by the meanings of
legal terminology, which are frequently ambiguous.
The ambiguity of the line between “business costs”
and “personal expenses,” for example, is a source
of anxiety for both taxpayers and tax authorities.
Tax havens:

z
To avoid taxing non-residents twice, most
governments have signed bilateral double taxation
accords with numerous other countries.
Legal vagueness:

z
Most nations levy taxes on income generated or
gains realised inside their borders, regardless of
the person’s or firm’s location.
Legal entities:

z
Individuals might potentially avoid paying taxes by
relocating to a tax haven.
Double taxation:

z
A firm may opt to avoid taxes by incorporating or
creating subsidiaries in an offshore jurisdiction.
Tax shelters are investments that allow for, or
claim to allow for, a decrease in one’s income tax
burden.
Transfer mispricing:

Transfer pricing fraud, also known as transfer
pricing manipulation, refers to trading between
related parties at rates intended to influence
markets or fool tax authorities.
Indian Economy
16.22.2 Tax Evasion Vs Tax Avoidance
16.23 ROUND-TRIPPING
z
z
z
z
z
Round-tripping, commonly referred to as “Lazy
Susans” is described as a type of barter in which a
corporation sells “.
An underutilised asset to another firm while
committing to acquire back the same or comparable
assets at a similar price.”
Swapping assets on a round-trip produces no net
economic substance but may be fraudulently recorded
on the books of the firms involved as a series of
productive sales and advantageous acquisitions,
breaking the substance over form accounting principle.
Although the businesses appear to be expanding and
highly busy, the round-tripping industry does not
make profits.
Even if earnings are low, growth is appealing to
speculative investors.


Such investment benefits businesses and
encourages them to pursue the false growth of
round-tripping.
They were instrumental in temporarily increasing
the market capitalization of energy dealers
including Enron, CMS Energy, Reliant Energy,
Dynegy, and Wirecard.
Indian Taxation System
16.24DOUBLE TAXATION AVOIDANCE
AGREEMENT (DTAA)
z
z
z
z
The DTAA was designed to correct the disparity in tax
collection on individuals’ global income.
It is a tax treaty between two sovereign countries
that spells out comprehensive processes and taxing
methods, as well as specified requirements that must
be scrupulously followed.
The DTAA protects taxpayers in certain nations from
being taxed twice on the same income.
The following areas are covered by the Double
Taxation Avoidance Agreements (DTAA):
 Accounts for savings/fixed deposits
 Services Property
 Gains in capital
 Salary
16.24.1 Objectives
z
z
z
Governments enter into such treaties with other
nations to encourage foreign investments and boost
the flow of cash.
It prevents income tax recovery in both nations.
Because of increased globalisation, more enterprises
are being conducted in cross-border jurisdictions,
resulting in instances of double taxation.
251
z
z
z
DTAAs assist to avoid instances of income double
taxation.
The division of taxation rights over a taxpayer’s
income between the two nations is fair and equitable.
This will result in more international commerce,
investment, and technology exchange, as well as
improved transparency.
z
There is no commonly agreed definition of a tax haven
nation.
16.25 BASE EROSION & PROFIT SHIFTING
(BEPS)

16.24.2 Benefits
z
z
z
Sections 90 and 91 of the Income Tax Act of 1961
grant specific exemptions to taxpayers in order to
avoid double taxation.
Section 90 of the Income Tax Act addresses limitations
imposed on taxpayers who have paid taxes to another
country with which India has a Double Taxation
Avoidance Agreement (DTAA).
Section 91 applies to countries with whom India has
no bilateral trade agreement (DTAA). India provides
aid to both types of taxpayers.
16.24.3 DTAA in India
z
z
z
Section 90 of the Income Tax Act of 1961 authorises
India to enter into DTAAs with foreign nations. India
has bilateral trade agreements with over 96 nations.
It is reciprocal in nature and applies to both Indian
inhabitants and residents of the negotiating country.
Individuals or corporations who are not citizens of
India or the countries with whom the DTAA is signed
are not eligible to receive advantages under the
agreement.
16.24.4 Importance
z
z
z
When difficulties of dual taxation are overcome,
a country becomes more appealing to overseas
investors.
It offers income tax breaks, exempts money generated
overseas from taxation in the home nation, or gives
credit for taxes already paid abroad.
It guarantees tax certainty between persons as a
result of a clear distribution of taxing rights between
various individuals.
16.24.5 Misuse OF DTAA
z
z
z
252
DTAAs signed with tax haven nations such as
Mauritius, Singapore, and others have led to lower
tax responsibilities for certain firms.
It may result in revenue loss for countries because the
corporation is only required to pay taxes in the tax
haven country and not in the country where it makes
a profit.
The DTAA may attract even legitimate investors to
route their assets via low-tax jurisdictions in order
to avoid paying taxes. As a result, the country loses
tax revenue.

Base Erosion Profit Shifting is a tax evasion method
employed by multinational corporations in which
earnings are transferred from countries with high
taxes to jurisdictions with low or no taxes (also
called tax havens).
This compromises the fairness and integrity of tax
systems since firms operating across borders can
utilise the strategy to obtain a competitive edge
over local enterprises.
16.25.1 Working Mechanism



The government imposes a tax on multinational
corporations based on a proportion of their
revenue or profit.
Using the loopholes, the global corporation
profitably relocates to another country that may
be attacked heaven.
As a consequence, the country that assists the
multinational firm with revenue does not receive
any tags, and there is tax erosion as a result of the
corporation moving money or profits.
16.25.2 The issue with Base Erosion Profit
Shifting




According to the Organization for Economic
Cooperation and Development (OECD), it is
critical for developing nations owing to their
reliance on corporate income tax, particularly
from multinational corporations.
It also predicts that since 2013, yearly losses
ranging from 4 to 10% of worldwide corporate
income tax receipts have been reported.
BEPS affects the fairness and integrability of tax
systems by allowing enterprises that operate
across borders to acquire a competitive edge.
Furthermore, seeing multinational firms lawfully
evade Income Tax weakens voluntary compliance
by all taxpayers.
16.25.3 OECD – BEPS project



It is an initiative created by the Organization
for Economic Cooperation and Development to
combat tax evasion.
To create a more transparent tax environment and
better synergy in international tax standards.
To accomplish the initiative, all interested nations
may work together on an equal basis with G20 and
OECD member countries.
Indian Economy







The initiative aims to modify international tax
standards in order to ensure that multinational
corporations pay their fair share of taxes wherever
they operate.
It is made up of over 135 nations that account for
more than 90% of the global GDP.
The countries also agreed on a fair allocation
of revenues and taxing rights for international
corporations, including digital behemoths like
Amazon and Google.
The initiative includes 15 activities that would
provide governments with the local and
international tools they need to combat tax evasion.
Countries may now ensure that earnings are taxed
where the economic activities that generate the
profits take place and value is generated.
It also provides greater freedom to enterprises
by minimising disagreements over the
implementation of foreign tax legislation and
harmonising compliance requirements.
The initiative contributes to the development
of a contemporary international tax system by
ensuring that earnings are taxed where economic
activity occurs.
16.25.4 Benefits of the BEPS Project




Increase previously lost tax revenues as a result
of BEPS.
Increase money from taxes for underdeveloped
countries.
It creates a fair playing field for both domestic and
global businesses by allowing them to conduct
business under identical conditions.
Increase transparency in corporate information by
making it available through automated information
exchanges.
16.25.5 The focus of the Project
z
z
z
z
z
Transparency and reporting.
Transfer Pricing.
Deductibility of Finance caused.
The right to tax treaty advantages.
Companies in the digital economy are taxed differently.
z
z
z
z
16.25.7 BEPS At International Level
z
z
z
z
z
z
z
At the national level, India imposed a 6% equalisation
tax on payments above one lakh rupees to online and
non-resident Indian services.
Following the OECD action plans, India is the first
country to impose such a charge.
It has also adopted some of the project’s key
recommendations through domestic legislation
changes as
Indian Taxation System
India has joined an international treaty-related
agreement to avoid base erosion and profit shifting.
To adopt a series of tax treaties in efforts to modernise
international tax standards and reduce the ability for
multinational corporations to avoid paying taxes.
The agreement or modification of India’s tax treaties
to reduce revenue loss due to treaty abuse by ensuring
that earnings are taxed where the actual economic
activity generating the profits take place.
India and the United States have also inked an
intergovernmental agreement on foreign account tax
compliance.
In 2015, it also signed the multilateral competent
authority agreement on the automated exchange of
financial account information.
16.27 TRANSFER PRICING
z
z
z
z
z
16.25.6 BEPS At National Level
z
Thin capitalisation is a state in which a firm is financed
with a high amount of debt relative to equity.
Patent box taxation: It was created by adding a new
section 115BBF to the Finance Act of 2016.
Country-By-Country Reporting is part of the OECD’s
Action Plan 13 on base erosion and profit shifting.
A CBCR is required to be furnished by an Indian
affiliate of a foreign parent group or an Indian Parent
business under the Indian Income Tax Act.
Transfer pricing is the price charged by one division of
a company to another division for goods and services.
It sets pricing for goods and services transferred
between subsidiaries, affiliates, or firms managed
jointly that are all part of the same larger corporation.
Transfer pricing allows corporations to save money
on taxes, although tax authorities may question such
claims.
Companies undertake it to decrease the total tax
burden; a transfer price is based on the market price.
Transfer Pricing may also be used as a tax evasion
strategy since firms when dealing with one of its
affiliates, intentionally set the cost of goods/services
to maximise advantages.
16.27.1 Objectives
z
z
It aids in the development of independent profits in
each part of the firm, allowing performance appraisal
of each section individually.
It not only generates distinct income, but it also
aids in better resource allocation in each part of the
organisation.
253
16.27.2 Need




It aids in better management accounting and
reporting by giving multinational corporations
(MNCs) choices when dividing income and costs
to subsidiaries located in multiple countries.
Transfer pricing aids in the better distribution of
revenue and expenditures to subsidiaries as they
are further subdivided.
It has an effect on shareholder wealth since it
affects the company’s taxable income and aftertax earnings.
It assists in reducing the risks associated with
noncompliance, particularly in cross-border
intercompany transactions.
16.27.4 Policy Measure to address Transfer
Pricing
The government has established guidelines for
calculating the Foreign Tax Credit (FTC).
Non-resident e-commerce transactions are subject to
an equalisation levy.
Budget 2016 included Base Erosion and Profit Shifting
(BEPS) Action Plan 13.
In 2001, the government enacted a Transfer Pricing
Code based on OECD recommendations.
z
z
z
z
16.27.8 Panels for Dispute Resolution:


16.28 PLACE OF EFFECTIVE
MANAGEMENT (POEM)
z
z
z
z

It asserts that related party transactions should be
conducted on an arm’s length basis, and that price
between related parties should be comparable to
that charged by an independent buyer.
Arm’s length can be determined using the
Comparable uncontrolled price (CUP) approach,
the Resale price method (RPM), the Cost plus
method (CPM), and other methods.
z
z
z
16.27.6 Advance Pricing Agreements
(APA) and Mutual Agreement
Procedure (MAP):


APAs are used to avoid transfer pricing conflicts.
APAs improve openness, provide tax certainty,
decrease litigation, and so forth.
According to the two nations’ agreed-upon double
taxation avoi�ance agreement (DTAA), a mutual
Agreement Procedure (MAP) was employed.
16.27.7 Base Erosion Profit Sharing (BEPS)
Initiative:

254
It is an OECD programme that aims to fix loopholes
in international taxes for corporations that
purportedly evade or decrease their tax burden in
their home country by engaging in tax inversions.
A site of effective management is one where crucial
management and commercial choices that are required
for the overall operation of an organisation are made.
The requirement of PoEM was added to the IT Act by
Finance Act 2016 and took effect on April 1, 2017.
It replaced the previous situation in which control and
administration of affairs were entirely in India.
Initially, the PoEM state known as control may be seen
in India at any time of year.
16.28.1 Poem Guidelines
z
16.27.5 Armed Length Principle:

It is composed of three income tax commissioners
or directors nominated by the Central Board of
Direct Taxes (CBDT).
Any firm with transfer pricing concerns can use it.
According to the PoEM Circular rules, “the procedure
of determining POEM would be essentially focused on
whether or not the corporation is engaged in active
operations outside India.”
The PoEM idea emphasises substance over form, and
because “residency” must be confirmed each year,
POEM must likewise be determined on a year-to-year
basis.
An entity may have more than one management
location, but only one effective management location
at any given moment.
According to the PoEM standards, a firm is regarded
to be involved in “active business outside India” if its
passive revenue is less than 50% of its overall income.
 India accounts for less than half of its total assets.
 Less than half of the total number of employees
are based in India or are Indian citizens.
 Such employees’ payroll expenditures account
for less than half of the company’s overall payroll
spend.
16.29 GENERAL ANTI-AVOIDANCE RULE
(GAAR)
z
z
z
z
It is a collection of laws employed by a country’s
revenue authorities to combat aggressive tax planning
with the goal of tax evasion.
In other terms, it is India’s anti-tax evasion statute.
GAAR was initially proposed in the Direct Tax Code
in 2009, however, it did not become law until 2017.
A group convened by Parthasarathy Shome proposed
delayed implementation for three years, citing the
Indian Economy
z
z
need to establish administrative infrastructure and
educate people for full-scale implementation.
GAAR was implemented in the 2012 Budget session
of Parliament, however, it was first proposed in the
Direct Tax Code in 2009.
The Parthasarathi Shome panel suggested that its
implementation be delayed for three years until 201617.


16.30 TAX TERRORISM AND HARASSMENT
z
16.29.1 Need




Many nations have specific anti-tax evasion
legislation to varying degrees. Australia has had
one since 1981.
The GAAR was adopted in India following
Vodafone’s agreement with Hutchison-Essar. The
transaction took place in the Cayman Islands.
The government claims that over USD 2 billion in
taxes were lost.
In the subsequent litigation, the Supreme Court
ruled in favour of Vodafone.
16.29.2 Importance









Loss of income to the government as a result of
corporate firms exploiting loopholes; hence, GAAR
would help incentivise actual investments and
allow the government to obtain more money.
Contribute to enhanced revenue production from
entities that were previously not paying taxes.
An increase in tax income would aid in the execution
of social programmes while also reducing the
budgetary imbalance.
It gives real enterprises a competitive advantage
over those who take advantage of loopholes.
It will make conducting business easier and
represent India as a serious country that promotes
free and fair trade practices.
Highlighting cases of tax evasion would aid in
increasing government income.
An increase in tax receipts would assist to reduce
the country’s budgetary imbalance.
It will assist to enhance the economic climate
by giving those companies that conduct honest
transactions and do not engage in tax evasion a
competitive edge.
This would stimulate more international
investment by promoting free and fair trade
practices.
16.29.3 Limitations


GAAR regulations might be enforced arbitrarily
due to the high subjectivity of rules.
Before GAAR regulations may be applied, many
levels of approval must be obtained.
Indian Taxation System
These restrictions may lead to greater harassment
by tax officers.
It gives the tax administration discretion and
authority, which might be misused.
z
Tax terrorism is defined as the unauthorised use
of power by tax officials to charge taxes using legal
or illegal ways.
The Vodafone case is a typical example of how,
notwithstanding a Supreme Court judgement in
favour of the firm, tax regulations were retroactively
modified.
16.30.1 Cause of Tax Terrorism and
Harassment
z
z
Complex tax structure: Even on relatively basic
transactions, several taxes apply. Such a tax web
works against the smooth flow of commerce.
Ambiguity in the law: This bends the law in favour
of those who enforce it.

z
In situations such as Vodafone and Cairn Energy Plc,
ambiguous definitions have led to disagreements
regarding the applicability of Minimum Alternate
Tax, Capital Gains Tax, and other taxes.
High imbalance: The IT Act empowers the CBDT to
deliver letters only on the suspicion that a person
has under-reported his income or underestimated his
taxes. Such authority over the authorities is sometimes
abused.
16.30.2 The issue of tax terrorism in India
may be classified into the following
different aspects

Retrospective legislation:
It is frequently stated that taxpayers must
comprehend and comply with regulations, and
that tax rules must be stable for taxpayers to
manage their business/financial affairs.
 While one cannot dispute that, in light of our
country’s social needs, changes to tax legislation
may be inevitable.
 However, any retroactive changes to tax rules
cause suspicion and shatter the faith of the taxpaying community in the tax laws, which hurts
the motivation to invest and the expansion of
industrialisation.
 Retrospective legislation also causes a lot of
litigation and provides little practical advantage
in terms of timely tax recovery.
 The issue with retrospective changes is that
they leave a foul taste in the mouth and are
exceedingly unfair to the assessee.

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Judicial indiscipline:
 We occasionally come across situations in which
the notion of judicial discipline is flagrantly
violated by failing to follow binding precedents.
 The Supreme Court noted this in the case
of Union of India vs. Kamalakshi Finance
Corporation Ltd.
 In the situation of quasi-judicial power, judicial
discipline demands that judgments of higher
authority be respected, according to AIR 1992
SC 711.
 As a result, a lesser official, such as an Assessing
Officer, is obligated to obey the judgement of a
higher authority, particularly in the case of the
same assessee.
 This concept requires junior officers to obey
the judgments of higher authority, such as the
Tribunal.
 Unfortunately, even a body like the Income
Tax Appellate Tribunal (ITAT) will occasionally
disregard court precedent by making incorrect
distinctions.
Mindless Appeals, Revision and Reopening of cases:
 This adds significantly to tax terrorism and
increases the number of pending cases before
the courts.
 While the government has taken a great step
in this regard by increasing the financial limit
of tax effect for not filing appeals before ITAT
and Courts.
 However, frivolous appeals continue to be
filed, and the Court chastises the Departmental
Officers for their attitude of favouring appeals
without regard for the merits of the problems
involved.
Coercive action during Search and Survey:
 To discover black money and bring undeclared
income to taxation, search and survey measures
are required.
 When assessees fail to produce books of
account, papers, and so on, search and seizure
activity may be conducted.
 At the same time, it is important to recognise that
search and seizure constitutes an infringement
of the individual’s privacy.
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16.30.3 Reforms to avoid Tax Terrorism
and Harassment
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The Advance Ruling Authority’s powers might be
expanded. This would save money on pointless
lawsuits.
Simplifying the indirect tax system through the
implementation of the GST will be beneficial to India’s
private sector.
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To untangle the direct tax framework, the Direct Tax
Code might be established. The GAAR provisions, on
the other hand, must be amended, maybe to SAAR.
The Corporate law service cadre might help to
foster collaboration between tax authorities and the
corporate sector.
An Anti-Tax Terrorism Bureau with quasi-judicial
powers might be established to investigate and decide
on cases of tax terrorism.
Avoiding complicated taxing systems as much as
possible Even before the Goods and Services Tax (GST)
was implemented in India, other sorts of indirect taxes
were in place.
This is a major component of a complicated tax
structure that frequently leads to uncertainty on the
one hand and exploitation on the other.
The Double Taxation Avoidance Agreement (DTAA)
is an international bilateral agreement signed by
governments to prevent taxation on the same income
from being levied twice.
DTAAs are an important component of foreign
investment since they not only protect the foreign
investor against unjust treatment in the host nation
of investment but also provide the investor with lower
tax rates on specific items.
16.31 TAXPAYER CHARTER AND BUDGET
2020
16.31.1 Taxpayer Charter:
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Taxpayers’ Charter was announced by the Finance
Minister in her Budget 2020 speech.
The aim of introducing the charter is to build trust
between a taxpayer and the tax administration and
reduce harassment.
It provides responsibilities of the Income Tax (I-T)
department towards the taxpayers.
It also lists the duties of the taxpayers towards the
I-T department.
The objective is to enhance the efficiency of the
delivery system of the I-T Department.
The taxpayer’s Charter is for building trust between
the taxpayer and the income tax department.
The Taxpayers Charter defines a taxpayer’s rights
and obligations under the law.
It also specifies the department’s commitment to
providing services to the taxpayers.
The Charter is a step in bringing transparency
in the tax services from the department and tax
compliance by a taxpayer.
Indian Economy
16.31.2 Taxpayers’ rights and commitments
from the department
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To assist taxpayers in a courteous, fair and
reasonable manner.
Treat taxpayers as honest unless the department
has a reason to believe otherwise.
To provide for a fair and impartial appeal procedure
and review mechanism.
To provide accurate and complete information for
tax compliance purposes.
To complete and decide income tax proceedings in
a time-bound manner.
To ensure the collection of the correct amount of
tax dues.
To respect a taxpayer’s privacy and to conduct an
enquiry or examination after following the due
process under the tax law. There will be no undue
enquiry or enforcement actions.
To maintain the confidentiality of information
provided by the taxpayers. There will be no
disclosure unless required under any other law
in force.
To ensure accountability for the actions of the
income tax officers.
To give a taxpayer the freedom to choose their
authorised representatives as per the income tax
law.
To put in place a procedure to raise complaints
and grievance redressal mechanisms.
To adopt a fair and impartial approach to the
resolution of tax disputes.
To review and publicly report the standards on
delivery of services.
To consider the cost of compliance, administration
and collection of taxes. The department seeks to
reduce the cost of tax compliance for a taxpayer.

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16.32 CASE OF AN INDEPENDENT
OMBUDSMAN IN INDIA – TO
ENSURE ENFORCEMENT OF
TAXPAYERS’ RIGHTS
16.32.1 Independent Ombudsman In India


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To make a complete and honest disclosure of facts
and information to the department. The taxpayer
should ensure compliance with all the tax filing
and reporting obligations.
To seek an understanding of the tax obligations
applicable to a taxpayer. For this purpose, a
taxpayer can seek clarifications and assistance
from the department.
To maintain accounting records and documents as
prescribed under the income tax law.
To be informed about the representations before
the department and seek details from their
authorised representatives.
Indian Taxation System
The Economic Survey 2020-21 proposes
the establishment of an independent tax
ombudsman to ensure the protection of taxpayers’
rights.
Previously, in India, a tax ombudsman existed
for both direct and indirect taxes, but they were
disbanded in February 2019 due to ineffectiveness.
Because their rulings were purely advisory, they
were abolished in 2019.
According to the study, worldwide experience
reveals that an ombudsman system is required to
ensure the preservation of taxpayer rights.
According to the report, one plausible explanation
for the abolition of ombudsman organisations in
India was a lack of independence from the revenue
department.
16.32.2 India’s experience with Tax
Ombudsman

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16.31.3 Taxpayers’ obligations

Respond to income tax notices and information
requests in a time-bound manner.
To pay their income tax dues and comply with
their filing requirements within the due dates.


In India, the Income Tax Ombudsman was
established in 2003, while the Indirect Tax
Ombudsman was established in 2011.
The ombudsman was chosen at the regional
offices by the Central Government from amongst
the serving personnel, to look into grievances/
complaints regarding the operation of the tax
authority.
Because the Ombudsman’s operation was
governed by guidelines (Income Tax Ombudsman
Guidelines 2010 and Indirect Tax Ombudsman
Guidelines 2011), and there was no act of law
granting it different functions, the Ombudsman’s
institution was ineffective, and its decisions were
only advisory.
The Ombudsman could address complaints
by conciliation and mediation between the
complainant and the tax department, or by passing
an award with minimal compensation for damage
sustained by the complainant not exceeding Rs
5,000.
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

As a result, the Ombudsman’s institutions for
direct and indirect taxes were eliminated in
February 2019.
The Taxpayers’ Charter was proposed in last year’s
budget and will go into effect in August 2020.
Individual taxpayers’ rights and duties are outlined
in the Taxpayers’ Charter.
16.32.3 Global Experience with
Independent Tax Ombudsman
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According to worldwide experience, nations having
an independent tax Ombudsman perform better
in tax administration due to increased confidence
between taxpayers and tax officials.
And have a higher average Tax to GDP ratio and
require less time to submit taxes (OECD 2017).
Tax-related complaints are investigated by
dedicated bodies such as the Ombudsman in
Australia, Canada, the United Kingdom, Brazil, and
South Africa, as well as tax mediators in Belgium
and France.
These bodies
administration.
are
distinct
from
the
tax
In the United States, for example, the IRS maintains
an independent entity called the Taxpayer Advocate
Service (TAS) that acts as a custodian of taxpayer
rights.
It safeguards taxpayer rights and fosters taxpayer
trust in the IRS’s honesty and accountability.
Similarly, the Office of the Taxpayers’ Ombudsman
(OTO), formed in Canada in 2007, is tasked with
reviewing and resolving complaints about CRA
services supplied to taxpayers.
Thus, via independent and impartial investigations
of service-related complaints and systemic
concerns, we are seeking to improve CRA
accountability in its service to and treatment of
taxpayers.
16.33 GLOBAL MINIMUM TAX (GMT)
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The Group of Seven (G-7) nations struck a
significant agreement on June 5, 2021, to create
a global minimum corporate tax (GMT) rate
of at least 15% on multinational corporations,
regardless of where they are domiciled or where
their sales are made.
Later, in July 2021, the G-20 endorsed this concept
as well.

This G-7 agreement contributes to a much larger
current effort by the Organization for Economic
Cooperation and Development (OECD) and major

economies.
For the past several years, major global economies
have made concerted efforts to deter multinational
corporations from moving earnings (and hence tax
income) to low-tax jurisdictions.
16.33.1 Objective

GMT is designed to address the low effective tax
rates paid by some of the world’s largest firms,
including Big Tech titans like Apple, Alphabet, and

Facebook.
These firms generally use complicated webs of
subsidiaries to funnel revenues out of major
markets and into low-tax jurisdictions or Tax
Havens like Ireland, the British Virgin Islands, the

Bahamas, or Panama.
GMT intended to limit the ability of Multinational
Enterprises (MNEs) to engage in profit shifting by
requiring them to pay at least some of their taxes
where they conduct business.
16.33.2 Working
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
A GMT would apply a uniform tax rate on a
specified corporate income base over the world.
Each country would be entitled to the tax money
and would be able to implement the rate and rules

into its tax system.
Governments may still establish corporate tax
rates, but if corporations paid lower rates in one
nation, their home governments could “top up”
their taxes to the minimal rate, thereby negating
the benefit of transferring earnings.
Indian Economy
16.33.3 Timeline of GMT
Timeline for GMT
Approves the
report on
Pillar Two
Blunpont
OECD releases
public
consultation
document
Oct 2020
July 2021
More than 130
countries gree
to support an
OECD tax reform
framework to
impose a GMT
on large
multinational
corporations
overseas profits
July 11, gives
broad support
to G7 Accord
July 2021
July 2021
Oct 2021
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2022
All-inclusive
meeting: the
technincal details
and negotiations
of the rules are
likely to be
agreed here
16.33.4 Stance of India
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Expected
consensus and
finalization,
followed by
internationsl
agreement and
enactment by
each signatory
country
Because the local rates applicable to firms in India are
higher than the aforementioned level, India is expected
to gain from the worldwide minimum corporate tax
rate of 15%.
The first idea will have no direct impact on India.
India is projected to continue attracting investment; it
is not one of the low-tax nations targeted by this idea.
However, the second idea of extending market
jurisdiction taxation rights might result in India
gaining the authority to tax tech companies such as
Facebook, Google, and others.
As long as it provides “significant and sustained
revenues to market jurisdiction,” India will most likely
strive toward a consensus.
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A GMT might lessen, but not eliminate, tax-based
competitiveness between countries.
If a common minimum tax rate provides multinational
corporations with little or no tax advantage for shifting
investments and profits to lower-tax jurisdictions,
v
Indian Taxation System
2023
Implementation
Way Forward
Individual
countries
modify their
local lawas
and treaties
Bloomberg Tax
economic competition among countries will be
influenced more by the comparative quality and
strengths of their infrastructure and workforce skills.
The goal of a GMT is to deter multinational corporations
from profit shifting and base erosion for tax reasons.
16.33.6 Balance of Tax Revenue and Foreign
Direct Investment
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16.33.5 Tax Competition
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Guidelines for
determining
income base and
other
adjustments
presents complex
legal, technical,
and political
challenges
The income inclusion rule, like other policies that
tax foreign earnings, would raise the tax expenses
of cross-border investment and influence corporate
decisions about where to invest across the world,
including in local operations.
As a result, there may be less FDI and slower global
economic growth.
#OpinionMatters
v
Do you think the taxation regime in India should
be overhauled so that the focus of taxes should be
on those who can bear the cost rather than taxing
minimal goods of everyday usage that harm everyone?
v
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17
Inflation
employed to calculate inflation by tracking the average
price change over time.
17.1 CONCEPT OF INFLATION
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The increase in costs of the majority of daily or
commonly used products and services, such as food,
clothing, housing, leisure, transportation, consumer
staples, etc., is referred to as inflation. The loss of the
purchasing power of a unit of a nation’s currency
is referred to as inflation (percentage is used to
express this).
Inflation can also be defined as the percentage change
in the values of the Wholesale Price Index (WPI) from
one year to the next.
Inflation occurs when there is an imbalance between
the supply and demand for money, changes in
production and distribution costs, or an increase
in product taxes. A basket of goods and services is
17.2 CONCEPT OF DEFLATION
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17.3COMPARISON: INFLATION VS DEFLATION
Parameters
Inflation
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Definition
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Results
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Effect on National
Income
Benefits
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In Totality
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When the value of money falls in the international
market, it is referred to as inflation.
Disinflation
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Deflation
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General increase in the price levels;
There is an unequal distribution of income;
It tends to decrease the purchasing power of
currency.
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Producers
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No impact on national income.
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Healthy and mild inflation represents good
economic growth.
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17.4 CONCEPTS RELATED TO INFLATION
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Deflation is defined as a drop in prices. It may appear
to be a good thing, but no economy wants deflation.
Deflation is typically associated with economic
slowdowns, lower productivity, and job losses.
Inflation reduces the purchasing power of money,
while deflation increases it.
This encourages people to save money now in order
to buy things later when they are cheaper. And this
economic behaviour leads to even slower growth.
During deflation, the value of money rises and
goods become less expensive. However, due to the
economic slowdown, your earnings may be reduced.
Deflation occurs when the value
of money rises in the international
market.
General decrease in the price level;
Increase in the unemployment
level;
It tends to increase the purchasing
power of currency.
National income
deflation.
Consumers
decreases
in
It is not an adequate indicator of
the economy.
Disinflation is a condition when the rate of inflation declines over time. Simply said, inflation is
slowing down (Disinflation is different from deflation as the term deflation denotes a decrease in
the cost of goods and services).
Example: India's retail inflation declined marginally to 6.44 per cent year-on-year in February
2023 as against 6.52 per cent in January, data released by the Ministry of Statistics and Programme
Implementation. It will be called disinflation.
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Stagflation
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Skewflation
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Reflation
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Giffen Goods
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Phillips
Curve
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Engel’s Law
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Inflation Tax
Inflationary
Gap
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Deflationary
Gap
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Deflationary
Spiral
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It is defined as an economic circumstance in which the growth rate slows, the unemployment rate
stays high and stable, and prices or inflation also remain high. A situation known as "stagflation"
is one in which prices are rising at the same time as the economy's growth is stagnant.
It is considered bad for the economy. Iain Macleod, a British Conservative Party lawmaker, first
used the phrase "stagflation" in November 1965.
Skewflation is a form of inflation in which the cost of a single good or group of goods increases
while the level of prices overall holds steady.
In the wake of the financial crisis that lasted from 2009 to 2011, a brand-new phrase i.e. skewflation
in economics was developed.
A fiscal or monetary policy known as reflation is intended to increase output, encourage spending,
and lessen the impacts of deflation, which typically happens after an extended period of economic
instability or a recession.
The first stage of an economy's recovery following a period of contraction may also be referred
to by this phrase.
Tax reductions, infrastructure investment, an expansion of the money supply, and a reduction in
interest rates are examples of policies.
Giffen products are inexpensive items, and when their prices rise, so does consumer demand. There
are just a few alternatives for these products, which are essential to meeting our requirement for
sustenance.
Giffen products include things like wheat, rice, and bread (Veblen goods are high-quality, premium
products, and as their price rises, so does their demand).
In other words, Giffen and Veblen commodities both contradict the conventional law of demand
and produce a unique demand curve. The curve for these products slopes upward. Demand rises
together with an increase in product price.
Giffen goods focus on low-cost products, whereas Veblen goods focus on luxury, exclusive, and
premium products.
The Phillips curve is a graphical representation of the inverse relationship (in an inverse connection,
one parameter's value tends to fall as the value of the other parameter rises. It is frequently
regarded as a negative relationship) between the unemployment rate and inflation.
According to the curve, unemployment decreases as inflation rises and vice versa. As a result, high
levels of employment are only possible with high inflation rates.
According