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There are 196 countries in the world .

25 of them are very rich ,defined as having an average wealth
per person of over $100000 a year
There are 20 countrys whose per capita is less than $1000 a year
.
Eleven of which have average income of $6oo or less .
There are differences with regard to natural resources , 2
Factors in economic development:
Rising gdp , increase in total output over a long –period
Continuous rise in Real per capita – oncome
Quantitative change : labour productivity improvement , sectoral
change in agri.
Developed money market & capital market
The concept of economic growth:the concept of economic
growth has been defined by different economists the similar
case .
Eco. Development = economic growth + eco . welfare

[ reduction in poverty , reduction of U. E. ]. According to Prof .

A.K.SEN.
DEVELOPMENT REQUIRES the removal of major source ,
poverty as well as tyranny , poor eco, opportunities as well as
systematic social deprivation , neglect of public facilities as well
as intolerance of oppressive states

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DE- INDUSTRIALIZATION OF India during British period

The economic de –industrialization of India refers a period of reduction in
industrial based activities the centuries within the Indian – economy from 1757
to 1947 . The said process started when the Indian –economy was colonised
under the British empire .
By the standards of the 17th and 18th centuries , before the advent of the
Europeans in our country , India was the Industrial workshop of the world .
‘ Economic data collected by the OECD shows that growth during the Mughal
Empire’s reign was more than twice faster than it was around five –hundred
years prior to the Mughal era .—Maddison ,angus .” The world –economic ,
Historical statistics ,Paris France . published by Development centre of the
Organisation for Economic cooperation and development .

Under the British rule , from 1880 to 1920, the Indian economy’s GDP
Growth rate and population growth rate was only one percent per year .
Prior to de-industrialisation , India was one of the largest economies
In the world . The Indian –economy specialised in Industrialisation and
manufacturing .
Further ,Indias traditional village economy was characterised by the
“ blending of agriculture and handicrafts “. But there took place destruction
Of a nations industrial capacity[ due to competition with British industry )
There was relative shift in the proportion of national income .
The affected industries were : jute, handloom , weaving of Bengal, woollen
Manufactures of Kashmir , silk manufacture of Bengal , hand paper industry ,
glass –industry, lac , bangles etc.

CAUSES OF DE- INUSTRIALISATION

[ 1] dis – appearance of the court culture of late Moghul days and old
aristocracy .

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[ 2] The establishment of an alien rule with the influx of many foreign influences .
[ 3 ] The competition from machine –made goods .
[ 4 ] tariff –policy
[ 5 ] internal –causes
Note: detailed explanation of the above is the main part of this discussion . This
will take place in the class –room .

As per study of the great experts

DADABHAI NAOROJI 1869 N.I. 370 . PER CAPITA INCOME Rs. 20
William Digby 1899 n.i. 390 per capita income Rs. 17
V.K.R.V RAO 1925 NATIONAL INCOME 1482 Rs 60
--------------- -------------- ------------------ ------------- -------------
COLONIALISM & INDIAS DEVELOPMENT
The British rule lasted two centuries . The sole purpose of the British
economic policy was to reduce India a feeder - economy for expansion of
Britains own modern industrial base .
1 disruption of the traditional economy
2 ruin of artisans and craftsmen
3 . impoverishment of the peasantry
4 .ruin of old zamindars and rise of New Landlordism
5 .stagnation and deterioration of agriculture
6 . development of modern industries
7 poverty and famine
Explanation of the above :
1 . there was a rapid trans formation of Indias economy into a colonial –
economy whose nature and structure were determined by the needs of the
British –economy .
In this respect the British conquest of India differed from all previous foreign
conquests .

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The previous conquerors had overthrown Indian political powers , but had made
no basic changes in the country’s economic structure.They had gradually
become a part of Indian life, political as well as economic . The peasant ,the
artisans and the trader had continued to lead the same type of existence as
before .
The British totally disrupted the traditional structure of the Indian economy .
They always remained foreigners in the land , exploiting India’s wealth as
tribute . the results of this sub-ordination of the Indian – economy to the
interests of British trade and industry were many and varied .
The GDP . growth rate for over 40 years prior to Independence was only half
per-cent per year .
Food shortage was widely seen . Prior to Independence about 40 lacs
Bangaleese died due to lack of food . More than 90 percent of Indian
population was ,what we call below the poverty- line .

Measuring country’s economic Performance

1. Introduction

2. Basic Concept

3. Method of measurement of GDP

4. Difficulties/ Precautions value

5. Items not included/ included

6. Purchasing – power Parity

7. G.N.P. at constant prices & at current prices

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The GDP Deflator

8. Exercises
9 Case Study

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Measuring Economic performance of a country

Introduction:
1. The main objective of all economic policies is to see an improvement in the
average real-standard of living of the people.

2. The term ‘real’ means that we have taken into account the effects of rising
prices so that we get an accurate picture of how much we can afford to buy and
consume.

The main objective of the govt. policy is to improve outcomes in the

following indicators:

1. Jobs- how high is employment? Is the economic creating enough new jobs
for people entering the labour-market each year? Area these sufficient
opportunities for people looking for work?

2. Prices: are price under-control?

3. Trade : is the economic performing well in trading goods and services with
other countries.

4. Growth: how successful ahs the country been in achieving growth and in
laying foundation for future expansion and development.

5. Development: the expansion of peoples freedom to live long, healthy and

creative lives.

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6. Efficiency: is the country improving productivity so that more goods and

services can be supplied such as education, law and order?

7. The environment ; whether eco-growth is sustainable in terms of

environmental impact.

8. Inequality of income and wealth – program towards achieving an

acceptable distribution of income and wealth.

The G.D.P. measures the values of economic-activity within a country.

Measuring the level and rate of growth of G.D.P./N.I. is necessary for

keeping track of
• Change to living standards
• The rate of economic growth
• Change in the distribution of income between groups within the population.

All of us want to enjoy more facilities each year. This means more than of the
previous year. The level of contentment improves if the people obtain more
quantity of goods to use and better quality of goods. Say for example; better
housing, cheap and better quality of food items, better quality of food items,
better quality of clothing etc. This national requirement can be satisfied, if there
takes place increase in the production of above mentioned items, in each
successive year. But how to collect information about this we can not add up
cars + veg. oil + cloth etc. These are expressed different measures of
measurement such as kilos, litres and metres etc. We can add-up on values
expressed in terms of one common value. This common measure of values is
money. The value of different products is calculated by multiplying the quantity
of each product by its market-price.

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Physical quality X Market Price = Money-value of the

product.
1) 100 K.g’s of wheat X Rs. 10 per Kg = Rs. 1000
2) 100 metre of cloth Rs. 8 per kg = Rs. 800
Total M.V. = 1800=

On this pattern money-value of the national output is calculated by the staff

of the Central Statistical organization (C.S.O.). The aggregate-money value; this
arrived of the entire production of the country is known as Gross Domestic
Product. In the above example, if we assure that only two goods have been
produced in the country than the total money value of output will be equip =
G.D.P. = 1800.

This, Gross Domestic Product is the total money value of national output
produced in a given year. To be more precise G.D.P. measures the total value of
final goods and services produced within a given country’s borders.

It is the most popular method of measuring an economy’s output and is

therefore considered a measure of the size of an economy. When we say one
economy is larger than another or that an economy is growing or shrinking
usually we refer to GDP figures.

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G.D.P is calculated by using the following 3 – methods

Money value of = Output sold in the = When the income is

output market becomes spent, it becomes
income expenditure

Output-method Income method Expenditure method

= =

Explanation of output-method:

The total value of final goods and services produced in a country during a
year is calculated at market prices (G.D.P. at MP)

This includes the following:

i) Net-value added at F.C. [ FACTOR- COST ]
IN primary - sector
ii) in secondary sector
{ iii) in Tertiary sector
iv) Depreciation
v) Net-indirect-taxes

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Income Method:

The total values of the following items in a given year, gives us the value
of G.D.P.
1) Compensation of workers = [ Wages + Salaries]
2) Operating Surplus = [Profit + Rent + Interest]
3) Mixed-income of self employed
4) Depreciation
5) Net-Indirect Taxes

3) Expenditure-method:

The sum total of the following information gives us the value of G.D.P,. in a
particular Year.

1. Personal final consumption-expenditure.

2. Government Final-expenditure on goods and services
3. Gross Fixed Capital Formation
4. Change in Stocks
5. Net-exports

The Value-added method:

The difference between the value of material output and input at each
stage of production is known as the value added G.D.P. is calculated by adding
up the above net values.

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Thus, calculation is made at the stage of addition of value. This method

measures the contribution of each producing unit in the Domestic economy
avoiding any possibility of double counting.

Calculation of growth-rate:
The growth rate of an economy needs to be calculated in order to draw
important conclusions about the economy. The following formula is used to
calculate growth-rate of an economy.

G.D.P. of current year 16790 Cr.

Exercise = G.D.P. of Previous year 13100 Cr.

G.D.P. of the Current Year - - -G.D.P. of Previous Year

Growth rate= ---------------------------------------------------------------------------- X 100
G.D.P. of the previous year

16790 – 13100
= ---------------------- X 100 = 28.16
13100

Concepts of G.D.P.:

1) Growth – Domestic Product at Market-Prices [G.D.P. M.P.]

-------------------------------------------------------------
G.D.P. M.P. = Total Production x Market = Money value
Value of all goods
and services

2) Net Domestic Product M.P. [ ND.P.mp ]

N.D.P. M.P = G.D.P. – depreciatio
3] . N.D.PM.P – N.I.T. = N.D.P. F.C.
N.D.P.F.C. is also known as dom- estic income .

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3) G.D.P. at F.C. = G.D.P. mp - N.I.T.

N.I.T = refers to the difference between indirect-taxes and subsidies

Indirect-tax raises the price of the market in market and subsidies have the
effect of lowering – down the market-price of a product. The money under
reference goes to the government.

4) G. National Product M.P. – N.I.T.

G.D.P. m p. + N.F.I.F.A. = G.N.P. m p

N.F.I.F.A. = Net Factor Income is measured as factor incomes flowing in

form abroad minus factor-incomes flowing out from the country.

5) Net National Product (N.N.P.)= GNP. - DEPRECIATION

This includes contribution of citizens of the country, even of those who are
working abroad and excludes contribution of foreigners working in our country.

6) By deducting Net-Indirect Taxes from NNP at market-price, we obtain NNP

at factor-cost.

N.N.P. F.C. is also known as National Income.

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National-Income
7) Per Capital Income = --------------------------------
Population of the country

8) Net-Value added at F.C.= Gross Output

= Intermediate consumption
= depreciation
= Net-Indirect Taxes

Impact of prices on G.D.P. / G.N.P.[ GDP AT CURRENT PRICES – AND AT

CONSTANT- PRICES]

The value of G.D.P. is obtained by multiplying total output with market-

prices. So the ultimate final-figure is influenced by these two respective values.
As already explained, more production means more G.D.P. The impact of prices
on G.D.P. is discussed below:

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

Years Production Price G.D.P. 2010 as a base year price
In Rs. (Current Price) (Col 2 x Col 3) of 2010 Col 2xCol 5)
(in Rs.)
In Units
2010 1000 2 2000 2 2000
2011 2000 3 6000 2 4000
2012 3000 4 12000 2 6000
2013 4000 5 20000 2 8000
2014 5000 6 30000 2 10000

On comparison of column 4 with column 6, a clear difference arises. A big

difference is seen between G.D.P. at the year 2010 price and G.D.P. at current –
prices.

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In Col.6, production figures have been multiplied by the Price-level of the

2010. This technique is known as calculation at constant prices. Production of
successive years is multiplied by Price of a base-year each time. In this case
base year is 2010. This increase in G.D.P. is known as real increase in G.D.P.

On the other Hand, it is the production of the current year multiplied by the
price of the same year. This method of calculation gives us G.D.P. at current-
prices. The increase in G.D.P., calculated through this method is known as
Nominal increase in G.D.P.

Column 4 gives us higher G.D.P. figure at current prices. This difference is

only due to difference in figures of prices of these two respective methods i.e. at
constant price and at current price. The per unit price continuously keeps on
increasing from 2010, onwards. So, the G.D.P. for all these years is much higher
than G.D.P. of Col-6, which is not influenced by the increase in G.D.P. The
increase in G.D.P. is real increase. This takes place only due to increase in
production of the country. This will result in improving the quality of life of the
people of the country.

The above description gives a difference between nominal increase in

G.D.P. and real-increase in G.D.P. The nominal increase in G.D.P. is like milk
adultered with water. The quantity of milk increases due to mixing of water in
milk. The likewise increase in prices also cause distortions in the G.D.P.

First, a base year is chosen. The price level for that year is taken as 100.
See the following formula.

Base year Price- Index = (100

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Illustration
Suppose National Income of a country Rs. 2000

g Price Index-number of this year (PIN) = Rs. 250

100
So 2000 X ------- = 8000
250

This is known as National income at constant prices. Nominal G.D.P. can

increase without increase in physical output. So G.D.P becomes deceptive on
the other hand real G.D.P. can rise only under one case i.e. When there is rise in
physical output during a year. Increase in real G.D.P. is thus a better tool to
make a year to year study of changes in the physical output of goods and
services. A continued rise in real G.D.P. over a period of time indicates
economic growth.

The Concept of Deflator:

The Nominal G.D.P. is converted into Real. G.D.P. by using the G.D.P.
deflator. calculation of G.D.P. deflator

PIN of the select year

GDP deflator = ------------------------------
100

(A) PIN means price-index number select years means the year whose ,
IF Real – G.D.P. is to be estimated.

(B) The G.D.P. deflator is the ratio of nominal G.D.P. to real G.D.P. in country.

Next step is to convert nominal G.D.P. into real G.D.P.

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ReaL GDP = Nominal G.D.P.

----------------------
G.D.P. DEFLATOR

Illustration: Obtain real G.D.P .from the following information.

The nominal G.D.P. of X-country is Rs. 17,40,207 crores in the year 2000-
01. Estimate the real G.D.P. for the same year.

Price-index number for year 2005 is 145

Price-index number of base year 2001 is 100

PIN in 2000-01 = 145 = 1.45

So G.D.P. deflator is = --------------------- --------
100 100

Real G.D.P. for 2000-01 = Rs. 1740207

145
` = Rs. 1200143 crores

Example: Calculation of Real G.N.P. and G.N.P. Deflator

Problem:

Year 2010-11 2011-12

Nominal G.N.P (Rs. Crore) 2248614 2531168

Wholesale PIN 166.8 175.9

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Solution:

Calculation = P.I.N. = 166.8 = 1.668

of Deflator 100 100

= 1.668 for the year 2010-11

REAL INCOME CALCULATION =

= 2248614
------------ = 1348089
1.668

Calculations for 2011-12 175.9

--------- = 1.759
100

= 2531169 = 2531169
--------------- ------------- = 1438981
175.9 1.759

Real GNP = Nominal G.N.P

-----------------------
Deflator

GDP Deflator shows how much change in the base Years GDP relies
upon changes in the price-level. The real values are adjusted for inflation.

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Values for real GDP are adjusted for differences in price-levels, while
figures for nominal GDP are not. The DGP deflator converts output measured at
current prices into constant G.D.P.

Exercise = calculate real GDP IN EACH year ,using 1011 as the base –year.

PRODUCT A PRODUCT B
YEAR Price quantity Price quantity
--------------------------------------------------------------------------------------
2011 $ 10 400 $ 2.00 1000
2012 $ 11 500 $ 2 .50 1100
2113 $12 600 $ 3.00 1200
Answer:
2011 : $ 10 x 400 + $ 2 x 1000 = $ 6000
2112 : $ 10 x 500 + $ 2.50 x 1100 = $ 7,200:
2013 $ 10 x 600 + $ 2 X 1200 = $ 8400
----------------------------------------------------------------------------------------------
RESULT
YEAR NOMINAL GDP REAL GDP
2011 $ 6000 $ 6000
2012 $ 8250 $ 7200
2013 $ 10800 $ 8400
N0TE : here , GDP has been corrected for Inflation

National-Income:

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National-Income is computed by subtracting indirect taxes, the net income

of foreigners, and depreciation from GDP. It represents the income earned by a
country’s citizens.

National-income represents income available for personal use. It is

calculated by making various adjustments to national-income.

Disposable personal-income is income available to people after taxes.

Special Cases:

1. Transfer-payments (transfer-income) are excluded from the calculation of

National-Income. Such as old-age pensions, unemployment allowance subsidy .

2. Imputed rent of owner-occupied houses and self consumption are included

in the calculation.

3. Services of housewives, income from sale of second hand goods, income

from sale of shares and debenture and windfall-gains are not included. Likewise
gift tax and wealth tax are also not included.

4. Double counting is to be avoided

5. Capital-gains are not included in G.D.P. calculation.

6. G.D.P. does not include value of intermediate goods.

7. G.D.P. includes only current-years production. Second hand goods are not
included in the calculation.

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8. If net factor income from abroad is zero, than the National-income will be
equal to Domestic-Income.

9. NDP will be equal to NNP if not factor income from abroad is zero.

Public Purchasing Power Parity:

G.D.P. in terms of P.P.P.

P.P.P. method adjusts for the different relative prices among countries
before making comparisons in a common currency.

PPPs between currencies are calculated using the prices collected in the
different countries for a basket of comparable and representative goods
services. The prices, thus collected, are used to derive price ratios for individual
goods and services.

The price ratios are then aggregated and averaged to obtain PPPs for
various levels of aggregation up to the level of G.D.P.

PPP is a technique through which a condition can be created between

countries where an amount of money has the same purchasing – power of same
basket of goods in different countries.

The prices of the goods between the countries would only reflect the
exchange rates .The PPP of each country’s currency in terms of the U.S. dollars
The National-income date of different countries is converted into a foreign
currency. For example, rupee to dollar rate World Bank publishes this data.

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It is believed that identical goods must have only same price in different
markets when the prices are expressed in the same currency. This feature is
known as one price.

Example, suppose a certain number of goods in selected goods known as

identical-basket of goods are sold in country A, at a price of 20,000 and at 200 in
country Y.

PPP based exchange rate of country A to country B would be 1 = 100

respectively.

Exercises:
Q.1 The national-income for the base year 2010 is Rs. 20000 crores. The
price index number set is 250. Calculated Real National income for the
year 20000.

Q.2 What is the meaning of GNP Deflator?

Q.3 What is the difference between the following?

(a) NNP and NDP (b) GNP and GDP
(c) Nominal GNP and Real GNP (d) GDP M.P and GDP F.C

Q.4 Calculate the real GDP for the year 2012. The value for base
year is (2010) is 100. While 115 is the price deflator for 2012.
The G.D.P. is 10 trillion rupees for 2012.

Q.5 Calculate real G.D.P. for 2011 and 2012 take the
(1) Year 2010 as the base year

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(2) Calculate real growth rate during 2012.

Year 2010 2011 2012

Product Qty. Price Rs. Qty. Prices Rs. Qty. Price Rs.
(i) Shoes 90 50.00 100 60 100 65
(ii) Chairs 75 2.00 100 2 120 2.25
(iii) Shirts 50 30.00 50 25 65 25.00
(iv) Cotton 10,000 0.80 8,000 0.66 12,000 0.70

Q.6 Calculate Gross National Product

The G.D.P. of India is 400,000 (hypothetical)
(i) Neel Sagar is Indian Citizen working in Dubai and earns 30,000.
(ii) Sheikh a Abu Dhabi citizen works in Bangalore and earns 40,000
(iii) Kapil Dev, an Indian Citizen, owns a flat in London, which he rents to
a British family for 20,000.
(iv) Sheena, an Indian Citizen, owns a commercial property which she
rents to U.A.E. firm for 70,000.

Q.7 On the basis of the following information calculate Gross Domestic

Product (in dollars)
(a) Personal final consumption expenditure 7.5
(b) Gross private domestic investment 2.2
(c) Government purchases 2.5
(d) Net exports of goods and services -1.0
(e) Depreciation of capital 0.5

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Q.8 Calculate Gross National Product at factor-cost (in dollars)

(1) Wages and salaries 26142
(2) Rent + Interest + Profit 12031
(3) Depreciation 4486
(4) Indirect Taxes 9703
(5) Subsidies 1350

Q.9 Some of the following items are not excluded from the calculation of
G.D.P.
(i) Expenditure on Bonds.
(ii) Expenditure on Subsidies
(iii) Imputed value of occupied houses
(iv) Grants to N.G.O’s

Q.10 Explain the following:

(a) GDP at current prices and at constant prices
(b) Net factor income from abroad.
(c) Imputed-value of self-occupied property.
(d) Mixed-income

Additional – Data on National Income

(in Rupees Lakh crores

Size of the Economy at current prices
Year At 11-12 series at Constant prices
current prices series in
crores

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2011-12 8659505 8659505

2012-13 9827250 9104662
2013-14 11093638 9679027
2014-15 12320529 10402988

2016 – 17 15185986 12153754

2017 - 18 16910192 13034121
2018-19 18816538 13932287

The Modi Govt. unveiled a new statistical method to calculate the national
income with a broader framework that turned up a pleasant surprise GDP in the
year 2013-14 grew 6.9 percent instead of the earlier 4.7 percent.

Base-year Change:

Base-year allows for the analysis of historical trends. The new measure is
calculated on a base-year of 2011-12 from 200

The new series , which has been in the works for a couple of years,
includes data on unorganized manufacturing and services and income from
public private partnership projects among other

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RATE OF GROWTH OF
G.N.I. at current prices
13 - 14 12.9
14- 15 11 . 1
15- 16 1o.5
16 ----17 11.6
17 -----18 11 .4
18-------19 11. 3
.
Rate of growth of GNI
AT CONSTANT PRICES
2012 -13 5.1
6.3
7.5
8.0
8.2
7.2
6.9

GDP in the part-year 2013-14 grew 6.9 per-cent instead of the earlier 4.7 percent.

The economic growth rate for 2012-13 has also been revised upwards to
5.1 percent from 4.5 percent estimated earlier.

The new data relies on value-added at various-stages of the production

chain. The new-series covers everything from farm-level livestock to mega
infrastructure project and smart-phones to capture activity across the country.

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Shares of Sectors
In GDP growth
Years Agriculture Industry Services
2011-12 18.40 23.7 57.90
2012-13 18.0 23.3 58.70
2013-14 18.0 22.4 59.60

The Family Spending Pattern

(in percentages)
1 Food 30.5
2. Housing, Water elect etc. 14.7
3. Transport 14.4
4. Clothing 6.7
5. Furnishing Housing equipment 3.9
6. Health 3.8
7 Education 2.8
8 Alcohol tobacco 2.6
9 Restaurants meals, hotels 2.3
10 Communication 1.9
11 Miscellaneous 16.4

The new-series includes data on unorganized manufacturing and services

and income from public – private partnership projects, among others.

Real G.D.P. at 2004-05 Growth rates at 2011-12

prices prices
2011-12 6.7 percent 6.7 percent
2012-13 4.5 percent 5.15 percent
2013-14 4.7 percent 5.9 percent

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Global Scenario
G.D.P. in billion dollars, year 2014
U.S.A. 17416
China 10355
Japan 4770
Germany 3820
France 2902
U.K. 2847
Brazil 2244
Italy 2129
Russia 2057
India 1816

Stages of growth:

Fiscal Year Average growth rate of India

1980-2013 5.9
1981-013 6.3
200-2004 (NDA rule) 5.9
2006-2013 (UPA rule) 7.9

Over the 33 years period from fiscal FY 81 to FY 13, the average

GDP growth rate was 6.3 p.c.

The rate was better than the 5.9 p.c. GDP growth rate recorded
between FY 99 and FY 04. (The period during which the BJP led
NDA was in power.

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India’s GDP growth was 8.4 p.c. between FY 05 and FY 09 during

the tenure of UPA-1 and 7.1 p.c. between FY 10 and FY 13,
during the term of UPA-II

During both these periods, India G.D.P. growth was higher

than the 33 Year trend growth of 6.3 p.c. and also 5.9 p.c. seen
during the NDA rule.

GDP growth rate during the nine full years, FY 05 to FY 13,

the number is an impressive 7.9 p.c.

Case Study

Top – 10 countries ranked

By Wealth Growth
During 2000-2015

An average citizen does not have a proper perspective about

India’s economic parameters. On most of the occasions
depressed views are held by the people. You may call it inferiority
–

Some of the major Western Countries have seen a marginal

increase in their wealth over the last decade and a half. While

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Japan’s Wealth increased by a modest 39 percent. In case of

U.S.A. and U.K. it was 41 percent and 58 percent respectively.

In case of India, increase in India’s

Individual wealth is private wealth held by all the individuals

in each country. In India, wealth per capita increased from $ 900
in 2000 to $ 2,800 in 2015

India is now the 10th richest country in the world, ranked

according to total individual wealth.

Total individual wealth refers to the private wealth held by all

the individuals in each country.

The downside, however in India and Indonesia make it to the

top 20 richest list due to their large population on a per capita
basis the two countries are quite poor.

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When ranked according to per-capita wealth. India ranks

last in the top 20 countries. According to the New World Wealth’s
report on the wealthiest 20 countries in the world, when looking
at per capita wealth.

Switzerland topped the charts with $ 285,190 per capita

wealth followed by Australia ($ 201400), US 150600 and UK ($
147600)

India has been a whopping 211 percent increase in its

wealth over the last 15 years. Only four other countries-Indonesia,
China, Russia and Australia, have done better than India.

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GDP NOMINAL [ billions of U.S. dollars ] source : I.M.F.

April 2017
Rank COUNTRY GDP
1 UNITED STATES -- 19,417,144
2 CHINA ----------------- 11,795, 297
3. JAPAN ----------------- 4841221
4. GERMANY -------------- 3423287
5. U. K. ----------------- 2,496,75
6. INDIA ----------------- 2454458
7. FRANCE ----------------- 2420440
8. BRAZIL -------------- 2140940
9. ITALY ---------------------2140940

POVERTY IN INDIA
Poverty is determined on the basis of per-day and per capita
incomes
Poverty comes in lots of variants and phases and is almost
invariably tried to the condition of world hunger as a result .
Hunger is not an issue of food availability , it is an issue of
access. Many people are not able to access because they do not
have jobs . This essentially means that unemployment , poverty

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and hunger all go hand In hand and one cannot be solved while
neglecting the other .
POVERTY – LINE
While the international poverty –line is drawn at an earning
of $1.90 per day decided in Oct. 2015, by the World-Bank .
The percentage of population living under Poverty line in
different – countries varies . From a staggering 82.5 percent in
Syria , 72 percent in Zimbabwe, 54 percent in Yemen , 15
percent in U.S. to merely 3.8 p.c. in Ukraine .
RURAL VS. URBAN POVERTY IN India .
Poverty line is the level of income to meet the minimum living
Conditions. Poverty line is the amount of money needed for a
Person to meet his basic needs. It is defined as the money value
Of the goods and services needed to provide basic welfare to
an individuals.
In Urban areas , consumption of 2100 calories per day
In Rural areas , consumption of 2400 calories per day
.
Two thirds of people in India live in poverty
More than 800 million people in India are considered poor . most
of them live in the country side and keep afloat with odd jobs .
they live in millions of corrugated ironworks

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Poverty is no longer a rural phenomenon . Rural poverty might

comprise people not getting two square meals a day .
Urban poverty is different and might involve in unsafe and
unhygienic and deteriorated standard of living .
The slums in urban areas of India reflect the Urban areas of
India reflect the urban poverty – phenomenon . Poverty means
Deprivations , vulnerability and powerlessness .
Poverty line
As per the govt .of India , poverty line for rural-areas is Rs. 816
Per month and Rs. 1000 per month for Urban –areas. It means
that people living poverty –line are not able to earn this much in a
month .
Now revised figures are Rs .972 a month in rural –areas and
day
Rs. 1407 a month in urban –areas .
The average calorie requirement for a person in rural –areas is
2400 calories per day and in urban areas it is 2100 calories per
day .
In 2010, as per planning commission , 26 p.c. of all people in
India fall below poverty line of U.S. $ 1.25 per day .
MAIN CAUSES OF POVERTY IN INDIA

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1 Historical factors
2 unequal distribution of income …….vicious circle of poverty
3 . Rapidly rising population
4 low productivity in agriculture
5 . price rise & food –prices
6 . unemployment & under- employment
7. low level of literacy & lack of opportunities
8. Social – factors
9 miscellaneous – factors ; lack of irrigation facilities

UNIT A II BUSINESS CYCLE

[ not for NDIM students ]

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1. Meaning and Implications of Business Cycle

2. Boom-features and causes

3. Recession – features and causes

4. Depression – features and causes

5. Recovery – causes and features

6. Policies to control Business-cycles

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Business – Cycle

The fluctuations in economic-activity that an economy experiences over a

period of time are referred as business-cycle. The alternating period of
expansion and contraction in the economic activity has been called business-
cycle.

The real GDP of economies goes through ups and downs. These are put
under four categories:

1. BOOM: This is an economic situation in which we find high levels of

economic-activity-expectation of rising profit and induce entrepreneurs. They
employ more people in their Industry. Demand for raw-material increases. More
production takes place. The employment increases when workers spend their
additional earning received from the entrepreneurs. The demand for consumption
goods also grows rapidly. The supply of these goods however, in the later stage
increases with a time lag and this leads to rise in prices. It happens in the later
stages.

Profit levels also increase, stock, market indices move upwards. As long
as prices are higher than cost of production, boom conditions continues.

The sentiments of business-community are positive and strong. Growth

creates new jobs. But as a result of the above scenario, cost of production
increases, prices of goods tend to rise-faster.

As long as prices are higher than cost of production boom condition

continues. But as margin shrinks, expansion process shows-down.

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(B) Recession: A recession is a significant decline in economic activity across

the economy.

In this stage economic scenario starts changing. A period of decline in

economic-activities start taking place, we find falling levels of consumer-
spending.

Negative and Positive output Gaps

Negative Output Gap Positive Output Gap
1. When actual GDP is less than 1. Actual GDP is greater than potential
potential GDP Gross Domestic Product
2. Some factor resources are under- 2. Some resources working beyond
utilized usual capacity (Shift work &
overtime)
3. Main problem is likely to be higher 3 Main problem is rising inflationary
unemployment pressures.

Causes of a Recession:
A) External-events:
(1) A recession in a trading partner e.g. The European Union or the
U.S.A.
(2) A sharp rise in global commodity prices e.g. rising oil and gas prices.
B) Tightening of Macro-policy:
1. Higher interest-rates leading to move expensive loans.
2. A rise in taxation or a cut in govt. spending.
C) Fall in asset prices or supply of credit.
1. Steep decline in the level of shares or house prices
2. A collapse in the supply of credit

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Drop in business and Consumer Confidence

1. Lower business confidence cuts investment and may lead to job losses.

2. Declining consumer confidence leads to less spending and move saving.

Profit of business community starts declining. Business confidence gets

hurt. Investors start becoming pessimistic. The investment plans start getting
postponed. Investment in the economy declines. Spare capacity in the industry
increases. Normally, two- years of recession is followed by a slow-economy.
This occurs when government tax revenues are falling and welfare benefit
spending is rising.

The fiscal deficit rises quickly. Large price discounts offered by businesses
in a bid to sell their excess-stocks.

3. Slump also known as depression:

This is regarded as a prolonged period of declining GDP. This condition is

marked by very weak consumer spending and business investment.

Workers are thrown out of jobs on a large scale. Prices start falling,
income level also starts falling, sales decline. Future looks very bleak.

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Recession and depression are very similar. The difference is of severity. It

was remarked that, if your neighbor becomes unemployed, it is recession. But, if
you also become unemployed, than it is depression.

The difference between Recession and Depression:

1. A depression is a prolonged slump, where real GDP falls by more than 10
percent from the peak of the cycle to the trough. In grace , real GDP has fallen in
seven successive years and real GDP is more than 25 percent lower than at the
peak of the cycle.

4. Recovery:
A stage again arrives due to the impact of certain factors. There is a sense
of hope, expectation become highly optimistic Gradual improvement in
economic-activities starts taking place. Investment increases. Things start to get
better consumers begin to increase spending. investment starts increases again.
It starts when price stop falling, production falls to such a low-level that Demand
becomes higher than supply. So increase in investment, results in more
production, more-income, more-demand. This upward movement begins.
Recovery occurs when real GDP picks up from the through reached at the low
point of the recession.

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Amplitude: The amplitude of the business cycle is the maximum deviation from
trend.

A Trough: A trough is a relatively large negative deviation from trend.

A lower turning point of business cycle, where a contraction turns into an

expansion

But to day business-cycles are widely known to be irregular-varying in

frequency, magnitude and duration.

Boom : A period when the rate of growth of real GDP is fast and
higher than its.

Slow down : Awaking of the rate of growth, real GDP is still rising
but increasing at a slower rate.

Recovery : A period of at least six-months when an economy

suffers a fall in output, or a broad-based contraction in
output, employment, investment and confidence.

Depression : A prolonged downturn in the economy and where a

nations GDP falls by at least 10 percent.

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Policies to Control Trade - Cycles

Various steps are undertaken to create economic stability. These

st3eps are categorized as (1) Fiscal policy (2) Monetary Policy and (3)
Foreign Trade Policy etc.

The state intervention controls the volatility of each-phase

especially economic slow down and depression. Tax policy and
government expenditure policy are used to control violent movements
in the growth rate of the economy Banking policies are also used to
achieve the objectives.

However it is not easy to achieve success in this context. We

may say that precaution is better than care.

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EXERCISES:

Q.1 What are the different phases of business-cycle? Explain the phases of

business cycle with various economic features and graphical

representation.

Q.2 What is mean by amplitude and Trough? How these help-us in

understanding the nature of business-cycles.

Q.3 Do we find signs of recessionary economy these days.

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Case Study No. 1

Economic – Slowdown

The China slowdown is hi8tting countries in the developing world the

hardest. China is now the top export-market for more than 40 developing
countries, and that number is up four-fold since 2004. Although barely 5 percent
of India’s export head to the dragon nation the slump in global trade partly
induced by China’s travails is hurting the Indian economy as well.

When India’s economy was growing at eight to nine percent during the
boom years of the last decade, its exports were surging at one annual pace of 25
percent. No economy has sustained an expansion of 8 percent without a major
contribution from export growth. Now India’s exports have fallen by 5 percent.

Outside of China, Overall growth in the emerging world fell below two
percent in 2015, implying that for the first time since the crises of the late 1980’s
and early 2000s developing countries are expanding at a pace slower than the
developed world.

The global economy’s best hope now is for China to escape a deeper
slowdown.

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SLOWDOWN B

Major growth engine to get into high gear U.S.A. is growing at a speed of 2
percent Europe and Japan are showing some sign of economic stabilization, but
their growth rates are still too meager to prevent a further slide in global growth,
which in turn would have serious implications for all markets.

With global recession defined as a growth rate of below two percent, the
world is just one shock away from drifting into recessionary territory.

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CURCULAR FLOW OF INCOME:

It is the study of a model that indicates how money, moves throughout an

economy between businesses and individuals. Investors spend their income by
consuming goods and services from businesses, paying taxes and investing in
the stock-market. Businesses use the money spent by individuals while
consuming and the money raised from selling stock to pay for capital to run their
businesses, purchase material to manufacture products and to pay employees.
All expenditures from individuals become the income of the businesses, and the
expenditure of the businesses becomes the income of the individuals. We study
how the different components of an economy interact.

In order to explain, how the economy works, economists create economic-

models. Circular flow of money is one such model which looks at how money
follows around the economy. This is going to be explained here bit by bit,
starting with a very simple version of the economy.

For the sake of convenience, all economic activities are put under two-groups:

Two-Sector Explanation:
1) Households and (2) Firms
Households are the owners of factors for example, households provide
firms with labour, for which they receive wages.
The money is then spent on goods and services provided by firms and
thus, the cycle-continues.

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Firms supply households with goods and services , for which they receive
payment.

TWO SECTOR MODEL

Factor Payments Income

FACTORS MARKETS

FIRMS HOUSEHOLDS

PRODUCT MARKETS

Sales Receipts Consumption-expenditure

Both the sectors are linked with each other, through economic activities. This

leads to the follow of money between the two-sectors.

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Three Sector- Model = Addition to two-sector model:

The three-sector model, refers to the inclusion of financial institutions in the

description. This has been done in the following description:

PRODUCT MARKETS

FIRMS HOUSEHOLDS

Households do receive income for providing their services as explained

and illustrated in two-sector model in the above discussion.

However households do not actually have to spend all their income. The

unspent part of their earning is known as Savings Banks and other financial

institutions collect these funds deposited by households with them. So,

households are paid back interest on their deposits.

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Banks land to firms who use money to invest and to give loan to firms and

to imports take money out of the economy. These are cases of leakages and

injections into the system respectively.

The above description illustrates the inter-dependence of different factors

in the economy.

FOUR SECTOR MODEL

Factor Payments Income

FACTORS MARKETS

Governments
taxes

FIRMS HOUSEHOLDS

Financial Institutions

PRODUCT MARKETS

Sales Receipts Consumption-expenditure

In a modern economy, the state also participates in economic- activities so

the government also becomes an important component of flows of income. This
give rise to the concept of Four-Sector-model, as illustrated above.

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The government imposes taxes on both, households as well as on firms.

Some of this money is returned to households in return of their services. The
rest of the government – income is spent on goods and services.

The state purchases goods from firms. So there takes place flow of money,
as a result of payment of goods. The government given subsidy to certain
products/ projects, as a result of this money follows from state undertakes
transfer-payments due to which payment goes to households.

Five-Sector Model

IMPORTS EXPORT
OVERSEAS SECTORS

The inclusion of foreign-trade in circular-flow gives Five Sector model.

This is the introduction of an open-economy.

Important-term to learn:

Withdrawals are in the form of Savings, taxes and imports so reducing the
circular flow of income and leading to a multiplied contraction of production.

Leakage is another name of withdrawals. We know that all income will not flow
from households to businesses activity. The circular flow shows that some part
of a household income will be:

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1. Put aside for future spending i.e. Savings in bans accounts and

other types of deposits

2 Paid to the govt. of taxation e.g. income tax etc.

3. Spent on foreign made goods and services i.e. imports (M) which

flow into the economy.

The other important term in this description::

Injections into the circular flow are additions to investment, govt. spending or
exports. So boosting the circular flow of income leading to a multiplied expansion
of output

1. Capital spending by firms i.e. investment expenditure e.g. on new

technology.

2. To govt. expenditure.

3. Overseas consumers buying Indian goods and services.

An economy is in equilibrium when the rate of injections = the rate of

withdrawals from the circular-flow.

Difference between Real flow and money flow:

1) Real flow is the exchange of goods and services between household and
firms whereas money flow between household and firms whereas money
flow is the monetary exchange between two sectors:

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2. In real flow household sector supplies raw material, land, labour, capital
and enterprise to firms and in return firms sector provides finished goods
and services to household sector. Whereas in money flow, firm sectors
gives remuneration in the form of money to household sector a wages and
salaries, rent, interest etc.

3. Difficulties of barter-system for the exchange of goods and factor-services

between households and firms sector in real flow, whereas no such
difficulty or inconvenience arise in money flow.

4. When goods and services flow one sector of the economy to another, it is
known as real flow:

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EXERCISES

Q.1 What are the two main flows in an economy? How do they arise in

all five sector economy? Explain with graphical representations

Q.2 What is meant by withdrawal and injections? How do they affect the

size of the circular flow of income and expenditure in an economy?

Q.3 How taxes affect the flow of money in the economy? Is I influenced

by transfer- payments.

4. Describe the difference between Money-flows and Real-flows. In

what way, these are related to circular flow of income?

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Effective Demand and

Employment determination N.A.

[not needed by students of NDI.M.]

During the Great Depression of 1930’s people were afraid to spend.

Businesses were reluctant to hire works because they could not expect and pick-
up in sales.

The purpose of Keynesian employment-theory is to offer a solution to

periods of excessive unemployment.

However, the economists at that time, believed that the economy’s total
output and employment could not fall below the full-employment level except very
temporarily.

It was believed that there would always a condition of full-employment. All

the able bodied persons willing to take up jobs would be provided to take-up jobs
would be provided jobs.

It was also part of the theories prevailing in the first-quarter of the 20th
century that unemployment may occur due to restrictions arising in the way of
free play of market-forces. These kind of ideas are referred as classical theory.

The argument was based on the following explanation: Production

does not increase supply of goods only but it also creates the demands for these
goods. Because workers are used to produce-goods and they are paid money
for their services. So the increase in production, results in more employment and
more income and thus more demand for goods. This phenomenon in known as

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say’s law of market, which states that supply creates its own Demand. Therefore
there is no scope for over-production in the economy.

Furthermore, market mechanisms of demand and supply of workers and

flexible interest rates were supposed to remove unemployment and deficient
demand. There ideas were floated in the context of a closed economy and the
possibility of savings was ruled-out.

The economic problems of prevailing during depression could not be

explained with the help of classical theory. These ideas could not provide a
workable solution of escape the depression.

The Birth of Keynesian ideas:

J.M. Keynes pointed out several limitations theory to explain the working of
an economy. According to Keynes real wage cuts does not contribute to creation
of jobs. The rate of interest mechanism does not bring equality between saving
and investment.

To understand his theory income determination, first, we have to be clear

about the following basic concepts:

Such as: (1) Aggregate Demand

(2) Aggregate supply and
(3) Effective-Demand
(4) Under employment equilibrium. These concepts are explained
below in a simple and easy manner.

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1) Aggregate-Demand:
It is a very important concept in this theory Aggregate Demand (A.D.) play
a crucial role in the determination of level of employment

Y A.D
A higher level of employment is
associated with higher level of
employment. The A.D. shown in the
adjoining figure represents a schedule of
money receipts expected from the sale of
goods and services produced in the
economy, corresponding to different
levels of employment.
O N1 N2 X

The total sale receipts increase with increase in the level of employment
and vice-versa.

Aggregate Demand has two components one is consumption and the other
is investment. A.D. = C + I

The aggregate demand rises either with an increase in consumption or in

investment expenditure or in both of them. The C + I = Total expenditure can
also be considered as income receipts by the firms, since all spending is
received by those who supply goods and services to firms.

Thus, the aggregate demand function represents a schedule of money

receipts expected from the sale of goods and services produced corresponding
to different levels of employment.

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The slope of the Aggregate Demand curve diminishes, because people

spend a smaller proportion of their income. At higher levels of income propensity
to save increases less proportion of their income.

Due to the above, the A.D. curve rises at a diminishing – rate.

The above diagram shows, the process of equilibrium of national income.

Production will not place after point E. Workers will remain unemployed between
the areas N.K. Likewise, production will not stop between the areas shown by
O.N. because the A.D. curve is higher than A.S. curve. This implies that
producers will have incentive to produce more. At point T, we find excess of A.D.
over as aggregate supply (A.S.)

The aggregate – supply is determined by the physical and technical

conditions prevailing in the economy.

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The A.S. curve rises upwards and becomes vertical, once the stage of full
employment is attained by the economy since production cannot increase
The A.S. curve shows the cost of producing various levels of output at different
levels of output at different levels of employment.

3. The Concept of Effective Demand:

Equilibrium level of employment is determined by the intersection of Agg.
Demand curve and the Aggregate supply-curve. This point is known as the point
of effective demand. The E point in the following diagram No.1 shows the
equilibrium position. Because it is only at point E, that, A.D. = AS otherwise, AD
and AS are unequal.

4. Under-emploment equilibrium:
It is not necessary that the equilibrium levels of employment are always at
full employment level. The economy can be in equilibrium at less than full
employment level.

The diagram No. 4, shows an equilibrium at point E, this equilibrium is not

showing full-employment in the economy.

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Because, the total number of workers is shown by OK area. To provide jobs to all
the workers, A.D. curve must go up higher. This is shown by AD-curve. The
equilibrium has to be established at point D.

Thus, we can state that, higher the level of effective demand, greater shall
be the level of income and employment in the country. This can be done by
raising the level of A.D. Keynes believed that A.S. cannot be increased in the
short-period. So attention should be on A.D. as for as A.D. is concerned it is the
investment expenditure that can increase A.D. This will give us higher level of
Effective-Demand.

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EXERCISES

Q.1 Explain National income determination with the help of Aggregate Demand
and Aggregate-supply approach.

Q.2 Write notes on the following:

(a) Classical theory of income and employment
(b) Say’s Law of market

Q.3 Explain the concept of under- employment – equilibrium, illustrate your

answer with the help of graphs.

Q.4 Write notes on the following:

(a) Effective – Demand
(b) Full-employment

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Chapter V
Investment Function[ not needed by NDIM students]
Investment is an important determinant of the level of income, output & employment in
an economy. The addition to the stock of physical capital such as plant machines, and
new factories etc is known as real investment. Investment means the new expenditure
incurred on addition of capital goods, such as machines, buildings tools etc. Keynes
made a difference between autonomous investments & induced investment.
Autonomous Investment is the investment which does not change with the changes in
the income level & is therefore independent of income. The is shown in the diagram I
investment depends on population growth & technical progress. Most of the investment
undertaken by govt. is of the autonomous nature.

I E1 E2 I

Investment Diagram: 1

O Y1 Y2 x

Y Income

E2

Investment

E1

O Y1 Y2

Income

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Induced investment is that investment which is affected by the changes in the level of
income. The greater the level of income. The larger would be the consumption of the
community, so more consumer goods will be needed, for this, more investment has to
be made in capital goods. This induced investment is undertaken both in fixed capital
assets & in inventories.

Investment

Rate of investment M.E.C(Marginal efficiency

Of Capital

Prospective Yeild . Supply price .

Expectation

Short Long term

Term expectation
Expections Future Demand

Current Demand

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Gross Investment and Net Investment

Net investment refers to the Gross investment minus depreciation. Depreciation of

replacement investment shows the expenditure made to maintain the stock of capital.

There is difference between financial investment and real investment. The financial
investment is in the form of expenditure on purchase of existing shares, debentures and
bonds.

On the other hand, investment is spending on newly produced capital – goods.

Private-investment is determined by two factors..

(I ) Marginal-efficiency of capital (M.E.C.)

(II) Rate of interest.

M.E.c. is a reference to the expected rate of profit from given investment. Investors will
invest money under one condition i.e. expected price must be higher than the rate of
interest.

The M.E.C. of capital is the percentage of profit expected from a given investment. This
may be regarded as the highest rate of return expected from an additional unit of a
capital over Over its cost. The cost of producing capital asset is known as supply price.

The rate of return expected from a new unit over its supply price is known as
prospective- yield. Thus, the M.E.C is the ratio between the prospective yield to
additional capital goods and their supply-price. This may be illustrated with the help of
an example. If the supply price of a capital asset is Rs.20,000 and its annual yield is
Rs.2,000. We can calculate the M.E.C. on the basis of this in formation. The M.E.C. is
2000/20000x100/1=10 per cent

𝑅1 𝑅2 𝑛 𝑅
Sp = + (1+𝑖) 2 + ⋯ … … … . (1+𝑖)𝑛
(1+𝑖)

Suppose, the supply-price of a new capital asset is Rs. 1000 and its life is two-years.
The expected yield is Rs.550 in the first year and Rs.605 in the second year.

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MEC is 10 percent which equates the supply price to the expected yield s of this capital
asset

550 550
Rs. 1000 = + (1.10)2 = 500 + 500
(1.10)

Present value is the value is the value now if payments to be received in the future. In
the above equations, the term is the present value of the capital asset. This is
influenced by the rate of interest at which it is discounted.

Whether to invest or not to invest in a capital asset? To decide this, it is essential

to compare the present value of the capital asset with its cost or supply price. The
investment is worth, if the present value of a capital good exceeds its cost.

The present-value is, “The value of payments to be received in the future,” it

depends on the rate of interest at which it is discounted.

Suppose we expect to receive Rs.100 from a machine in a years time and the rate of
interest is 5 percent, The present value of this machine is

R1 (1+i) = 100/(1.05) = Rs.95.24

If we expect Rs.100 from the machine after two years then its present value is
100/(1.05)2 = Rs. 90.70

The present value of a capital asset is inversely related to the rate of interest.

Rate of interest – P.V of an asset of Rs. 100 for

One year is 95.24

It will be Rs. 90.91

The MEC curve of an economy. It has a negative slope level of capital stock, the MEC
is higher.

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The Marginal Efficiency of Investment (MEI)

This refers to expected rate of return from additional unit of investment. We find
inverse relationship between volume of investment and Marginal efficiency of
investment.

MEI shows the rate of return on units of capital over and above the existing stock of
capital.

The MEC shows the rate of return on all successive units of capital without regard to the
existing stock of capital.

Determinants of incentive to invest

The propensity to invest depends on a number of factors such as :-

(1) Uncertainty : The prospective – yield depends on expectations. These are highly
uncertain factors.
(2) Level of income: increase in income creates more confidence among investors.
More income means more demand and thus more profit.
(3) New products, inventions and innovations etc create environment of optimism.
This will attract more investment

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EXERCISES

Q. No.1 What do you understand by investment function? Explain the factors that
influence the level of investment in an economy!

Q.No.2 What are the determinants of induced investment? Will an increase in

marginal efficiency of capital always lead to an increase in induced
investment?

Q.No.3 What do you understand by autonomous investment and induced.

Investment?

How does induced investment depend on the level of Aggregate income?

Q.No.4 Explain the concept of Marginal efficiency of capital? How does investment
gets determined by the Marginal –Efficiency of Capital?

Q.No.5 Discuss the factors which determine the inducement to invest in an

economy?

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CHAPTER – V

NOTNATIONAL INCOME DETERMINATION

INCOME – DETERMINATION

[NOT NEEDED FOR NDIM STUDENTS]

The equilibrium level of National Income can be determined by the equality of Aggregate
Demand and Aggregate supply.The equilibrium level of National-income is determined at a point
where the Aggregate Demand intersects the Aggregate-supply curve.

The Aggregate Demand consists of two parts. Demand in the economy comes for consumer-
goods and capital, goods. Money expenditure on consumer –goods is known as consumption
and money expenditure on capital goods is known as investment. Therefore we obtain
Aggregate- Demand by adding up consumption and investment. So A.D. is expressed as A.D
=C+I

If Aggregate-Demand is not equal to the Aggregate-supply, the economy will either move
forward or backwords for example, if Aggregate-supply (A.S.) is more than Agg. Demand the
economy will shrink-because there will be a situation of unsold-stock and profit of firms will
decline, Investment will decline production will decline. Un-employment will increase. Individuals
will earn less. National income will fall and vice-versa.

The central idea is that equilibrium of National income will only take place when A.D. is
equal to A.S. This reasoning can be explained with the help of the following diagram

Y T A.S = Y = C+S

K C+ I

C E C

I 45
O Income Y x

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The 450C line  shows the Aggregate supply, Y = C+S

The Agg. Demand is shown by C+I. The equilibrium is determined at point E in the
diagram. The equilibrium level of National income is OY. This is also known as point of
National income determination.

National-income determination can not take place either to the left of E point (as
shown by k point) or to the right of E-point as shown by T point why does it happen?
Because at point K, Aggregate Demand is greater than Aggregate Supply. To satisfy
excess demand firms will increase production. This, will result in more production and
employment National income will increase. Equilibrium will be restored at point E.

In the opposite case, the equilibrium will move down from point, T to point E.

The case of open-economy

The inclusion of government-investment and foreign-trade in this model can be shown

with the help of the following diagram

 in this case equilibrium is established at point A and not at point H. At point A, we

study the equilibrium in an open-economy. Now A.D. = C+1+G+(X-M). This incorporates
government expenditure and takes into account net-exports. The basic-structure
remains the same

THE ALTERNATIVE APPROACH TO DEPICT NATIONAL INCOME DETERMINATION.

S E I

S+i K

O
Y Income

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The alternative approach to depict National – Income determination

The saving and investment intersect at point E. This is regarded as the point of national
income determination.

Otherwise, equilibrium will take place either to the left of E point or to the right side of
point E. in other words, equilibrium will take place only when S=1

At point T, saving exceeds investment which means that people are NOT consuming
more and reducing demand for goods. This implies that Aggregate Demand is less than
Aggregate – supply. This will result in increasing the inventories, so firms will reduce
production. As a result of this, output income and level of employment will decrease.

So National income will start decreasing. This will continue till point, E.

In the area below E point more investment will be made. Economy will move forward to
settle at point E.

Thus National income determination will take place at point of equality of savings and
investment.

Exercises for students

Q.No.1 Explain the national equilibrium by using Aggregate –Demand and
Aggregate supply approach.

Q.No2 Explain income-determination by using savings and investment Approach.

Q.No.3 Why Aggregate demand curve is shown as C+1 Explain with the help of
diagram

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Chapter : 8

VERY IMPORTANT TOPIC

MULTIPLIER

The Multiplier shows the relationship between change in investment to change in

Income in an economy. When investment is increased, the production also rises. This
creates more income.

Further the process of Multiplier-effect can be illustrated with the help of an example.
Suppose, an investment of Rupees 100 crores is made on the construction of a bridge
in a backward area. It is assumed that marginal propensity to consume (m.p.c.) is 0.5

Once the investment of Rs. 100 crores is made, the group of workers, engineers and
contractors etc. will spent 50 percent of this amount. This amounts to 50 crores. This
money will be spent by the individuals constituting First – group of the recipients of 100
crores investment. The rest Rs.50 crores will be saved. The remaining Rs. 50 crores will
be spent on consumption which will go to increase income by the same amount in the
second round (group II)

The amount of Rs.50 crores will further be divided into two parts 50 = 25+25. Half
of the amount will be spent on consumption. This expenditure will increase the income
of the next group . The consumption of one group becomes the income of the next
group.

So Rs. 25 crores will be used for consumption as well as for saving25 = 12.50crore.
and 12.50 The following further explains the working of the Multiplier process. If we add
up the increase in the income of all the groups, we find Rs.200 crores as the total
increase in income Y, due to increase in investment by Rs.100.

Here the increase in income is two multiple of initial investment. So the value of
multiplier is 2

∆𝑌 200
K= = 100 = 2
∆1

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The above income –multiplying process is explained with the help of the following
table:-

Groups I Y c s
M.P.C. = 0.5
I 100 100 50 50
2 50 25 25
3 25 12.5 12.50
4 12.5 6.25 6.25
5 6.25 3.12 3.12
After few Total 100 Total Income Total 100 Total saving
more rounds 200 100

Thus, the Multiplier (K) shows the relationship between change in investment and
change in income of an economy.

Therefore K = Y / I

Therefore Y = change in income level I=Change in Investment

level

Example : If I = Rs.100 crores, K = 5 then

Y= K x I

Or

Y = 5 x 100 = 500

Assumptions

1) Short Run
2) Price Mechanism

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3) Competition
4) No taxes and no government spending
5) Closed Economy – No exports, no imports.
6) Constant APC, APS, MPC, MPS

Derivation of Formula for Multiplier

We know

Y = C+I

Multiplying the equation by Y

Y = C + I

Dividing the equation by Y

I/ Y = C / Y + I/Y

Or I = MPC + I/Y [because C/Y = MPC]

Or I/ Y = 1 – MPC

Reversing the question

I/ I = 1/1 – MPC

Or K = 1/1-MPC (because Y/I = K)

Factors determining Multiplier

Relationship between MPC, MPS and Multiplier

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a) If MPC is high, K is also high and vice versa

(More MPC, means consumption, more AD therefore income rises by a
greater amount)
Example : High MPC
K = 1/1-0.5 = 2 K = 1/1=0.9 = 1/0.1 = 10
1<K < α
Because ()<MPC<1
b) MPS and K
If MPS is high, K is low and vice versa
Example:
High MPS
K = 1/0.5 = 2 K = 1 /0.1 = 10
1<K < α Because ()<MPS<1
Process of Multiplier

The value of the Multiplier depends on the value of M.P.C.

Higher the M.P.C. greater is the value of Multiplier

Marginal propensity to Multiplier k

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Consume .
= C vvva v k
Y
0 1.0
0.2 1.25
0.4 1.67
0.5 2.0
0.6 2.5
0.8 5.0
0.9 1.0
1.0 ∞ (infinity)

MULTIPLIER

Injections of Multiplier

Injection takes place through government spending. There takes place infusion of
income through various channels So total increase in income would be more than
actually calculated

1. Exports: When the exports of the country are more than the imports a part of the
foreign income will become part of the domestic country. An increase in the
investment will result in additional level of income in the country.
2. Receipts of pars debts
The present level of the consumption of the community will increase more than
anticipated.

If the private investment also goes up due to increasing economic activity than,
increase in income will be more than anticipated

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Use of Multiplier

Multiplier is an important of analysis. This is useful in undertaking proper policies. If a

certain target of achieving National income is to be achieved, then multiplier can help us
to determine amount of investment. For example.
If the objective is to increase income to a level of Rs. 400 crores and the value of
multiplier is 4 then

Y 400
1 = --------- 1 = --------- = 100 Crores
K 4

Moreover, the likely change in income due to a given investment may be known
with the help of Multiplier.

REVERSE MULTIPLIER

Multiplier can be used to study impact on income in case of clearance increase in the
investment expenditure. The shifts in the opposite direction are also possible in the case
of the reverse operation of the multiplier. The initial reduction in the investment will
cause a multiple contraction of the income.

Suppose, that MPC is 0.80 and the investment declines from Rs.200 lakhs to
Rs.100 lakhs.

The process of the decline of the income will be completed over a number of rounds.
Initially, the fall in the income will be equal to the fall of the investment, that is, Rs. 100
lakhs.

Thereafter, the consumption level falls and results in the further fall of the income to Rs.
80 lakhs, then to Rs.64 lakhs and so on, till the investment again equals saving.

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Suppose decline in Investment is Rs. 100 Crores.

MPC = 0.5 k=2
Leakages of Multiplier = -100 x 2 = - Rs. 2 crore
LEAKAGES
Increase in income in each round declines due to leakages in the income stream. These
are the following:
(1) Saving
(2) Purchase of old stocks and securities
(3) Debt cancellation
(4) Liquidity preference
(5) Net imports
(6) Taxes

Relevance of Multiplier to Under-developed countries (U.D.C.)

1. U.D.C’s have a relatively higher MPC. This implies that multiplier must be
higher in U.D.C’s so increase in income must also be higher. But this does
not happen in reality. If is agreed that the logic of multiplier does not apply to
the L.D.C
2. Non-existence of Keynesian assumption in U.d.C

Keynesian theory assumes :

(i) A high level of industrial development
(ii) Involuntary –unemployment
(iii) Existence of excess – capacity
(iv) Elastic –supply curve
NUMERICAL Problems

Question

I = Rs.70 crore, C= 60 + 0.80 Yd

(1) Find the equilibrium level of income when there is a Rs. 10 crore increase in
autonomous investment increases from Rs.70 crore to 80 crore.

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Answer:

(1) Y = C+1
= 60+0.80Y+70
= 130 + 0,80Y
Y- 0.80 Y = 130
or Y (1-0.80) = 130
= 130/0.2 = Rs. 650 crore

Further developments in the concept of Multiplier [ not for NDIM

]

An increase in government –expenditure will lead to a multiple-increase in

income.
The impact is similar to an increase in investment.
This is also known as three-sector model – Because,
(i) Consumption – function C= a+bY
(ii) Investment expenditure – I = Ia
(iii) Government – expenditure G= Go
(iv) Y = C+I+G
KG indicates government expenditure. Its working is identical to working of
investment – multiplier. Change in equilibrium level of income is equal to
the product of the change in G and the multiplier

1
KG =
1−𝑏

1
Or Y =  Go
1−𝑏

If p.c. = 2.5

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Tax – Multiplier (Kt) THE FOLLOWING DETAILS ARE NOT

REQUIRED BY NDIM STUDENTS .

Imposition of taxes reduce the flow of income. We all know that an increase in
taxes, results in decreasing the income in the hands of consumers,
consequently, there will be decrease in consumption and income.

The tax-multiplier (Kt) explains the change in the level of income resulting
from a given change in taxes

−𝑏
Y = (1−𝑏) T

T is the change in the level of government taxes. b is the M.P.C.

Kt can be calculated on the basis of –b/1-b If value of MPC is 0.6 then

−𝑚.𝑝.𝑐. −0.6
Kt = = 1—6 = - 1.5
1−𝑚.𝑝.𝑐

This implies that the imposition of the tax will decrease the income level by 1.5 times,
the initial change in taxes, so 1.5 x Rs 40 crores = Rs.60 crores is the reduction in
income [assuming that the volume of taxes is 40 crores.]

Transfer payment Multiplier (KTT)

When the government spends money on items known as Transfer payment such as
welfare policies, pension, and unemployment allowance etc. the level of income
increases.

Again, taking b as the value of m.p.c.

KTT = b/1-b

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The transfer payment multiplier = K TT = b/1-b

To calculate the value of transfer payment multiplier, we need value of m.p.c. and the
amount of transfer payment.

Suppose, the MPC is 0.6 and the amount of government transfer payment is Rs.40
crores.

0.6
Y = x 40 = Rs 60 crores
1−.6

We can obtain the increase in income due to increase in Transfer payment.

BALANCED BUDGET MULTIPIER

If Y = 𝐺 = KB =1

If government expenditure and multiplier are increased by equal amount, the net
change in income, then balanced budget Multiplier is known as KB=1

Foreign – Trade Multiplier

The value of the multiplier depends on the value of the marginal propensity to save and
marginal propensity import. This may be noted that there is an inverse relation between
the two propensities and the export – multiplier.

Y = C+ I + X-M
Here, Y is the National – income
C is national – consumption
I is total – investment
X is exports

And M is imports

Exercises
1. What is Multiplier ? Explain income –generating process of Multiplier!

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2. On what factors does the value of Multiplier depends? Give examples to illustrate
your answer.
3. Write notes on the following :-
(a) Reverse – Multiplier
(b) Leakages of multiplier
4. On the basis of following information
(i) What will be the equilibrium level of income
(ii) What will be the increase in national –income if investment increases by
Rs.25 crore.
I = 200 crore; C = 80 + 0.75 Y
5. From the given – information
(i) Find equilibrium level of income in four –sector Economy
(ii) Find out Equilibrium level of income if exports are of 30 crores.
(iii) What would be the foreign-trade Multiplier given information is C=200+0.85
yd
I = 100, G=50, X = 10, M+m = 5+0.3y and T = 50

Q.No.6 (a) Given –information is as follows :-

Y = Rs. 400
C = Rs.50 + 0.7Y
I = 50
Find change in equilibrium of income

(A) Government spends Rs.20 without any increase in income

(B) Government taxes Rs. 20 and does not spend it
(C) Government – expenditure Multiplier
(D) Tax Multiplier

Q.No.7:Suppose structural model of an economy is given as follows :

C= 50 + 0.6 Yd

Yd = Y-T X = 20

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I = 35 (M+m) = 8+0.1Y

G= 25 T = 20

Find the following:

(A) The equilibrium level of income in closed – economy

(B) The equilibrium level of income in open economy
(C) If economy is open what is foreign. Trade Multiplier and impact on National-
income.

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Chapter 9

SUPPLY OF Money { not needed }

Money has several components in the modern world. We regard paper currency notes and
coins as money. But money deposited in the bank also serves the purpose of money. We can
carry-out transactions with the help of bank-deposits, deposits in the post-offices, N.S.C’s etc.

Since these variants of money are used to settle day-to-day transactions, so these are
regarded as components of money. The degree of liquidity is not same.

Cash and coins are the most liquid forms of money. These can be used at the spur of
the moment. Demand deposits are also quite liquid, as they can be used to write cheques
against, in settling daily transactions. The sum of currency in circulation and demand deposits
with banks are called M1, or narrow money:

Time deposits, though not as liquid and instantly available as transactions settling
medium as M1 are still money, since it will be available at some point, and very often, as in the
case of fixed deposits, can be converted to cash for some penalty The sum of M1 and time
deposits in called broad-money.

High-Powered Money

Cash-reserves are maintained by the banks, under R.B.I. instructions, to satisfy

unexpected demand for withdrawals. The cash reserves are the base on which bank money
(credit) is created as a multiple. So it is regarded as the monetary base. So, the sum of the
above and cash-reserves held by banks are called high-powered money.

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Money-multiplier:

1. It is the ratio of Broad money (M3) divided by Reserve-Money (M0)

2. Therefore, broad-money (m3) = Reserve Money (M0) x money-multiplier

3. When reserve money increases, broad-money will also increase (Direct Correlation) for
2013-14, money-multiplier was 5.5

Money-multiplier M3 divided M0)

Components of Money-supply in India

If we see the components of money supply, we can see bank-deposits from bulk of the
money-supply.

Within deposits, it Is time deposits which form around 3/4 th of the money supply.

The share of time deposits has declined from 74.7 p.c. in Oct-Dec. 09 to 74 percent on
April, 2010.

Components of Money-supply in (p.c.) India

1. Currency with the public 13.9 as on 09, 2010

2. Demand deposits with banks 12.0

3. Other deposits with R.B.I. 0.1

4. Time deposits with banks 74.0

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5. Money Supply 100.00

1. Concept of Supply of Money

• Two different concepts of money

1. In the narrow sense, Assets performing the function of medium of exchange are
treated as money.
2. In the narrow sense, we include currency with the public and deposits with
commercial banks and other deposits with the R.B.I.
3. In a Broad sense, money supply includes time deposits (fixed deposits), besides
currency, demand deposit and the other deposits with R.B.I. these assets can be
converted into money.

2. Measures of Money Supply

• R.B.I. presented four measures in 1977. These are defined below in decreasing order of
their liquidity. The following measures of Money supply are used by the R.B.I.
Mo=this is also known as Reserve money. This includes currency in circulation
+ Banker’s Deposits with banks
+ other deposits with the R.B.I.

3. M1 = this is known as narrow money. This includes; currency with the public

+ demand Deposits with banks

+ other deposits with the R.B.I.

M2 = M1 + time liabilities of the saving deposit with banks

+ Certificate of deposits issued by Banks

+ term deposits with Bank (excluding FCNR) (B)

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4. M3 = this is known as Broad money

This consists of:-

= currency with the public

+ Demand Deposits with Banks

+ time Deposits with banks

+ other Deposits with the R.B.I.

Or M3 = M1 + Time Deposits with Banks of the four measures of money supply, Mo, M1
and M3 are the most important money supply measures from the policy point of view.

5.

• Currency is the highest liquid asset, following the demand deposits, which can be easily
converted into money on demand.

• Savings deposits with the Post Offices fall next in terms of liquidity which can be
redeemed into money after giving a short notice.

• The degree of liquidity is the least for the time deposits; these are non-redeemable into
money before period without loss of time and money.

6. High Powered Money

The high powered Money (H) is money produced by the R.B.I. and the Govt. of India,
small coins including one rupees note, and held by the public and banks.

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The R.B.I. calls it reserve money High powered money consist of:

I. Currency held by the Public (C)

II. Cash reserve of Banks (R) and
III. Other Deposits of the R.B.I.

7.

• Other deposits of the R.B.I. can be excluded for the purpose of theoretical analysis, as
they constitute only abouit one percent of total ‘H’.

8. Determinants of Money Supply.

The following facts are responsible for the change in money supply.

1) Central Bank through its monetary policy.

2) Commercial Banks, through credit creation

3) Government through its Fiscal policy

What are the R.B.I. measures of money

Exercises for students

Q.1 Supply and what is the purpose of these measures? How is M3 different from M1.

Q.2 What is credit? Explain the process of credit creation with the help of balance sheet
method with suitable example; Also write the determinants of the process of credit-
creation.

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Q.3 Explain constituents of Money-Supply in Indian Economy. Why is proportion of M3

increasing at a fast-rate in Indian-economy?

Chapter 10

[ NOT NEEDED ]

Credit Creation

Banks need only a small percentage of cash to deposits. If banks keep 100 percent cash
against deposits, there would be no credit-creation. These days’ commercial banks do not keep
100 percent. The Central Bank of the country (R.B.I. in India) a certain percentage of their
deposits in cash. They lend and/or invest the remaining amount which is called excess-
reserves. A bank can lend equal to its excess-reserves.

The entire banking-system can lend and create credit upto a multiple of its original
excess-reserves. The deposit multiplier depends upon the required reserve which is the basis of
credit creation. The required reserve--ratio:

RRr = RR/.D

Or RR = RRr X D

Where Rr are the required cash-reserves with bank

RRr is the required reserve-ratio

And D is the demand deposits of banks

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To explain that D depends or RR and RRr, we divided both sides of the above edquation
by RRr

RR/RRr = RRr X D/RRe

Or PR/RRr = D

Or 1/RRr = D/RR

Or D = 1/RRr = X Rr

Here 1/RRr, the reciprocal of the percentage reserve ratio, is called the deposits (or credit)
expansion. This sets the limit of the deposit expansion of a bank.

The maximum amount of demand deposits which the banking system can support with
any given amount of RR is by applying the multiplier to RR.

Taking the initial change in the volume of deposits (DD) and in cash reserves (DRR), it
follows from any given percentage of RR that.

AD = Rr X 1/RRr

This may be explained with the help of an example.

C.C.-3

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If RRr for the banks is fixed at 10 percent and the initial change in cash reserves is Rs.1000. On
the basis of the above formula, the maximum increase in Demand deposits will be:

 D = 1000 x 1/0 . 10 = Rs.10000

This is the extent to which the banking system can create credit. The above equation
can also be expressed as follows: z

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Chapter 11

Monetary Policy

MEANING

Monetary policy is administered by the Central Bank of a country. The

Central bank controls and regulates the supply of money in the economy.
Flow of credit is directed by the Central Bank.
i
The objectives of Monetary policy vary from situation to situation. But
the most important objective is to equate the demand for credit and the
supply of credit in the economy. For this purpose, the following two types of
credit control measures are used in other words, Monetary policy has two
aspects.

(A) Quantitative credit control measures.

(B) Qualitative credit control measures.

]a]The quantitative credit control measures try to regulate the total

availability of credit in the economy. This is done either by increasing /
decreasing quantity of credit in the country.

(B) Qualitative credit control measures are used to check the use of bank
loan (credit) in the economy. The credit is diverted from non-priority sectors
to priority-sectors(These measures do not impact the quantity of credit in
the economy).

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The detailed working of above measures is given below:

Quantitative Credit-control measures

The quantity of credit in general is controlled with the help of the
following techniques:

(1) Bank-rate-policy: The standard-rate at which the Central Bank

rediscounts bills of exchange etc. from commercial banks.

In simple language, bank-rate is the rate of interest charged by the

RBI for providing funds or loans to the banking system.

When the Central Bank raises the bank – rate, then the commercial
banks also increase lending-rates to the business-community. This
increases the cost of borrowing increases. So, less loans are taken, supply
of money decreases. The spending power of the people also decreases.
This is expected to reduce the level of Demand for goods and price-=level
in the economy.

During depression, the bank-rate is increased and the opposite-effect

takes place.

2) Cash-reserve-ratio (C.R.R.)

The C.R.R. is another measure to control the overall quantity of credit

in the economy.

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The commercial banks are required to keep a part of their deposits in

the form of cash. The C.R.R. is the rate at which commercial banks keep
the part of their deposits with the Central bank.

Statutory Liquidity – ratio (S.L.R.) =

It is the rate at which the commercial banks have to a keep a part of their
deposits in the form of cash, with them selves.

In India the R.B.I. has been using CRR quite frequently as a major
instrument of controlling the supply of money.

To check inflation, C.R.R. and SLR are kept at higher level. This
reduces the lending capacity of the banks. So less bank-money comes in
the circulation. The level of spending decreases. The demand for goods
and price start moving-downward
3) Open market operations:
This refers to the purchase and sale of govt. securities by the Central
bank from to the public and banks on its own account.

To check, inflation, the Central Bank sells securities in the market.

Commercial Banks buy the securities. The cash-holding of Commercial
banks get reduced. So the banks are forced to stop granting fresh loans.
Commercial banks may start recalling loans already granted. The total
spending power gets reduced. Therefore, the inflationary pressure gets
reduced.

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Repo-rate: Under the repo system, The R.B.I. buys securities back from
the banks and thereby provides funds to the banks for lending,
the repo-rate is the rate, at which the R.B.I. short-term money
to banks against securities.

It is a short-period transaction of (1) In case R.B.I. wants to make it

more expensive for the banks to borrow money, it increases the repo-rate.

The opposite action to the above is known as reverse repo-rate. An

increase in reverse repo-rate can cause the banks to transfer more funds to
R.B.I. This reduces money from the system. R.B.I. receives back money
from the Commercial banks.

(B) Quantitative Credit-control measures:

(1) Rationing of credit:

This is to control and regulate the purpose for which the credit is
granted by the banks.

This is done in the following manner:

(a) Quota may be fixed for borrowers
(b) Maximum amount of loans to be given to different sectors, preference
is given to the priority sectors.
The objective is to divert the resources from non-priority sectors to
the priority sectors.
(ii) Moral Suasion: This means, advising, requesting and persuading the
Commercial banks to co-operate in the interest of nation

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(iii) Marginal Standard Facility (MSF)

It is the rate at which scheduled banks could borrow funds overnight
from R.B.I. against approved government securities.

MSF rate is pegged one percent above the repo-ra

Credit Authorization Scheme:

Under this instrument of credit-regulation, RBI as per the guideline
authorizes the banks to advance loans to desired sectors.
SELECTIVE CREDIT CONTROLS:

Direct-action:
Under this system (1) the Central Bank may refuse to rediscount the
bills of exchange of the Commercial banks (2) It may charge a panel rate of
interest over and above the bank rate (3) The Central Bank may refuse to
grant more credit to the particular banks.

Varying Margin requirements;

Change in the minimum margin for lending by banks against the
stocks of specific goods kept or against other types of securities.

Another step is to fix limit on advances to individual borrowers against

stocks of particular sensitive commodities.

The above two policies are very useful in checking hoarding of stocks
of food-grains etc. Another step can be to change discriminatory rates of
interest.

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Qualitative credit controls are also known as Selective Credit control

measures.

Such measures affect only a particular use/area of the country and

not the whole-country. So these measures are very effective in checking,
hoarding and black-marketing of food-grains etc. in the country.

The flow of credit from non-productive use to the productive use can
be effected through the selective credit control measures.

Assessment of Monetary Policy

1) Monetary policy does not work in isolation. Monetary Policy works in
tandem with Fiscal-policy.
2) Monetary policy is not effective during recession. Due to low
profitability in recession, the demand for loans becomes interest in
elastic.
3) Demand can be interest inelastic making rate-changes less effective
in managing aggregate-demand.
4) Problems of inflexible labour market, inadequate infrastructure etc.
policy limits the effectiveness of the monetary policy.
5) Time-lag is an obstacle in the success of monetary policy. Difference
between implementation and response time.

The inside-lag: This is a reference to the time lost in, identifying the nature
of the problem, sources of the problem and assessing the severity of the

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problem. Furthermore, time is wasted in deciding the appropriate policy and

again, its implementation.

The outside lag: the time taken by the economic agents in reacting to the
action taken by the monetary-authorities.

The decisions may not be based on correct forecast regarding the

problems.

Next section, deals with the transmission of monetary-policy in India.

Objectives of Monetary Policy:

The main objectives of monetary policy are the following:
1) Economic development i.e. promotion of fixed investment.
2) Price-Stability
3) Promotion of Exports
4) Increase in Employment opportunities

Monetary Policy is used to maintain a judicious balance between

price-stability and economic growth.

With changing economic conditions of the country, the R.B.I. has

been changing monetary policy objectives and has been using a
combination of monetary policy instruments to achieve its objectives R.B.I.
has tried to provide abundant quantity of credit to the firms and at
reasonable rates, depending on the conditions.

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2) Price Stability:
The R.B.I. had tried to adjust its policies to keep prices under check
3) Promotion Of Exports: Provision of greater accommodation to the
exporters such as cheap refinance facilities, and advances to the exporters
etc.
4) Increase in Employment Opportunities:
Facilities of finance are made in those sectors of the economy which
have greater potential to provide jobs.

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C-5] Monetary Policy of Reserve Bank of India

The monetary policy has been used in India to achieve two conflicting
objectives i.e. economic growth as well price-stability.

Central bank is expected to follow an expansionary monetary policy

to achieve the objective economic growth. But this policy works against the
objective of price-stability.

R.B.I. has used all the traditional techniques of monetary policy

namely, Quantitative credit controls, consisting of Bank rate, open market
operations, variable Reserve ratio and Qualitative credit controls. Some
new innovations were also made.

Inflation has persisted in India on a Long term basis. But it is also

clear that had RBI not adopted the monetary policy with main objective of
price stabilization inflation rate could have been much higher.

Monetary Policy is credit for keeping inflation rate below 5 percent

during 1995-96 – 2006-07. It was the second most important objective of
monetary policy.
Brief History of Monetary Policy of R.B.I.
Between 1950’s to end of 1980’s.
i) The main objective of monetary policy was to maintain price-stability
and to encourage economic-development.
ii) The policy objective was to regulate credit on priority basis.

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iii) The main operating-policies were, the use of interest rate regulations,
selective credit control, SLR and timely changes in cash reserve-rate
(C.R.R.)
Between 1990’s to 1998-99:
i) The main objective: The main objective was to control inflation and
to regulate supply of credit in the econ
iii) There was deregulation of interest-rates, along with selective-credit
controls and reserve ratios

Between 1998 to present day:

Basically R.B.I. has been trying to make a judicious balance between
the objective of controlling inflation and to accelerate the rate of economic-
growth in the economy.

In this period, some new-instruments like repo-rate, were introduced.

The policy of R.B.I. has taken the following form:
i) to ensure adequate credit flow to productive areas.
ii) to manage liquidity.
The main objective can be stated as follows:
i) Price stability
ii) Economic-growth
iii) Social Justice i.e. different sectors of the society should have access
to bank funds.
iv) Promotion of export and food procurement operations.
The achieve the price-stability R.B.I. maintains high bank rate of
interest, high S.L.R. Other restrictive measures have been used to regulate

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availability of credit (loans) in the economy. All these measures taken

together are known as Dear Money Policy (or restrictive credit policy)

To achieve other objective, liberal monetary policy is used, the

opposite of the above policy
R.B.I. has used bank rate policy as per requirement of the economy.
Bank rate is the rate of interest charged by the R.B.I. for providing funds
loans) to the banking system. Increase in the bank rate means dear Money
policy i.e. less loans due to higher-cost of loan.
Year Bank rate
1992-97 12
1997-98 11
1998-99 10
1999-2000 8
2000-01 7
2001-02 6.5
2003-04 6

AS of 29th January, 2013

Indicators Current rates
Inflation 4.25 percent
Bank rate 8.74 percent
CRR 4.00 percent
SLR 23 percent
Repo-rate 7.75 percent
Reserve Repo rate 6.75 percent

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It was in June 1993, when R.B.I. raised the ratio from 3 percent to 5
percent . After this, cash ratio has been changed many times. Higher the
C.R.R. , less is the liquidity in the system.

In view of the opinion, that, high cash reserve ratio adversely affects
bank profitability. The CRR was reduced on April 24, 2010 to 6 percent.
Now it is 4 percent.
S.L.R.
As a January, 2013, SLR was put at 23 percent. To achieve its
objectives, R.B.I. has used the technique of Repo-rate and the reverse
repo rate. Thus affecting the fund-supply available to commercial banks.
When R.B.I. wants to increase supply of credit, the S.L.R. rates are
reduced.

R.B.I. has also used from time to time, the Selective credit control
measures like regulation of consumer credit etc. from time to time.

On March 19,2013
Repo-rate was reduced from 7.75 percent to 7.5 percent Reverse Repo-
rate is now 6.50 earlier it was 6.75 percent bank rate is now 8.50 percent,
earlier it was 8.75 percent.

On 22.01.2014: The important policy parameters were;

Bank rate 8.75 percent
C.R.R. 4 percent
S.L.R. 21.5 percent
Latest Scenario in India

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c.r.r. 4 percent
s l r 19. 5 percent
repo rate 6.50

reverse –repo rate 6.25

bank- rate 6.75

on 7th AUGUST 2019

repo rate reduced from 5.75 percent to 5.40 percent
reverse repo rate reduced from 5.50 to 5.15 percent
bank – rate is 5.65 percent
C.R.R. IS 4 %
SLR IS 18.75

- the rate cuT.

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Impact of Monetary Policy:

As per R.B.I. data, credit growth has shown as increase of 8.4
percent over the corresponding period in 2014-15.

Single-digit credit growth continues to hit banks, already having

problem of rising level of bad loans.

Banks have started to reduce their base rates and this may finally
push appetite for credit even from the industry.

However from April to October, non-food credit growth was a mere

1.8 percent with credit growth to industry declining by 1.1 percent.

It is reported that banks especially those owned by the government

have had a tough run for the last couple of years with increase in non-
performing assets. Due to this, bank adopted a cautious approach while
lending.

Lending has been mostly to the personal loan segment especially

housing, private Banks have given more attention on the retail portfolio.
There has been no problem with the repayment structure in the retail
segment.
Credit growth across various sectors:
1. Personal loans 18 percent

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2. Agriculture and allied activities 12.8 PERCENT

3. Priority – Sector 10.9 per cent
4. Services 5.9 percent
5. Industry 4.9 percent
6. Food Credit -2.3 percent
Press release R.B.I.
Source: 14th November, 2015
Personal loans did well across segments, with individual loans leading the pack
Individuals 26 percent
Credit card 22.2
Housing 18
Vehicle 16.3
Against F.D. 13.3
Consumer durables 12.7
Education 7.3
Others 23.3
Impact of cut in interest rate on Indian Economy:

The cut in interest rates have reduced borrowing costs and freed-up
money for companies to use in capital expenditure (capex), but barring a
few sectors in manufacturing such as automobiles and types, companies
would wait and watch for an increase in demand to pres ahead with large
investments.

According to business leaders, the R.B.I.’s move to reduce the key

lending rate will take time to show effects.

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Another side of the issue is low demand. Volumes are slow so

investment is not getting the required push in the form of more demand.
The rate cut is one of the factors to stimulate demand but investment cycle
will need more demand.

Manufacturing has to be made profitable. Reduction in rates is one

factor. Dealing with unfair imports is also important to make manufacturing
viable. So it is a very difficult task to accelerate India’s economic
development.

R.B.I. Governor said,

“There are savants and idiot savants available to give you advise. So
we hear a lot of advice… There are people who say interest rates should
be zero”.

There are people who say cut your lending rates and raise deposit
rates. However, some-experts are of the view that inflation has been largely
contained; has shifted focus to growth and front-loaded a rate cut.

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Further rate cut will help to reinforce the governments structural

policy reforms, allowing an investment led, job-creating revival in demand.

But deposit rates may also be reduced. This hurts the interest of vast-
number of small savers middle class people and pensioners etc. The rate
cut does mean that savings will deliver less returns, but the government is
banking on alternatives such as tax-free bonds and mutual funds.

Special Assistance to Commercial Banks:

Bank are being advised to finance only those projects that are viable:

The government is looking to set-up a special fund to tackle the issue

of stressed assets. This is expected to be part of the National Investment
and infrastructure Fund (NIIF). This would be like India’s sovereign wealth-
fund.

The commercial banks are grappling with a huge pile of bad debt due
to problem in certain companies such as metals, and inability of several
infrastructure projects to take off. Total stressed assets are estimated at
over 11 percent of total loans.

The proposed mechanism will help take the stressed assets off the
balance sheets of banks and reduce pressure on them.

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The proposed fund will work with promoters and creditors to see how
the capital structure could be restructured and induct operators or
professional management that can take over the asset and nurse it back
into shape.

Critical review of R.B.I.s monetary policy:

R.B.I. has met only partial success in achieving objectives of

monetary policy. Experts have concluded in their studies that the bank rate
policy has not proved to be an effective means of controlling money-supply
in India.

Open market operations basically depend on the purchase and sale

of bonds to the commercial banks etc. By R.B.I. This measure has not
been highly successfully due to absence of fully – developed and organized
money market.

In spite of use of various monetary measures, inflation still reigns very

high from time to time in India. It was only after 1995-96, the inflation rate
touched 5 percent.

The indigenous money lenders are very active in the rural as well as
in urban areas. Such Mahajans etc. are not under the control of R.B.I.

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Rapid-growth of non-banking financial intermediaries have reduced the

scope of effectiveness of this policy.

To be fair enough, we may say that things might be much worse in

the absence of monetary control adopted by the R.B.I.

RBI GIVES BANKS MORE ROOM TO LEND TO N B F C’S

ON OCT 2018 , RBI , GAVE BANKS MORE HEADROOM TO LEND TO

NBFC’S by exempting these loans from some of the prescriptions on
liquidity requirements. .

The debate

------the Govt . argued that RBI KEEPS more reserves – the

money it can retain from its operations -- than most other central banks.

RBI WAS unwilling to let the Centre tap its corpus for pre-poll spending
.. RBi “ reserves estimated at RS. 9 .7 LAKH CRORE, or around 28% of
its assets .

Rbi wants current level of reserves to guard against shocks such as oil
prices, depreciation of rupee or exit of foreign investors from stock
markets .thus reserves meant to be used during periods of stress and not
for meeting normal needs .

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Exercises on Monetary-Policy

Q.1 Monetary Policy is always either expansionary or contractionary.

Explain.

Q.2 Write short notes on

a) Repo and reverse-repo rate

b) Call Money

c) Bank rate

d) SLR

e) Base-rate of interest

Q.3 What is the meaning of credit control?

Q.4 Explain the Quantitative and Qualitative methods of credit control

Q.5 Review the monetary policy of the Reserve Bank of India.

Q.6 Do you agree that the Reserve Bank of India faces two conflicting
objectives? What are these contradictory objectives explain?

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CHAPTER - XV

Fiscal Policy:

Meaning of Fiscal Policy

The governments income and expenditure policy is known as the Fiscal Policy.
This is also known as Budgetary Policy.

Thus Fiscal policy involves the govt. changing the levels of taxation and
government spending in order to influence Aggregate demand and the level of
economic activity. Attempt is made to achieve desirable macro-economic
objectives by changing the level and composition of Aggregate Demand.

Types of Fiscal-Policy:

1) Discretionary Policy: Refers to policies which are decided and implemented

by one-off policy changes.

2) Automatic-stabilization: More collection will come in the hands of the

government during a period of rising incomes. The expenditure on welfare
schemes like unemployment allowance will be reduced. This will put a
check on Aggregate Demand on the contrary, during recession opposite will
take place.

Evolution of Fiscal Policy in Modern Era:

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It was J.M. Keynes who advocated the use of fiscal policy as a way to stimulate
economies during the Great Depression.

Fiscal-policy was particularly used in the 50’s and 60’s to stabilize economc
cycles. During 70’s and 80’s monetary policy became more popular.

Again, in the latest 2008-13 slow-down phase, Fiscal-policy became more

prominent.

Objectives of Fiscal-policy

Can mobilize more resources for investment and thus rate of development can
be speeded up. The govt. may spend on creation of infrastructure that will
contribute to more development.

2) Creation of Job-opportunities: The govt. may plan expenditure with a view

to create additional job-opportunities in the economy. Special schemes
may be launched for this purpose.

3) Control of Inflation: Fiscal measures may be used to withdraw the

resources from the consumers. This will cut their spending power due to
taxes.

The production and supply of goods may be increased by the govt. by

increasing capital expenditure.

4) Reduction in income inequalities: More taxes may be imposed on rich

people. The low-income class people may be provided those basic facilities that
they can’t afford themselves such as housing, medical facilities etc.

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In addition to the above, the objectives of Fiscal-policy may be decided by

the government of the country.

Components of Fiscal-Policy:

(1) Tax (2) Government spending (3) Public debt

1) Use of Tax-Policy:

The government can divert resources from un-productive activities to the

productive activities by imposing higher taxes on non-merit goods.

Tax concessions may be provided to the investors, investing money in

infrastructure and in merit goods.

Progressive taxation system may be used to take away a part of their

additional income.

2) Govt. spending: The government can spend money on transfer payments,

capital formation and on providing merit goods etc.

Transfer payments; include social security payments, state pension,

housing benefits.

The government sector may invest more money on public goods and merit
goods. More basic facilities may be provided to low-income classes to raise their

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standard of living. The government spends money on the following and

contributes to the eco development of the country.

The government spends money to create additional supply in the country.

Such as spending on education and training to improve labour productivity. This
includes creation of infrastructure in the economy such as, roads and bridges etc.
in a country like India, the positive scope for fiscal policy, is vast and unending.
The government contributes to the development of the private sector in several
ways. The government may provide capital subsidy and can provide electricity,
water and rail, road transport etc. on cheaper rates and undertake development
of backward areas.

The government may arrange financial support at reasonable rates to the

private sector.

4) The public sector looks after the provision of merit goods such as hospitals
and schools, and welfare payments and benefits, including assistance to
needy people of the country.

5) Expenditure may be paid on removing inequalities of income.

6) Law and order is another area which has to be looked after by the
government.

C) Public-borrowing:

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If revenue is insufficient to pay for expenditure, there will be a Fiscal deficit.

In this situation, government must borrow by selling long-term bonds or
short term bills.

Bonds are long-term securities that pay a fixed rate of return over a long
period until maturity, say for 15 years.

Government also sells Treasury bills, which are issued into the money
markets to help raise short term cash. Bills have a life of 90 days only.

Crowding-out

There is a section of experts, who do not approve the government

intervention in the economic activities. They do not want too much of money
spent by the government in the economy. According to them rising share of
public sector in the gross domestic product of the country, creates obstacles in
the way of growth of Private Sector. Whatever is gained by the public sector is
lost by the private sector, so there is net gain to the country. Resources are
limited so public sector becomes a stumbling block in the way of private sector.
Since, the opportunities for private sector go on shrinking. This phenomenon is
known as “crowding out” simply. That means, no space is left for private sector
investments in the economy. The public sector is held responsible for the
unfavorable scenario of the economy. The economic -conditions become adverse
to the interest of private entrepreneurs.

Crowding-out works through the followings mechanism:

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1) In order to expand the public-sector, the government has to increase its

expenditure. So the need for more funds arises. To meet the ever
increasing demand of resources, the governments take resort to higher
taxation. The burden falls on the private-sector. This reduces the capacity
of private sector to invest money in the economy.

2) Another area of concern is government debt, to collect more funds, the

government may sell debt to the private sector. To sell more debt, the rate
of interest is kept at higher levels. A rise in interest rates will crowd out
private-investment’s Costs will go up and shortage of finances for private
sector will take place. Moreover ,private sector profitability diminishes due
to higher cost of capital .

3) The private-sector is known for its efficiency. But, resources will get
transferred to public sector. Where, the level of efficiency does not match
up with the private sector. So the growth prospect will be hampered.
Ultimately, private individuals have to suffer.

Crowding in

The government spending may result in favourable impact on private sector. The
government may create infrastructure in the economy . This will create more
possibilities for investors .So more private sector investment will be made .This
phenomenon is known as crowding-in.

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In case the economy is working well below full employment level, the
government spending will push the economy forward.

If the government makes judicious use of resources than additional income

will be generated. This will generate additional Tax-revenue.

Moreover, the multiplier of government spending is higher than the

negative multiplier effects of an equivalent rise in Taxes.

A balanced budget fiscal expansion occurs when a change in government

spending is matched by an equal change indexations that there is a neutral effect
on the annual fiscal deficit but with the hope that real national income will
expand.

The government may create infrastructure in the economy such as

roads bridges, etc. So private sector entrepreneurs will also enjoy

these facilities. This will encourage private investment

in the economy.

Chapter F-3
Budget (A)

The governments annual statement of the estimated receipts and expenditure

for each financial year is known as the budget.

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STUDY OF UNION BUDGET

National Budget-its components
Terminology
• The budget is a financial statement showing the expected receipt and
expected expenditures of the government in the financial year.
• What is meant by Deficit?
• If receipts are less than the expenditure, it is known as deficit.
• STRUCTURE OF GOVT. BUDGET
-----------------------------------------
BUDGET EX .
BUDGET RECEIPTS:
A] REVENUE-RECEIPTS B ; CAPITAL RECEIPTS: RECOVERY OF LOANS
{ a] TAX –REVENUE { b] NON – TAX - REVENUE : INTEREST RECEIPTS
DIRECT & INDIRECT TAX PROFITS &DIVIDENDS
FEES & FINES
EXTERNAL GRANTS
RECEIPTS

A: Revenue-receipts

This includes revenue from taxation, profits of enterprises and receipts from
interest, received from states & U.Ts & Miscellaneous.

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B. Revenue Expenditure consists of the following:

• Interest Payments
• Defense-Expenditure
• General services like police and administration
• Social Services (Education, health, broadcasting etc.)
Other general services, tax – collection charges external affairs
Postal-deficit
Pensions
Write off loans to state governments
Grants to foreign governments
Revenue Deficit= Excess of revenue expenditure over revenue receipts

(A) Capital receipts consists of the following:

(i) Net recoveries of loans and advances to state governments and
P.S.U.’s
(ii) Net-market borrowing
(iii) Net saving collection
and Other capital receipts

(B) Capital expenditure refers to the following:

(i) Loans to states and P.S.U’s

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(ii) Loans to foreign governments

(iii) Capital expenditure on social and community services.
(iv) Defence and general services

Capital receipts consists of the following:

1) Net-recoveries of loans & advances to state govts & P.S.U’s (Public

Sector Undertakings)
2) Net-market borrowing
3) Net-saving collection
4) Other capital – receipts

Capital Expenditure refers to the following:

1) Loans to states and P.S.U.’s

2) Loans to foreign governments
3) Capital expenditure on social and community receipts.
4) Defense and general services

Study of deficits :
A. Total receipts =revenue receipts + capital receipts
B. Total Expenditure = Revenue expenditure + Capital expenditure

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D: Fiscal deficit = Total expenditure – revenue receipts – Recovery of loans –

others receipts.

Total Receipts = Revenue receipts + capital receipts

1] Revenue Deficit = t. Revenue Expenditure- t. Revenue Receipts
2]Budgetary deficit =total expenditure –total receipts
3] Fiscal deficit =total expenditure – total receipts excluding borrowing

4] Primary deficit =Fiscal deficit -- interest payments

An example of a Union Budget – Broad Outline

In Rs. Crores
1.Revenue Receipts 1,27,160
2.Capial Receipts of which 69,860
a)Loan recoveries and other 12,460
receipts
(b) Borrowing and other receipts 57,400
3. Total receipts (1+2) 1,97,020
4. Revenue expenditure 1,60,660
5. Capital expenditure 41,360
6. Total expenditure (4+5) 2,02,20 (1,60,600+41,360)
7. Revenue deficit (4-1) 33,600 (1,60,660 - 1,27,160)
8. Budgetary deficit (6-3) 5,000 (20,220 – 1,97,020)
9.Fiscal deficit 6-1 (1+2a) 62,400

Budget – 2014

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Non-plan expenditure- most of which is on things like interest payments,

subsidies, salaries and pensions – being higher than budgeted and tax revenues
being lower than expenditure.

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Budget – 2014
(in percentages)

1. Borrowings 25 1. Interest payment 20

2. Corporation Tax 21 2. States shares of taxes and 18
duties
3. Income tax 14 3 Plan assistance to states 16
and U.T.S.
4. Customs 10 4. Subsidies 12
5. Service Tax & other 10 5. Other non- plan 11
taxes expenditure
6. Union excise duties 9 6 Defense 10
7. Non- tax revenue 8 8 Non plan assistance to 3
states & U.T.S.

Union Budget 2015-16

Main Features:
1. Non plan expenditure Rs. 13,12,200 crores
2. Plan expenditure Rs. 4,65,277 crores
Total expenditure Rs. 17,77,477 crores
Gross Tax receipts Rs. 14,49,490
Non tax revenue Rs. 2,21,733 crores
Fiscal deficit = 3.9 p.c. of G.D.P.
Revenue deficit 2.8 p.c. of G.D.P
Pattern of Expenditure Figures in Rs.’000 crore

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1. State share of taxes and duties 23 percent

2. Interest payments 20 percent
3. Capital plan 20 percent
4. Defense 11 percent
5. Other plan expenditure 11 percent
6. Subsidies 10
7 Plan Assistance to state and UT 9
8 Non Plan assistance to states UTS 5
UNION BUDGET 2015-16
Receipts Expenditure
1. Revenue receipt 1141.6 1. On Plan Expenditure 1312.2
2. Capital receipts 635.9 2. Plan expenditure 465.3
3. Total receipts 1681.2 3. Total expenditure 1777.5

Since expenditure is greater than Receipts, this creates a situation known as

Deficit.
Revenue deficit 394.5
Fiscal Deficit 555.6
Primary Deficit 99.5

Features:
Proposed expenditure for 12 months of financial year 2015-16
Agricultural sector

Agricultural-Sector:

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1. Rs. 25,000 crore allotted for Rural infrastructure development bank.

2. Micro irrigation programme was allotted Rs. 5300 crore
3. Farmer’s credit was provided 8.5 lakh crores.

Infrastructure:
1. Rs. 70,000 crore to be spent on the development of infra-structure-sector.
2. It has been proposed to set up 5 mega power projects with a capacity of
4000 M.W.
3. Rs. 150 crores to be spent on total innovation mission to be established to
develop an expertise of entrepreneurs for development of scientific innovations.
4. Infrastructure development to take plan through PPP model.

Defence Sector:
1. Defence sector to be allotted Rs. 246726 crore, an increase of 9.87 percent
over last year.
2. Attempt to be made to develop make in India programme for defense
sector.

Education:
1. Six-new AIIMS would be established.
2. One new IIT would be established .Indian school of mines in Dhanbad to be
upgraded to status of IIT.
3. A new post-graduate institute of Horticulture to be established in Amritsar.

1. Six crores toilets across the country under the Swachh Bharat Abhiyan

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2. Provision was done for MUDRA bank to refinance micro finance orgs. To
encourage first generation of SC entrepreneurs
3. Housing for all by 2020
4. Upgradation of 80,000 secondary schools .
6. Jan Dhan Yojana and Aadhaar to be developed.
7 Pension scheme to be known as Atal Pension Yojana to be introduced. In
this scheme. Govt. will contribute 50 percent of the premium. .

Rs. 75 crore allotted for production of electric cars.

Renewable energy target for the year 2022

Solar Energy 100 K.M.W
Wind Energy 60 K.M.W
Biomass energy 10 K.M.W
Small Hydro Energy 5 K.M.W

Gold:
A new scheme, known as sovereign Gold Bond to be introduced. Under this
scheme, gold to be deposited with banks which will earn interest for depositors.

Gold-coins to be made in India to reduce the demand for foreign coins and recycle
the gold available in the country.

Financial – Sector:
Forward Markets commission to be merged with the SEBI.

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NBFCs registered with the RBI and having asset size of Rs. 5000 crore and above
to be considered as “Financial Institution”

Revenue Side:
Taxation – main proposals
1. No change in Tax-slabs
2. Total exemption of up to Rs. 4,44,200 can be achieved.
3. 100 percent exemption for contribution to Swachch Bharat, apart
from CSR.
4. Service tax-was increased to 14 percent.
5. The wealth tax was abolished, as this Tax was not a rational-tax.
6. Additional 2 percent surcharge for super rich with income of over Rs.
One crore. .
.7 . Rate of corporate tax to be reduced to 25 percent over next-four
year.
8. Govt. to borrow Rs. 6 lakh crore in F.Y. 16.
Gross-market borrowings at Rs. 6 trillion.
9. To reduce custom duty on 22 items .
11. Wealth Tax to be replaced with additional 2 percent Surcharge on
super rich.
11. Net gain from Tax proposals at Rs. 150.68 billion
12. GAAR (general anti-avoidance rule) to apply prospectively from April
1, 2 017.
13. Strict provisions against black money.

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Case-Study No. A Fiscal Policy

Goods and services tax will replace a complex web of central and state indirect
taxes.

The impact of G.S.T. is not clear. Many goods and services which are
currently not taxable-like apparel may come within the GST net.

It is expected that exemption be confined to a few merit goods like food,

power, education and health.

A government appointed committee has suggested GST rates varying

between 17 percent and 18 percent. A lower rate of 12 percent for certain goods
and services like medicines, clothing etc. More tax on luxury goods such as cars
and aerated beverages.

Consumers who currently pay a service tax of 14.5 percent will pay around
4 percent more.

It has been argued that, prices may increase for many goods. In some cases,
companies may not pass on the entire tax saving (due to GST) arising to the
customers.

Importers may gain due to imposition of G.S.T. under G.S.T. importers

would be able to claim an adjustment on taxes paid on rentals etc.

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The tax reform is expected to plug leakages, shore up revenues and to

contribute to overall economic growth.

Earlier, the rate was expected to be 27 percent . Finance Minister

suggested a Mechanism for a dispute resolution- forum. This will resolve disputes
which might arise after implementation of GST.

Some groups insist that the taxation rate cannot be written in the
constitution Amendment Bill.

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CASE STUDY: JOB-CREATORS NOT JOB-SEEKERS

Start UP India. Stand UP India:

What do you understand by the above. This is a strong reference to new

age companies. There is a plethora of start ups spanning various sectors like e-
commerce, consumer services, there new-age companies have not only made life
easier for consumers, they have also ensured jobs for large number of
unemployed persons. Startups have provided 80,000 jobs in the country this
year. 72 percent of the founders of such companies are less than 35 years old.

Start up face several problems like complying with laws such as the
Minimum wages act and Employees state insurance Act. As a starter the centre is
also planning to give exemption to start ups for participating in government
procurement.

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UNIT – G

BALANCE OF PAYMENT

G-1 Concept of Balance of Payments

G-2 Current Account and capital account

G-3 Causes of disequilibrium in the balance of payment of India

G-4 India’s balance of payments position

G-5 Methods of Correction in B.O. Payments

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G-6 Rate of exchange

G-7 Convertibility of rupee

G-8 Case Study

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UNIT G

BALANCE OF PAYMENT

There are certain functions which connect one particular country with other
countries, through the medium of money for example, when Indians sells
goods abroad India receives money from abroad. On the other hand, when
we import goods money goes abroad. Thus international trade results in
inflow and outflow of money. The difference between yearly value of
exports and imports of a country is known as “Balance of Trade”.

However financial transactions are also related to travel, transportation

insurance, banking, incomes remittances gifts foreign gifts and payment on
foreign investments etc. Such economic transactions are known as service
transactions. Thus we can state that.

Balance of Trade = Value of imports – Value of export + Net Invisibles.

The Balance of service transactions is known as Net invisibles. All the

above financial transactions are also known as current account
transactions. Because the said transactions are taken into account on
current years transaction’s.

There is another broad category also of financial transactions. This is

known as capital – Account transactions. These consist of foreign

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borrowings and inward foreign investment on the credit side and lending to
foreign countries and outward bound direct-investments.

There takes place certain transactions of official-account.

So the overall payments position of a country vis-a- vis rest of the world is
known as Balance of payments.

Balance of Payment

Balance of Trade Capital account

Value of export Net invisible

(-) value of
Imports

(i)Foreign loans received i) Loans to foreigners

Direct foreign inward investment by ii) Direct investment made
Foreigners by local in foreign
Countries.

The above description can be written as follows:

1) Balance of Trade = Value of exports- Value of Imports
2) Balance of Trade on = Balance of Trade+ Net Invisibles

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On current Account

3) Balance of = Current account – Capital account

Payments Balance

Thus, Balance of payments is an instrument to monitor country’s

international payments.

Capital account may be explained as follows as given below:

Capital Account

Capital Flows

Physical Flows Port folio Flows

Equity markets Fixed income markets

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1. The measurement of all international economic transactions between

the residents of a country and foreign residents is called the balance of
payments.

2. Balance of payments is based on double entry book keeping. Every

transaction is received twice, once as a debit and once as a credit entry.

3. Inflows are reported with a positive sign and list3ed as a credit entry.

DIFFERENCE BETWEEN BALANCE OF TRADE AND BALANCE OF

PAYMENT

Balance of Trade [ B.O.T. ] is a part Balance of payments.

Balance of trade is a year statement of money transactions of the current
year only on account of visible account. This account tells us nothing
about capital movements like portfolio investment, loans and foreign
exchange reserves etc. Such transactions are known as capital – account
and these are included in Balance of payments account.

The following tables provides a single explanation of B.O.P. Consider the

following imaginary example:

(A)1 Export of goods Rs. 1500

2. Import of goods 1800

Balance of Trade 1800 – 1500 = - 300

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[B] Export of Service 450

Import of Services 350
+ 100

(C) Balance of Trade current account – 300 + 100 = - 200

(D) Receipts on account of

(i) Capital account + 500
(ii) Capital payments - 300
(Capital – account = + 200

Balance of Payments = - 200 + 200 = ZERO

Thus, it is stated that Balance of Payments balances itself.

(1) Current - account

(a) Capital – account

(3) Official – reserves account

On Technical reasons, there is a fourth account, the net errors and
omissions account.

B.O.P.
What is current account?

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The current account includes all international economic transactions with

income or payment flows occurring within – one year. It consists of the
following four sub categories:

(i) Goods trade and import of goods (visible trade)

(ii) Services – trade (invisible trade)
(iii) Income – Trade (investment income)factors of production profit in
terms.
(iv) Current – transfers: money flows from private, public for example:
donations, aids & grants, official assistance.
The current Account is typically dominated by the goods trade which is
known as the balance of trade.

The Capital Financial Account

1) Includes long – terms and short-term capital movements.
2) Direct-investments (that stay in the foreign country)
3) Portfolio investments-purchasing securities in an overseas company
or govt. bank deposit.
4) Official- financing: covers the overall deficit or surplus for the rest of
the accounts.
5) Also known as net changes in countries reserves.

Money comes into country Money leaves

From exporting goods and Counties due to import of
Services goods and services
+ -

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Money comes into country Money leaves the country

Study of - India’s Foreign Trade

The description of India’s Foreign trade is summarized into the following
groups.

A) From 1951 to 1992 – 93

B) From 1992-93 to 2012-13
C) Recent Developments

The main features of the above time periods is described below:

(A) from 1951 to 1992 – 93 (Rs. Crores)

Year Balance of Net Invisibles Balance of

Trade payments
First Plan -542 +500 -42

II F.Y. Plan -2339 +614 -1,725

III F.Y. Plan -2382 +431 -1,951

IV Plan -1564 +1664 +100

V Plan -3179 +6221 +3082

Situation was rather comfortable during the period 1951-56. But even then
India faced deficit in the balance of trade. During the ambitious industrial
programme of IInd F.Y. Plan, Indian imports went up skyrocketing. India
made heavy imports of capital – goods heavy capital goods and defence

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goods. This was a Period of import of food grains also. On the other hand,
exports could not match imports.

India had to use the policy of devaluation. But situation did not improve.

In the IV F.Y. Plan, the policy of import substitution was given a big thrust.
The other area of thrust was export- promotion. The adverse balance of
trade continued in the V. F.Y. Plan also. The oil price increased to much on
the global level. Although exports also increased but again failed to match
imports. But the earnings on account of invisible receipts increased
manifold. There was a big increase in the number of Indian nationals going
abroad for jobs. India received huge remittances from U.A.E. and other
Arab countries. India enjoyed surplus balance of payments.

But India again suffered adverse balance of trade in 1979-80. The excess
of imports over exports went on increasing

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Rs. In crores
Year Trade Deficit Net Invisibles Balance of
payments
IV F.Y. Plan -30,456 +19,072 -11,384

(1980-85)

VII F.Y. Plan -54,204 +13,157 -41,047

1985-90)

VIII Eighth Plan -302,334 +86,090 -62,914

(1992-97)

1997-02 302,334 +249,159 -53,175

2002-07 -776674 + 770823 -5631

The above clearly shows continuous and sustained deficit in India’s

balance of trade inspite of positive net invisibles. This results in
unfavourable balance of payments position.

After liberalization of foreign trade, there was higher demand for consumer
durables, such as coloured TV’s, UCR’s air-conditioners, cars etc.
However, situation started improving after the implementation of
liberalization policy. There took place marked improvement in the in the
coverage ratio i.e. ratio of export bill to import bill. In 1990-91, it was only
2.5 months. Whereas in 1991 it was only for 15 days and it was 14.3
months in 2004-05.

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After three years of surplus, the current account re-attained the old
situation with a deficit of 5.4 bn dollars in 2004-05 and continues to be in
deficit.

India continues to remain the highest remittance receiving country in the

world. It has become the single most important source of India’s invisible
earnings for long, have shown strong growth. This showed more than six-
fold growth from $ 2 billion in 1990 to almost $ 13 billion by 2000-01. It was
2.7 percent of G.D.P.

The contribution of software service exports etc. became an important item

of India’s foreign exchange earnings.

There has taken place big increase in the foreign investment. This resulted
in sharp increase in capital flows. This has resulted in accretion in foreign
exchange reserves.

Recent-developments in India’s Foreign Trade:[ 2018 ]

India’s exports have been lower in every month as compared to the
corresponding month of the previous year. Exports have been lower than
in the corresponding period by over 17 percent. India’s trade deficit up to
a 56 month high of $16.3 billion in January ,18 as imports of precious
stones and crude surged , while growth in exports slowed down .Crude
petroleum is India’ biggest import with $ 155 bn spent on it.

It has been noticed that India’s exports to every region of the world have
declined. Exports of Africa have declined the most by 25 percent.

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I Indias’ imports in billion US dollars

years amount
2013 465.4
2014 462 .91
years amount 2015 392 . 87
2007 229.37 2016 361.21
2017 447 .0
2008 321.03
2009 257.2
2010 350 .23
2011 464. 46
2012 489.69

India has been making consistent efforts to diversify its export markets by
reaching out to regions like Africa. More worrisome are the export numbers
for the three regions India sees as its largest potential markets, namely
Europe, West Asia and East Asia.
EXPORTS IMPORTS TRADE- BALANCE
[ all figures in Rs. Crores ]
2013-14 1905011 2715434 -- 810423

2014- 15 1896348 2737087 -- 840738

2015- 16 1716384 2490306 -- 773921
2016----17 1849434 2577675 -- 728242
2017----18 1956515 3001033 --1049519
2018----19 2307663 3594373 --1286710

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Year 18-19s
INTERNAL BORROWING = Rs. 8703657
EXTERNAL BORROWING = Rs. 2 61 516

2018----19
- 18
201

Over the past decade, India has been engaged in formalizing free- trade
agreements to deepen its economic relations. Exports to the Asian member
countries have declined by nearly 25 percent, while exports to the three
North- Asian countries namely China, Japan, South Korea have declined in
excess of 16 percent.

India’s exports have driven by two commodity groups – petroleum products

and gems and jewellery for nearly a decade. Since the beginning of the
current decade, these commodity groups have been accounting for more
than a third of the exports.

The share of India’s core manufacturing sectors including chemicals,

metals, textiles and clothing, machinery including electronic equipment and
transport equipment, declined to below 30 percent. These are clear signs
that Indian manufacturing is losing its competitive edge.

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Exports of petroleum products and gems and jewelry have declined, year
on year in varying magnitudes. Garment Industry, the high employment
sectors were unable to keep pace with their competitors and were
overtaken by Bangladesh and Vietnam.

Indian’s major imports

Imports of gold and silver amounted to $ 62 bn . electronic goods and
pearls and precious stones are also top import items for the country .

1) petroleum
2) electronics
3) gold
4) defence equipment
5) technology
6) Edible oil

Indian’s Major Export

1 petroleum products [ natural – gas ] 2 . jewellry 3 . automobiles [
m&m] 4 . steel [ mittal ,tata ] 5 . agriculture [ tea ,coffee ] 6 . metals
[copper & alumi ]
INDIA’S TRADE BALANCE
2004 [ - ] 2.8 USD BILLION
2006 [ -] 59.7
2008 [ - ] 118.4
2010 [ -] 118.6
2012 [ -] 190. 3
2014 [ - ]137 .7

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2016 [ - ] 108 .5
2018 [ - ]156 .8

Causes of Disequilibrium in India’s Balance of payment

(A) Very large and fast increase in imports
1) Large increase in Development Imports. This includes capital goods,
including transport equipment
2) Large increase in import of P.O.L = Petroleum, oils and lubricants are
needed for the development of the country. Petroleum is a major source of
major source of energy used in Industry. Petroleum is a raw-material for
many synthetic products. So India’s demand for these products is price-
inelastic.

ii) Fertilizer imports: To meet the requirement of agricultural sector,

fertilizer has been an important item of India’s imports.

iii) Imports of Pearls and Precious stones:

India imports these items. These are then worked upon, polished
and then these are exported out of India.

Miscellaneous factors:
(ii) Slow growth of exports:
i) Limited exportable capacity: Most of the goods receiving foreign
demand do not have big export surplus due to high domestic demand.

ii) Impact of Inflation: Indian economy suffers from inflation. So our

goods are treated as expensive in the international markets

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iii) Low quality of goods: Due to use of old technology, the quality of
goods is not of international standards.

iv) Low income and goods of Indian export-goods: The demand for
Indian goods was less income elastic

(In U.S. $ Million)

2012-13 2013-14

Trade balance Trade balance

1. Current account -195656 -147609
Curret account balance -88163 -32397
2 Capital account balance 89300 48787

There was widening of trade deficit. This led to depreciation in the value of
rupee. There were higher imports under POL.

CAD moderated sharply in 2014. It was placed at U.S. $ 32.4 billion as

against U.S. $ 88.2 billion in 2012-13

Capital inflows increased significantly by 40.9 percent to U.S. $ 92.0 billion

in 2012-13 as compared to US $ 65.3 billion during 2011-12

Capital inflows for financing the higher CAD and there was net accretion to
foreign exchange reserves to the extent of US$ 3.8 billion in 2012-13.

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The account of monetary transactions with the rest of the world turned to a
deficit US$ 0.9 billion in July/ Sept. 2015
From interest and dividend interest and dividends payments
Payment from foreigners to foreigners that invest in the
Made by locals in foreign country
countries.

Money comes into country in the Money Leaves the country in the
Form of grants and aid form of grants and aid.

Balance of Trade is the most important part of the above. This is the largest
portion of current account. This is the largest portion of current account. If a
country is importing more than what it is exporting than the country has an
adverse (deficit) balance of trade.
TRADE SCENARIO IN 2018 -19
India”s trade deficit narrowed to the lowest level in 10 months as exports
remained flat and imports concerned in December due to a fall in global oil
prices .imports fell 2.3 % to $41 billion in December.
However, a contraction in imports is seen to be a negative for the
economy as it provides the required inputs and raw material to keep
factories running .
December 18 $bn % change
Exports 27 . 9 0.3
Imports 41 - 2.4
The fall in imports was attributed to a slowdown in oil imports ,which were
estimated to be 3 .2 higher at $10.7 billion in December.

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METHODS OF CORRECTION IN B.O.P.

In such a situation to make payment the country has to obtain money from
abroad. The best policy is to increase exports and reduce imports.

It should be seen what the country is importing. The deficit is simply not
bad. It may be importing to improve its infrastructure & productivity to
eventually increase its exports. This will be good from long term point of
view. So details of current account should be studied thoroughly because
deficit comes from balance of trade section.

Capital - Account
Movement of capital into and out of the country
Possible action for removal of persistent imbalance in the B.O. Trade
These steps take the following routes:
(A) Exchange controls’
- Regulation of imports
- Quotas & licenses

B) Demand – management – policies

- Contracting fiscal or monetary policy with expenditure- reducing
policies.

C) Expenditure – switching – policies.

Devaluation – allow local currency to depreciate

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The balance of trade affects the balance of payments. If a country like

India, is suffering from heavy current account deficit, then it will have to
depend on other countries to finance its investment needs and
consumption needs. To control this situation, following steps are
undertaken.

A) Direct controls over foreign exchange and imports, use of foreign

exchange is strictly monitored only those parties are allowed the use of
foreign exchange who can do not in the larger interest of the country. So
import- license and quotes are issued for this purpose.

ii) All exporters have to submit their earned foreign exchange to the
central Bank of the Country. The Central Bank allots the limited foreign
exchange among the licensed importers.

B) Expenditure Reducing Policies

These are also known as Demand management policies. These are used
to reduce the aggregate consumption, in order to reduce the demand for
foreign goods. An attempt is made by the policy makers to deduct
aggregate consumption of the people to reduce the Trade-deficit of the
country. This is attempted through the use of fiscal policy and of Monetary
policy. A policy mix is also used.

1) The use of Fiscal- Policy to cut down the deficit.

A contractionary fiscal Policy is used to obtain this objective Correction of
Imbalance.

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Contractionary Fiscal Policy (Expenditure reducing policies)

Fiscal policy this is down as follows:
1) Let the govt. spend less money, so income will be less. Demand will
decrease.
2) Further, let there be higher taxes, this will reduce income &
purchasing power of the people in the country.
3) Due to the above, the level of demand for goods will decrease.
4) As a result of all these, the demand for foreign – goods will decrease.
Reduction in imports and cut in trade deficit will take place.
Similar, impact on imports can be created through Monetary – policy:

1) Let the interest rates be increased. Less loans will be taken. So

money supply will decrease.

2) The volume investment will decrease.

3) This will reduce the level of income and the level of demand. All the
above factors will reduce level of imports. Thus the Trade deficit will be
reduced.

C) Expenditure – Switching Policies (Devaluation policy)

The policy makers try to reverse the domestic expenditure from foreign
goods to domestic goods. This objective is attained by lowering the value
of a currency in respect of gold/ a basket of leading currencies of the world.

Devaluation makes foreign-goods expensive in the devaluing country. So

imports go down.

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Devaluation makes domestic – goods cheaper in foreign markets therefore

the exports of the devaluing country increase.

But the successes of this policy depends on several factors. If price

elasticity for imports of devaluing country in more elastic, then, the deficit
will be reduced.

Devaluation-policy is only a means. It is not an end in itself. For example if

the elasticity of demand for imports of products like machinery, crude oil is
low in the country. Then the country would find it difficult to reduce its
imports in response of devaluation.

CORRECTION IN DEFICIT
On the other hand, the high elasticity of demand for exports, than,
devaluation, will help in reducing deficit. But, countries like India face a low
elasticity of demand for their export items in foreign countries. Therefore
devaluation policy is not a very successful policy

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Rate of Exchange

Fixed exchange rate

It is the rate at which one currency will be exchanged for another in foreign
exchange. It is also regarded as the value of one country’s currency in
terms of another currency.

There are several approaches to the determination of rate – of – exchange.

The major theories are described below:

(A) Fixed rate of exchange

An exchange rate between currencies that is set by the government

involved rather than being allowed to fluctuate freely in the market.

The details of the above have been explained below:

a) Fixed – rate of exchange

b) Floating - rate of exchange
c) Managed – rate of exchange

It is the system of following a fixed rate for converting – currencies.

In this system, the central bank of the country intervenes in the currency.
Market in order to keep the exchange rate close to a fixed target.

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It does not allow major fluctuations from the central – rate.

The govt. determines the exchange rate for a period of time based on the
value of another country’s currency such as US dollar.

This method of determining exchange-rate was to dominate until 1970’s.

The purpose of a fixed rate system is to maintain a country’s currency

value within a very narrow band.

Fixed – exchange rate: an exchange rate between currencies that is set by

the govt. involved rather than being allowed to fluctuate freely unit market
forces – authorities activities enter the currency. Currency market to buy
and sell according to variations in supply and demand. Helpful for small
nations.

The govt. of a country does not let the exchange rate change in
accordance with the demand and supply for the currency. The purpose of a
fixed rate system is to maintain a country’s currency value within a very
narrow band.

Advantages of fixed – exchange – rate

1. It provides the stability of exchange rate and reduces volatility and

sharp fluctuation in relative prices.

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2) Fixed-rates provide greater certainty for exporters and importers.

Thus eliminates exchange rate-risk.

3) Good policy for increasing exports due to certainty in the payments in

the international market.

Dis-advantages of fixed-exchange-rate:

1) The system of fixed-rate of exchange is too rigid to take care of major

upheavals

2) This system can only be successful if the country is having abundant

foreign-exchange-reserves, to defend the fixed exchange-rate.

3) This system creates conditions suitable for speculation. Most of the

currency crisis had taken place in the past, in countries having fixed
exchange-rate system. Black-markets will emerge.

4) The fixed exchange – rate system does not reflect the true value of
the currency.

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Fixed exchange rate – regime shown in the figure, above the official
exchange rate has been fixed at a level of $ 1.00 = $ US 0.60, which is
above the market of US$ 1.00 = US$ 0.50

For the exchange – rate to be fixed at a level higher than the market
requires official intervention by the central – Bank of the country.

At this level the Central Bank would have a but the excess supply of local
currency equivalent to Q1Q2 at the price of $ 0.60 to buy the surplus of
local currency the govt. would need to sell its reserves of foreign currency.

A fixed exchange – rate system does not imply that the rate will stay at the
same level all the time. The govt. may decide to exchange the rate
because of adverse effects on the economy. For example if the currency is
over valued exporting industries will become internationally – competitive,
affecting internal trade and the government might take action to devalue
the exchange rate.

Fixed rate become internationally – competitive, affecting international

trade and the govt might take action to devalue the exchange rate.

Flexible or floating exchange rate:

Under a flexible – exchange – rate the value of a countrys currency
changes frequently. The market rate will depend on the demand for and
supply of that country currency in the forex markets. When there is no
intervention in the free-market operations by a govt. agency a ‘clean float”
is said to exist.

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A country’s exchange – rate regime its currency is set by the foreign –

exchange market through supply and demand for that particular currency
relative to other currencies.

If exports of a country increase, then the supply of foreign currency will also
increase. Price of foreign currency will fall, thereby, price of foreign goods
will decline. So imports will increase it vice-versa. Thus there is a system of
automatic adjustment in Demand & supply of foreign currency.

Benefits of Floating exchange rate:

• Promotes economic-development
• Increase in liquidity
• Independent-action
• More confidence of traders/ investors
• No speculation, because quick changes are made
• There takes place automatic adjustment for countries with a large
deficit in balance of trade.
• No need to maintain large international – reserves.

Limitations:
1. The system is inflationary
2. Flexible exchange rates are highly unstable so that flows of foreign
trade and investment may be discouraged.

Too much fluctuations may take – place:

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1. Due to change in the rate of interest

2. Change in the real income
3. Speculative demand & supply
4. Structural change in the economy.

For under-development countries, the fixed rate is appropriate.

Purchasing Power parity
The price of a good that is charged in one country should be equal to the
one charged for the same good in another country, being exchanged at the
current-rate.

The rate of exchange between two-currencies in the long-run will be fixed

by their respective purchasing powers in their own nations.

This rule is also known as the Law of one price. Otherwise, ne could make
profits by buying the goods in the cheap market and resettling it in the
expensive-market.

The general implication of relative PPP is that countries with high rates of
inflation will see their currencies depreciate against those with low rates of
inflation.

This gives us a relationship between relative inflation rates and change in

exchange-rate. Currencies that have had the largest relative decline in
purchasing power see the sharpest erosion in their foreign exchange
values, and vice-versa.

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The exchange- rate between the two countries currencies should be equal
to the ratio of their price levels.

Example: If the price index in US Dollars is the price of basket of goods in

the US and a price index is AUD is the price of a similar basket of goods is
Australia then.

Price if only internally traded are relevant up takes in to account, domestic

price of all goods.

Price Index USD= Price index AUD (spot USD/AUD) criticism.

1. Difficult to get similar basket of goods for both countries, due to each
country’s different consumption- patterns.
2. Constraints on the movement of commodities.
3. Price index construction
4. Effect of the statistical method employed.
5. Impact of tariff a subsidy does leave its impact
Example: The India USA
A basket of goods Rs.100 $2
So the exchange $ 2 = Rs. 100
Rate
(D) Managed exchange rate
Managed means the exchange rate-system has attributes of both systems.
Through such official interventions it is possible to manage both fixed and
floating exchange rates.
The system permits the government to place some influence on an
exchange rate that would otherwise be freely floating.

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Under this system exchange rate is determined by the process of supply

and demand.

Determinants of foreign exchange - rate

1. Interest- rate
2. Inflation rate
3. Govt. budget
4. Political conditions

A group of 49 nations including India, Indonesia Russia etc. have adopted

the managed floating system.

CONVERTIBILITY

Meaning: Currency convertibility refers to the freedom to convert the

domestic currency into other internationally accepted currencies and vice-
versa at market determined rates of exchange.

A) Current account convertibility: allows residents to make and receive

trade related payments.

B) Capital account convertibility: means the freedom to convert the local

financial assets into foreign-assets.

Basic difference among the above two: It is important to have a transaction

such as, importing and exporting of goods etc. but in case of capital-

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account convertibility a currency can be converted into any other currency

without any transaction.

Partial-convertibility on current account:

Before 1992-93 all external payments had to be made through R.B.I.
Exporters had to surrender their earning to authorized dealers and get
rupees in exchange of foreign-currency.

Partial- convertibility: 60 percent of export earnings could be converted at

the free market determined rate and 40 percent to be sold to R.B.I.,
through dealers at the official rate of exchange.

Full- convertibility ? Market rate of exchange will give higher returns.

Advantages: Exports are motivated to increase their export.

1. Encouragement to exports. Incentive to Indians working abroad to set

money to India

• A self-balancing mechanism
• Integration of world-economy

Dis-advantages:
1. May lead to inflation
2. May lead to depreciation of currency
3. May lead to volatility of currency

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All current transactions of India will all other countries, with regard to trade
on merchandise – services, such as education, travel, medical expenses
etc. and remittance are now fully convertible (rupee) into other currencies.

Tarapore committee put certain conditions:

1. The average rate of inflation should vary between 3 Percent to 5
percent.
2. Decreasing the gross fiscal deficit to the DDP ratio by 3.5 percent.

Full- convertibility of the rupee we have adopted for our country is tied up
with exchange – controls and restrictions envisaged by the provisions of
the foreign-exchange rules.

Through the rupees is not freely convertible on the capital account, in

certain transactions full convertibility prevails.

Foreigners N.R.I.’s engaged in investing in portfolio or direct investments

are given freedom to bring in and repatriate their funds.

It is felt that a strengthening of the reserve-position will make India ready to

adopt full- convertibility on the capital account. It is observed that
movement towards fuller CAC should be a process and not an event.

Foreigners would be able to invest in the Indian stock markets, buy up

companies and property.

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Capital account convertibility:

This was introduced in India in Aug. 1994

The committee on capital account convertibility was set-up by RBI under

the chairmanship of S.S. Tarapore.

The report submitted by this committee in the year 1997 and proposed a
three-year time period for total conversion of rupee.

C.A.C. as the freedom to convert local financial assets into foreign assets
and vice-versa at market determined rates of exchange without any
regulation.

India does not have fully CAC

The Government has its own rules and policies to regulate foreign
investments.

In case of full CAC, any investor from anywhere in the world can invest in
any asset in the country.

The local traders can conduct transnational business freely without any
regulation Indian could convert their rupees into dollars and deposit it in the
U.S.A. under full account capital convertibility.

Q.1 Give arguments in favour of and against.

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Fixed – exchange – rate system. How exchange rate can be determined

under flexible exchange rate-system? Explain your answer on the basis of
hypothetical example and complete interpretation.

Q. Explain the concept of Balance of Payment with its complete working

process? Describe expenditure – reducing and expenditure – switching
policies to correct the disequilibrium in the balance of payments – position.

Q. Explain the concept of deficit in Balance of payments of an economy.

Distinguish between temporary and fundamental disequilibrium in balance
of payments.

Q. Explain the structure of Balance of payments statement and examine

in detail the recent trends observed in the B.O. payments position of India.

Q. Discuss the disequilibrium in balance of payment. What are the

measures to correct it.

ADD TO YOUR KNOWLEDGEW

ADR & G.D.R
Depository receipts are societies denominated in foreign currency which
consist of shares of an Indian issues in a fixed promotion.

The shares are help with the trustee- bank depository receipts were in
vogue in the 1990’s and early part of the millennium and were meant to
help Indian companies tap global investors.

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In recent – years with the entry of large foreign investors ADR’s and DGR
have lost some of the prominence that they enjoyed earlier.

Indian companies raise funds to retire loans taken overseas and unutilized
had to be parked only with Indian Part

Some Fears
SEBI fears that unlisted local companies with rush for overseas depository
receipt. Insurance Finance Ministry wants a common repository for all
financial products as per budget of February 2014. The minister wants to
enlarge the scope of depository receipt.

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Case Study
Management of India’s External – debt a wonderful story

1. India has external debt of Rs. 3.66 lakh crore till March 2015

2. Out of the above Rs. 2.37 lakhs or 65 percent is unutilized committed

loans.

3. Between 2012-2015 more than Rs. 400 crore paid as commitment

charges on unutilized external assistance, biggest beneficiaries being
Japan and Asian Development Bank.

4. 90 percent of Rs. 1400 crore commitment charges paid between

1991-2009 were to World-Bank and ADB.

5. Some other reasons were delay in awarding procurement contracts.

Poor performance of supplies, lack of professional managers, and
transport issues etc. also caused delays>

6. The large undrawn money is in sectors of urban development Rs.

33,000 crores, atomic-energy Rs. 31,000 crore and power Rs. 28,500
crores, railway Rs. 25,130 cr. Water supply and sanitation Rs. 14,900
cr. Among others.

7. India has paid over Rs. 400 crore in the last four years as
commitment charges. Commitment charges are a fee charged by a
lender

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Debt-Page 2

To a borrower for an unused credit like or undisbursed loan. They are

incorporated in external financial assistance negotiated by the Central
Government. Experts do not like such commitment charges under the head
“interest obligation”, for obvious reasons.

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Rupee Bonds 101

Bonds are instruments through which companies raise funds. Rupee
denominated bonds are issued in overseas markets.

Indian companies have been borrowing money from overseas markets. But
these are denominated in dollar or other foreign currencies such as the
Euros.

Off-shore rupee bonds allow companies to ledge currency fluctuation risks.

A company’s costs may rise sharply if, for instance, the rupees value had
weakened sharply during pay back time compared to its value at the time of
issuing the bonds.

A rupees bond negates such risks. Besides, interest rates are lower
by about two percentage points, which helps companies cut costs.

Rupee bonds can influence local interest rates and the domestic currency
rupee bonds, if they take-off can reduce the demand for dollars and present
a slide in the local currency’s values.

Besides, it can help prop up the rupee’s position the global currency
market, similar to how growing demand for dim sum bonds encouraged the
use of yarn in global trade and investment.

Case Study no.

India’s growth prospects

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As per reports released by World Bank, India would remain comfortably the
fastest growing large economy in 2016.

As per world bank projections, the world economy as a whole would grow
at 2.9 percent.

It has been pointed out that, with Bangladesh projected to grow at 6.7
percent, South Asia will be the world’s fastest growing region.

On the other hand, Russia’s economy is projected to shrunk by 0.1 percent.

South Africa is expected to grow very slowly at 1.4 percent.

As per as India is concerned, India has made important gains in productive

capabilities, allowing it to diversify its exports into more complex products,
including pharmaceuticals and even electronics.

World Bank, 2016 Growth Forecast (%)

World 2.9
U.S.A. 2.7
Euro Area 1.7
Japan 1.3
U.K. 2.4
China 6.7
India 7.8

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Alternative View

The Indian economy is like a car running on two wheels. According to an

opinion the Indian economy has been stuck in a groove. Because GDP
growth for 2015-16 is not likely to be higher than 7 percent.

The main culprits are explained as follows. Private investment and exports
are not growing and corporate balance sheets are stressed. Net sales have
fallen by 5.3 percent and profit after tax is flat. Non food credit growth at 8.3
percent is slowest in 20 years. Growth of credit to industry is 4.6 percent
while credit to medium enterprises has actually shrunk by 9.1 percent.

It has been pointed out that the decline in exports for 12 successive months
compared to the corresponding periods of the previous years.

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CHAPTER : 14

Study of Inflation

E-1 Features of Inflation,

Demand Pull-inflation and cost-push inflation
Degrees of Inflation

E-2 Measurement of Inflation

E-3 Inflationary gap

E-4 Inflation in India

E-5 Impact of Inflation

E-6 Control of Inflation

E-7 Phillips Curve

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CHAPTER : STUDY OF INFLATION

E-1
E-1 Inflation
Features of Inflation

Inflation is the rate of increase in prices for goods and servicesThe

inflation rates are expressed as percentages. If C.P.I. is 3 percent, this
means that on average, the rate at which the general level of prices for
goods and services is rising is 3 percent. The purchasing power of money
keeps on falling during inflation.

As inflation rises, every dollar will buy a smaller percentage of a

good. For example, if the inflation rate is 10 percent, then a Rs. 1 pack of
X-good, will cost Rs. 1.10 in a year.

Thus, inflation is defined as a sustained increase in the general level

of prices for goods and services

Causes of Inflation:
As for as causes are concerned, there is no one cause that’s
universally agreed upon, but at least two following theories are generally
accepted.

Types of inflation on the basis of causes:

(A) This occurs when the demand grows faster than supply, prices do
increase. This usually occurs in developing economies like India.

The demand-pull-inflation may be caused by the following reasons:

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(1) Increase in disposable income: If the income levels rise at a faster-

rate, resulting in higher level of purchasing power and Demand for goods.
And, hence, higher prices. Black money also leads to high consumption.

(2) Increase in money supply: These days, the government print too
much currency. Money-supply level goes up. This pushes up the level of
purchasing power and the level of demand. So inflation is also called as a
monetary phenomenon.

(3) Increase in govt. expenditure: The government have become big

consumers, too. The demand level pushes-upwards for examples. In India,
the govt. is the biggest consumer of petroleum products.

(4) Increase in supply of bank money: Growth of banking system results

in too much expansion of credit. This also leads to more money supply in
circulation in the country. The becomes a contributing factor to level of
Demand for goods from consumers as well as from producers. More-credit
means less interest rates and more demand and more prices.

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(5) Increase in Foreign Demand: Prices also increase if the demand for
domestic goods goes up substantially. In India, whenever, the export-
demand of (vegetables especially) prices shoot up. The local prices of
onions go up higher.

The above are some of the important factors that lead to higher
demand for goods and higher prices. Following diagram shows the impact
of higher Demand as compared to supply and the resulting increase in
prices.

Another factor, high levels of foreign investment in the country

increases employment, income, consumption and ultimately Aggregate
Demand.

(B) Cost-push inflation:

When cost of production goes up companies, they need to increase
prices to maintain their profit-margins.

Increased costs may be the result of increase in; wages, taxes, inputs
or increased costs of imports.

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1) Increase in prices of inputs

An increase in the prices of inputs shifts the aggregate supply. Curve
to the left due to rising costs.

2) Wage-increase: Wage increase lead to higher production costs. The

additional cost is passed on to the consumers by the producers.

3) Higher import-prices: Due to rise in prices of products like Crude-oil

and machinery etc. the cost of production goes up. This results in cost-
push inflation.

4) Increase in Administered prices: The govt. also keeps on increasing

the prices of electricity, water, gas etc. This also leads to higher-price of
finished goods. The increase in procurement prices of wheat, rice etc. by
the Government of India also leads to cost-push inflation.

Types of Inflation on the basis of rates

Types of Inflation on the basis of rate of inflation

Type of inflation
Creeping inflation
Walking inflation
Running inflation
Galloping Inflation
Hyper-inflation
Rates of inflation
Inflation rate 2 percent to 5 percent
Inflation rate 5 percent to 10 percent
10 percent to 20 percent
Rate above 20 percent
Extra-ordinary rates

1. Creeping Inflation:

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The creeping inflation is a tolerable situation. No one complaints of

this type of inflation

2. Walking-inflation: This affects the economy. It becomes cause of

concern to the policy makers.

3. Running Inflation: The prices of finished goods rise substantially. But

the producers do not feel happy because the input costs also show
upward-trends.

Domestic products are out priced in foreign markets.The real worth of

the local currency starts depreciating.

4) Galloping-Inflation:
The inflation becomes quite severe. The purchasing power of money
depreciates fast. Savers get discouraged. Uncertainty takes place in the
economy.

5) Hyper-Inflation: This is a rare situation. Price rise is so high that

currency-notes loose their values. People loose faith in currency of the
country.

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E-2 Measurement of Inflation:

How is the rate of inflation calculated?

1. The cost of living is a measure of changes in the average cost of

buying a basket of different goods and services for a typical household.

3. The prices of everything to be included in it are simply added up

and divided by the number of items.

CALCULATION OF CONSUMER PRICE INDEX [ C.P.I. ]

Measuring the cost of living
METHOD OF CALCULATING C.P.I.
FOLLOWING STEPS ARE TAKEN:
1] fix the basket
Find out what’s in the typical consumers ‘shopping – list ‘.
2 ] find out the prices
Collect data on the prices of all goods in the basket
3 ] calculate the basket’s cost
Use the prices to compute the total cost of the basket
4th step : choose a base year and compute the index
The C.P.I. in any year equals

cost of basket in current –year

100 X ------------------------------------
Cost of basket in base year
5th step :
Compute the Inflation –rate

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The percentage change in the CPI from the preceding period

CPI this year -----CPI last year

INFLATION RATE = ------------------------------------------- x 100 p.c.
C P.I. LAST YEAR
Example year 1 year 2
1. Apples price quantity price quantity
$ 1.00 2 kg. $ 1.5o 4
2. Bananas $ 2 3 k.g . $ 2.50 3 k.g.

Cost of market basket :

Year 1. $ 1.00 x 2 =2 $ 2.00 x 3 = 6 total =[[ 8
Year 2 . 1.50 x 2 =3 $2.50 x 3 =7.50 [[ 10.50

CPI = COST OF BASKET IN CURRENT YEAR X100

-------------------------------------------------------
COST OF BASKET IN BASE – YEAR
Year 1 = 8/ 8 x100 =100

Year 2 = $10. 50 / 8 = 1.35 / 100 = 131.25

Rate of inflation =

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It is assumed that the consumer’s basket consists of two products only . we

call them as product –X [ qty . 4 units ] and product –y [ 10 units ]

Year price of product –x price of – y product cost of basket

2010 10 2.oo 10X4 +2 X10 =60
2011 11 2.50 11X4 + 2.50X10 =69
2012 12 3 . 00 12X4 + 3 X10= 78
----------------------------------------------------------------------------------------------------
computation of CPI in each – year using 2010 as the base – year

2010 100 X [ 6O/ 60 ] =100 1 15 -100 X100 =15 p.c.

---------------
100
2011 100 X [ 69 / 60 ] =115
2015 100 X [ 78 / 60 ] =130 =130 -115 =13p.c.
----------- X100
115
Hypothetical example:
Category Price Index Weights Price X Weight
Food 104 19 1976
Alcohols & Tobacco 110 5 550

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Clothing 96 12
Transport 108 14
Housing 106 23
Leisure Services 102 9

Weights are attached to each category, we multiply these weights to the

price-index for each item of spending for a given year.

The price-index for this year is:

The sum of (price x weight)/ sum of the weights

So the price-index for this year is 104.1 (rounding)

The rate of inflation is the % change in the price index from one year to
another.

So if in one year the price index is 104.1 and a year later the price-index
has risen to 112.5, then the annual rate of inflation = (112.5 – 104.1)
divided by 104.1x100. Thus the rate of inflation = 8.7 percent.

Inflation rate is calculated as the percentage rate of change of a certain

price index.

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PINt – PINt-1
Rate of inflation = -------------------- x 100
(PINt-1)

Wholesale price Index is calculated on the basis of average price level of

goods at wholesale-market.

A particular year is chosen as a base year at 100

Suppose the base year is 2008-09

Suppose, the price of a Kilogram of wheat in 2008-09 base year =
Rs. 5.75

The WPI of wheat for the 2010-11 is Rs. 6.10

= Wholesale price of wheat in 2010-11 WP wheat in 2008-09
----------------------------------------------------------------------------- X100
WP Wheat in 2008

(6.10 – 5.75) x 100

------------------------ = 6.0-9
5.75

Since WPI for the base-year is assumed as 100 WPI for 2010-11 will
become 100+6.09 = 106.09

= Composite WPI of current year – WPI of previous year

--------------------------------------------------------------------------- X100
WPI of previous year

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Suppose, WPI of 2010 is 109.09 and WPI of 2011 is 109.72, then inflation
rate for the year 2011 is
107 – 101
= ------------- - X 100 = 5.94 percent
100
E-3: Inflationary Gap

The term inflationary gap is a pointer to a condition which gives rise to

inflation. The gap is called inflationary because it causes inflation in the
economy. This gap leads to continuous rise in prices.

When would it happen? When all the resources have been fully
utilized. The economy is having a situation known as full-employment.
When aggregate demand exceeds aggregate supply, then, this situation is
known as excess demand and the gap is called inflationary gap. If we take
the case of a country where the total production by using all its available
resources is one million units. But the demand is for 2.5 million units. As a
result of this, the excess requirement of (2.5m one million) 1.5m is the
excess demand. The excess of 1.5 million is called as inflationary gap.

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Factors creating inflationary-situation:

The inflationary gap may arises due to the following factors:

1. Increase in household consumption would mean more demand for

goods. Increase in private investment demand causes aggregate Demand
to move upwards.

2. More demand from foreign markets for the local products also pushes
up the Aggregate Demand curve upwards.

3. The increase in public expenditure also leads to creation of additional

demand.

4. Increase in money supply in the economy due to deficit financing

policy of the government.

5. There may take increase in the disposable income of the consumers

resulting in higher demand.

Impact of Excess demand:

1. If excess-demand takes place, when there are no unemployed

resources in the country them there will be general rise in price level.
Output will not increase since all the available resources are already being
used fully. However, there can be a possibility of increase in output only if
productivity of labour is increased in the long period. But this may not

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happen in the short period. Because it is not possible to increase

productivity of labour in the short period. A continuous increase in prices
may take place.

If supply of factors is inelastic, prices will rise since output cannot be

increased appreciably.

E-4 INFLATION IN INDIA:

The inflation rate 6.84 percent in February of 2013.

1 From 1969 to 2013, India inflation rate averaged 7.74 percent.

2. All time high in 1974 at 34.68

3. On the other hand, a record low of (-) 11.31 percent in 1976

4. During 2005-12, the average inflation rate was 7 percent.

5. The inflation rate was 6.84 percent in February of 2013

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E-4 Inflationary Trends in India:

The inflation problem emerged in India, during the second Five Year
plan. The forces on the Demand side have been forceful all these years,
resulting in rise in prices, which we call as demand pull inflation.

There has taken place increase in the supply of goods, but this could
not match the demand. The demand and supply imbalance has been the
main cause of inflation.

Main factors may be put in the following categories:

(A) Demand-pull factors
(i) Increase in govt. expenses
(ii) Vast increase in Money supply
(iii) Impact of black money

(B) Cost push factors:

(i) Slow increase in productive capacity
(ii) Rise in Administered Prices
(iii) Heavy burden of taxes
(iv) Rise in procurement prices

(C) Other factors:

Defective distribution system
Black-marketing and hoarding

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The above are some of the important factors for creating inflation in
India.

INFLATION IN INDIA:
Retail inflation came down from 11.24 percent in November 2015 to 5
percent for December 2014, after touching record lows of 4.38 percent in
the previous month, November 2014.

Food and fuel prices that had significantly spiked during 2013
condensed. These two items together constitute 57 percent of the C.P.I.

Crashing oil prices have been dropping since June 2014. From $
111.25 per barrel in the middle of June, 2014, US crude prices dropped by
over 95 percent to $ 56.55 per barrel in December 2014.

It was observed that more loans to agriculture have fostered

substantial private investment in agriculture, this may have pushed up rural
wages.

Rural inflation has been higher than urban inflation throughout the
calendar year.

The R.B.I. hiked the repo-rate by 0.25 percent to 8 percent in

January, 2014.

On June 3, 2014, the SLR was reduced by 0.50 percent to 22.5

percent and by another 0.50 percent on August 5 to 22 percent.

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INFLATION RATES IN INDIA

YEARS RATE OF INFLATION

---------------- -----------------------------------
2017 4.0
201 6 2.23
2015 6.32
2014 5.86
2013 9.13
2012 11.17
2011 6.49
2010 9.47
2009 14 .97
DURING LAST 12 MONTHS inflation – rate 4.36 percent s
DURING 60 MONTHS Inflation -rate 28’13 percent
Last 120 months inflation – rate 109 .49 percent

Besides above, several other measures were undertaken by the

government such de-hoarding drives against hoarders of vegetables and
pulses. Food prices were quite notorious in the last week of the year 2015.

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E.5 IMPACT OF INFLATION:

Inflation affects different people in different ways.

(1) The salaried middle class suffers the most under inflation since, cost
of living goes up. Their standard of living goes down.

(2) Creditors lose and debtors gain because of fall in the value of money.

(3) Uncertainty about what will happen next makes corporations and
consumers less likely to spend. This hurts output in the long run.

(4) If the inflation rate is greater than that of other countries, domestic
products become less competitive in the international markets.

(5) Workers feel reduction in their real incomes due to rise in prices. So
more demand for rapid wage increase arises in the economy.
Sometimes, this results in social unrest.

(6) Anti-social elements become active. Investment is diverted from

productive activities to non-productive activities, such as hoarding
and black marketing etc. Investment in non productive activities
provides quick profit with less risk. Production is adversely affected.
Inflation leaves adverse effect on balance of payments. It becomes
difficult to compete with firms abroad.

We all agree that Deflation is bad but inflation is unjust.

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The lengthening of inflation brings bad news for the economy;

inflation leads to rise in the cost of inputs. The firms feel the heat in the
form of reduction in the rate of profit. The investment starts declining.
Production in the real term starts decreasing. Gross domestic product goes
downwards. Economic progress of the country takes a dip. Cost of
borrowing goes up due to inflation High inflation may also lead to higher
interest rates for firms and people needing loans and mortgages as
financial market protect themselves against rising prices. This leads to
increase in the cost of borrowing on short and longer term debt.

Business becomes less competitive. Suppose, one country has a

much higher rate of inflation than others for a considerable period of time.

This will make its exports less price competitive in foreign markets so
exports will decline. The country’s foreign exchange earnings will decline,
with the increase in the prices of basic commodities like sugar, petrol and
vegetables etc.

Due to rise in cost of living workers will demand higher wages. This
will reduce entrepreneur’s earnings.

If interest rates on savings accounts are lower than inflation, people

who rely on interest from their savings will be poorer. Real interest rates for
millions of savers become negative, Availability of funds becomes less.
Thus, the economy faces hurdles from various sides and ultimately this
hampers investment in the country.

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Due to rise in prices, the value of money in hand gets reduced. With
the increase in the prices of basic commodities like sugar, petrol and
pulses etc. one needs to spend more money to buy the same amount of
goods. But wages/ salaries do not rise in the same proportion. So life
becomes difficult.

Chapter E-6 CONTROL OF INFLATION

Inflation can be controlled by those policies that slow-down the

growth of aggregate-demand. This also requires policies to boost the rate
of growth of production and supply of goods in the economy. Controlling
inflation is not an easy job. Various steps needed to control inflation can be
summarized as explained below:

(A) Use of Monetary Policy to Control Inflation:

Inflation is said to be a monetary-phenomenon. Therefore the use of

monetary instruments becomes more important in controlling inflation in the
short period. A dear money policy may be used to check inflation. This
policy takes interest-rates to higher levels. The impact is felt on consumers
and investors. The use of monetary policy to control inflation is known as
contractionary policy. The first step is to increase interest rates through the
Central Bank of country.

The Bank rate is the rate at which banks borrow money from the
Central bank. When the Central Bank increases its interest rate. In such a
situation, commercial banks have no choice but to increase their lending
rates as well. This enhances the cost of capital. Taking loans becomes

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expensive. So people want to borrow less-money. . Obviously, prices do

drop. We say that inflation has slowed down.

Another method to decrease spending in the economy is to reduce

the banks capital to lend-money. This is done by increasing reserve
requirements. Banks are instructed to keep in hand more cash to cover
withdrawals. This step reduces banks capacity to lend money. Thus less
bank money is generated in the economy. The level of purchasing power
and demand for goods diminishes. This helps in controlling prices.

The third method is to pay more interest on bonds so that investors

will get attracted towards bonds. More money will be withdrawn from
circulation, instead of being spent on goods.

USE OF FISCAL POLICY TO CONTROL INFLATION:

Fiscal-policy refers to the use of Public revenue and public

expenditure public-revenues consists of tax-receipts and Public borrowing.

The government may reduce its own

i) Spending on non-productive activities and on non-merit goods.

Subsidy on various items may be reduced. Welfare payments may be
reviewed.

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ii) The government can choose to raise direct taxes. This will result in
reduction in disposable income and lower demand for goods and services.

1) Implementing policies to increase production and supply of goods to

satisfy the demand of the buyers.

2) A reduction in taxes which may encourage risk taking and productive

investment. This will result in more production and availability of
goods.

3) These policies seek to increase competition, and productivity. All of

these can increase production and thus control prices.

4) The state may undertake construction of infrastructure such as to

increase productive-capacity and production in the economy.

Direct-Controls:
The govt. may introduce direct controls on prices. The distribution of
goods may be improved. There should be no scope for hoarding and black
marketing of goods especially of essential goods.

The state may import goods whose shortage is felt in the country and
whose prices keep on rising.

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E-7 PHILIPS-CURVE

The government’s main objective is to attain full employment and stable –

economy. Philips-curve explains the trade off between these two-
objectives. Both of these objectives cannot be obtained at the same time,
as per the concept of Philips-curve. This is known as the trade-off between
these two-objectives.

Professor A.W. Philips observed that one stable-curve represents the

trade-off between inflation and unemployment. This implies that if
unemployment decreases, inflation will increase and vice-versa. This
observation was based on the analysis of data ranging between1861 to
1957.

Chart

As the economy grows faster and more people are employed, wages will
start slowly. This will increase the firm’s cost of production and the high
costs are usually passed on to the customers in the form of higher prices.
So, a decrease in unemployment has led to increase inflation and vice--
versa.

Short-run Philips-Curve:

As explained above, the Philips-curve shows an inverse relationship

between inflation and unemployment. To reduce unemployment, we have
to accept higher inflation as a trade off in the above diagram, when

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unemployment rate is 6 p.c., the inflation rate is only 1.5 per cent. But, with
the reduction in unemployment rate the inflation rate is much higher at 2.5
p.c.

The Long-Run Philips-Curve

To counter the rise in unemployment government undertakes expenditure

in the economy. The result is a short-term fall in unemployment but higher
inflation. This higher inflation fuels further expectation of higher inflation
and so the process continues.

The long-run Philips-curve is vertical at the natural rate of unemployment.

Chart

The above diagram, at a higher level of 7 p.c. of unemployment, the

flirtation rate is low at 1 per cent only the government takes measures to
reduce unemployment by an expansionary fiscal policy that pushes
Aggregate Demand to the right.

Although, there takes place fall in unemployment but at the cost of higher
inflation. Unemployment reduces to 5 per cent from 7 p.c. but inflation rate
goes up higher 7.5 per cent. Employers grant higher wages, so the costs of
production goes up. They reduce engaging les workers and unemployment
reverts back to higher level of 7 per cent. The data gives us a vertical
shaped curve.

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Philips-curve is still used in short-term scenarios. It is believed that policy

makers can manipulate the economy only on a temporary basis.

For example, if unemployment is higher and stays high for a long-period of

time in conjunction with a high, but stable rate of inflation, the Philips-curve
shifts to reflect the rate of unemployment that “naturally” accompanies the
higher rate of inflation.

The theory states that with economic growth comes inflation, which in turn
should lead to more jobs and less –unemployment.

Natural rate of unemployment (NAIRU)

The lowest rates of unemployment that an economy can sustain over the
long run some experts believe that a government can lower the rate of
unemployment if it were willing to accept a higher level of inflation.

The natural rate is the lowest level of unemployment at which inflation

remains stable. This is known as non-accelerating inflation rate of
unemployment (NAIRU).

When the economy is said to be at full employment, it is at its natural rate

of unemployment.

Governments stimulate the economy to reduce unemployment. This action

leads to higher inflation. When inflation reaches unacceptable levels, the
government tightens fiscal policies, which decreases inflation and increase
unemployment.

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Ideally, the perfect policy would result in an optional balance of low-rates of

inflation and high rate of employment.

But in the long-run, since unemployment way returns to its natural rate
(unemployment rate at which GDP at its full employment level that is, with
no cyclical unemployment

(A) When unemployment rate is below natural-rate of unemployment,

GDP, is greater than potential output.

Economy’s self correcting mechanism will then create-inflation.

(B) When unemployment rate is above natural rate of unemployment,

GDP is below potential output.

The self correcting mechanism will then put downward pressure on

price level.

Critical assessment of Philips-curve

Critics have pointed out that ways rise or fall in relation to the demand for
labour.

In the 1970s, the outbreak of stagflation in many countries resulted in the

simultaneous occurrence of high levels of inflation and high levels of
unemployment.

EXERCISES FOR STUDENTS

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Q.1 If economy is overheated with inflation what policy measures you

could suggest as a prudent economist so that growth of GDP of the
country should not be affected. Critically examine the effectiveness of
Monetary-Policy with examples.

Q.2 Distinguish between Demand- Pull and cost push inflation alongwith
type of inflation. Is inflation bad or good for economy and business?
Explain with examples.

Q.3 Explain the trade off between inflation rate and unemployment both in
the short and long run. Is long run Philip curve related to stagflation?

Q.4 Explain the concept of “Crowding out”? Why we do not have it in

liquidity trap situation?

Q.5 Explain the trade-off between inflation-rate and unemployment rate

both in the short run and long run.

Q.6 Explain the concept of stagflation? Has Indian-economy faced the

situation of stagflation ever?

Q.7 What is the difference between frictional and structural

unemployment.

Q.8 Why long-run Philips curve is vertical? Is long run Philip curve is
related to stagflation?

Q.9 Explain various degrees of inflation and relate it to Indian inflationary

situation with suitable examples. What are the different methods to
measure inflation?

Q.19 Why long – run Phillip-curve is vertical in the long run.

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Explain with suitable examples.

UNIT : D ECONOMIC REFORMS IN INDIA

D-1 India’s Industrial Policy

D-2 Economic – Reforms in India

(a) Liberalization (b) Privatization (c) Globalization

D-3 Foreign Direct Investment

4
D-4 Recent – Scenario
Business-case

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Chapter : 13

ECONOMIC- REFORMS IN INDIA

At the time of independence, India was a poor country. The industrial base
was too-small. There was strong need for policies which could result in fast
industrial-development of the country.

Meaning of Industrial-Policy:

Industrial-policy of a country explains the government attitude towards

industrial development. Various issues related to industrial development are
clarified by the government such as, whether industries will be developed
through public sector or private sector? The industrial policy deals with the issues
like size of industries. Will foreign capital be allowed to enter into the country or
not.?

INDUSTRIAL POLICY

The Industrial Policy Resolution of 1948.

Industries were classified into four categories:

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1) This policy marked the beginning of Public-Sector in India. Industries such

as arms and ammunition, atomic-energy, railways and space-research were
made exclusive monopoly of the state.

2) In the second category, a list of industries was announced with the

provision that all new units would be established only by the state, while
the existing units of this category were to remain in the private sector for
the next ten-years. After that, the issue of their nationalization was to be
decided. The list included industries such as coal, iron and steel, aircraft
manufacture and ship building etc.

3) There was mention of certain industries with the provision that such
industries were to remain in private ownership, such as, automobiles,
tractors, sugar, cement, cotton, woolen etc. These industries were to
remain under overall regulation and control of the government .

4) Rest of the industries were to remain under the private sector.

2) Cottage and Small Scale Industries:

The government expressed its intention to develop cottage and small scale
industries by providing various facilities to such industries.

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3) Foreign Capital

The government was not totally against the entry of foreign firms in India,
but on certain conditions only.

4) Industrial-relations

The government wanted to protect the interest of industrial workers.

However the relationship between employers and employees was expected
to be an ideal relationship.

Industrial Policy of 1956

In this policy, industries were put under three categories.

1) A list of 17 industries was notified. All new units in these industries were to
be set-up only by the state.

2) A list of 12 industries was declared. A provision was made that such

industries would be progressively state owned. But the private sector
would also operate in these industries.

3) Rest of the industries were left for the private sector. These were mainly
consumer-goods industries. This policy to see a balanced industrial-growth

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among various regions of India and development of cottage and small –

scale industries. Foreign capital was allowed to enter into India on the
condition that ownership and management would be in the hands of
Indians.

The Industrial Policy of 1991

This policy is popularly known for L.P.G. i.e. Liberalization, Privatization and
Globalization. Main features of this policy are explained below:

1) Liberalization of government controls and licenses. More opportunities for

undertaking investment by private sector. Some industries were reserved
for public sector, but number of industries were de-reserved. The earlier
industrial policy of 1956 had reserved 17 industries for the government
sector. But under this policy of 1991, nine-industries from this list were
opened up for the private sector.

More progress was made in this area, more industries have been opened
up for the private sector. Now the public sector is maintaining its unique
presence only in :

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1) Railways (2) Arms and ammunition (e) atomic energy (4) strategic mining.
The present approach is quite flexible. Now there are no water tight
compartments.

2) The Provision of Dis-investment:

The government decided to sell a part of its share holding of public sector
units in the market to the private sector.

3) Management modalities of Public sector units

This policy decided to give greater autonomy to the public enterprises in

their working. Boards of public sector companies would be made more
professional and would be provided greater powers.

4) The case of loss making P.S.U’s

P.S.U’s suffering from losses would be referred to Board of Industrial and

Financial Reconstruction for formulation of revival and rehabilitation
schemes.

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5) Liberal Policy towards Foreign Technology:

Use of foreign technology would be encouraged. This was done with a view
to improve and modernize the technology. Automatic approval for
technology agreements would be given.

6) Amendment in Monopolies and Restrictive:

Companies were allowed to expand as much as they wished. Restrictions

imposed on large companies under MRTP Act were withdrawn.

7) Foreign Capital:

It was announced that approval would be given for direct foreign-

investment upto 51 per cent of equity.

The 1991 policy is regarded as a milestone in history of Indian Industrial-

development. This policy opened the gates for modernization of industrial-
technology and introduction of foreign technology in India.

This policy liberalized the entry of private sector companies in the industrial
sector of India. Conditions regarding licensing were to be made liberal .Earlier

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license system was a hurdle in the way of establishing new industrial units in
India.

The removal of limit on asset expansion of Indian companies was a very

positive step in accelerating industrial development in India.

Note: Detailed discussion of L.P.G. Policy has been given in the separately in the
next chapter.

Chapter: D-2

Economic- Reforms in India

An Industrial policy was introduced in 1991. The Government

introduced a series of measures to restructure Indian-Economy in order to
give a push to industrial-development. The series of reforms were under
taken to remove hurdles in the way of development of industrial-sector,
foreign-trade sector as well as in financial sector. All these steps were
implemented to remove to remove to then prevailing economic problems.
The economic problems mentioned below, gave rise to the L.P.G. policy. In
other words, the L.P.G. policy came into existence, due to then prevailing
economic problems.

Some features of Indian economy at the start of nineties:

1. Low foreign exchange reserves only $ 1.2 billion in (Jan. 1991)

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2. High-inflation rate 13.87 percent in year 1990-91.

3. The low annual growth rate of Indian-economy stagnanted
around 3.5 percent from 1950’s to 1980’s while per capita
income averaged 1.3 percent.
4. Large and growing fiscal imbalance, gross fiscal deficit rose to
12 percent of G.D.P. in 1991.

• Over-protection to Indian Industry

• Mounting losses of public sector enterprises
• Growing-inefficiency in the use of resources
• Low foreign exchange reserves
• Heavy Burden of national debt
• Inflation: Indian was suffering from high rate of inflation

• There were various distortions like poor technological development

shortage of foreign exchange were some of Indian problems.

• Lack of contact with foreign technical experts.

Liberalization – Policy
Meaning:

This is referred to as loosening of government regulations in the

country to allow for private-sector companies to operate business with

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lesser restrictions. Liberalization refers to relaxation of government

restrictions in economic-policies. Thus, when government trade liberalizes
trade and industry it means removal of restrictions.

Liberalization refers to relaxation of previous government restrictions

usually in areas of social and economic-policies.

Thus, when government liberalizes trade it means it has removed the

tariff, and other restrictions on the movement of goods and services
between countries.

Liberalization in economy stands for the process of making policies

less constraining of economic activity and also reduction of tariff or removal
of non-tariff barriers.

Liberalization refers more to liberalization of further “opening up” of

their respective-economies to foreign capital and investments. There of the
fastest growing developing economies.

It also means opening of the economy for foreign investors and

foreign companies.

Components of Liberalization:

1. Industrial Liberalization
2. Trade Liberalization
3. Financial Liberalization

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4. Fiscal-sector-Refers.

(1) Industrial Liberalization: Private sector industrialists were permitted

to establish those industries which were not permitted to them earlier.

• Industrial licensing was abolished except in 6 sectors

• Liberal attitude towards foreign technology
More liberal permission to Foreign Director investment

(2) Trade-Sector-refers: These included elimination of import licensing,

reduction in tariff-structure and use of flexible exchange rate. Freedom to
import capital-goods and freedom to import technology

(3) Financial Liberalization: This is deregulation of domestic financial

markets and further removal of controls over capital account. Some
controls were removed over the insurance-sector, capital-market and in
banking sector.

(4) Fiscal-sector-reforms:
Fiscal-prudence-fiscal correction was needed in the form of check on
Fiscal deficit.

It involves sale of minority stake in P.S.U.’s

Between August 1991 and March, 2003, in all 48 companies

underwent the dis-investment process. Dis-investment: means disposal of
public sector’s units equity in the market or in other words selling of a

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P.S.U. to private entrepreneur. This may take the form of sale of one
P.S.U. to other PSU’s or private sector.

(i) Sale of the entire equity to private-sector example, BSNL.

(ii) The govt. issues share to the public to reduce govt. stake.
(iii) The govt. transfers the management control to make it more
accountable.
(iv) Sale to employees: Sale of shares to employer.

In Indian, so far, dis-investment has been carried out in a hasty, unplanned

and hesitant manner. The progress has been poor.

Privatization: It refers to the transfer of assets from govt. ownership to

private-ownership. Privatization can be achieved in many ways:
franchising, leasing, contracting etc.

Some dis-invested companies are Bharat Aluminum Co. Ltd., Hotel

Corporation of India, Hindustan Zinc, Pradeep Phosphates Ltd., Modern
Foods Ind.

Under strategic sales method, dis-investment price would be market

based and not prefixed.

Privatization and Disinvestment in India:

Privatization has mainly taken the form of dis-investment of equity.

The Privatization process has not let to 100 percent transfer of control from

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public-sector to private sector. Only in few cases, 100 percent Privatization

has taken place.

Methods of Disinvestment:

1 Initially, equity was offered to retail investors through domestic public

issues.

This was followed by issuance of the Global Depository receipts

(G.D.R.”s) to top overseas-markets.

2) Cross holding: In this method, the govt. simply sells part of its shares
in one PSU to other PSUs.

3. Warehousing: Government’s own financial institutions buy govt’s

stake in select PSU’s and hold them until a third buyer emerges.

4) Golden-share: Retaining govt’s stake up to 26 percent in the PSU’s to

protect its interest.

Advantages of Privatization:

1. Privatization was expected to improve the efficiency in the working of

companies in India.

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2. It was supposed to make public sector units more competitive. It was

to provide better financial health to the public sector units, with out govt.
financial help.

3. It was to create favourable climate for independent decision making

by the managers.

4. The fate of sick units was also expected to improve due to

Privatization.

Dis-advantages of privatization:

1. The economic-power gets concentrated in the hands of big-business

houses. This leads to concentration of income and wealth in the hands of
few-selected people.

2. Private-capital is shy of entering socially useful productive capital.

Private capital enters only in the few profitable areas of economy.

3. This may lead to creation of black money in the economy.

• Private enterprises may not show any interest in buying shares of

loss-making and sick-enterprises.

• Privatization offers both i.e. opportunities and threats to the economy.

• Try to exploit opportunities and minimize threats to the economy

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Latest policy initiative

The govt. decided ‘ in principle’ approved for enabling reductionof the
governments paid –up share capital below 51 percent in select
• The

Globalization:

This consists of reduction of trade-barriers, free flow of capital, free-

flow of technology, and free-movement of technology.

In other words, we may state, that, globalization consists of

globalization of production, globalization of technology and globalization of
investment. In this context reference can be given of reduction of import-
duties, encouragement of foreign investment, and reduction in custom-
duties, devaluation of Indian currency6 and introduction of partial
convertibility.

Globalization – implies the opening of local and nationalistic

perspectives to a broader outlook of an inter connected and interdependent
world with free transfer of goods and services across national frontiers.
This does not include unhindered movement of labour.

Advantages of Globalization:

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1. This policy resulted in greater efficiency of resources, reduced the

capital output ratio, updated technology entered into India.
2. This increased inflow of foreign capital.

3 Restructures the production and trade patter.

4. With the entry of foreign, competition and the removal of import tariff
barriers, the domestic industry will be under pressure to improve quality.
5. Due to more competition efficiency will improve in the banking sector
and financial sector.
6. Benefit to consumers.
7. Indian economy recorded its highest GDP growth rate of 9 percent in
2007.

Dis-advantage of Globalization:
1. Foreign goods will flood the Indian markets.
2. Lack of level playing field between Indian Companies and foreign.
3. Expectation of technology transfer into India has not been fulfilled.
4. Danger to small-scale enterprises of India. Since such industries use
outdated – technology.

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D-3 FOREIGN DIRECT INVESTMENT:

An investment made by a firm into a company based in another

country. The investing company may make it overseas-investments in a
number of ways-either. 1. By setting up a subsidiary or associated
company in the foreign country.2. By acquiring shares of an overseas
company 3. Through a merger or joint venture. According to some experts,
the foreign investor must own at least 10 percent or more of the voting-
stocks of the investee-company.

Foreign direct investment may be defined as a company from one

country making a physical investment into building a factory in another
country. The direct investment in buildings, machinery and equipment, on
the other hand portfolio investment is entirely a different kind of investment
and is considered as an indirect investment.

There are two forms of F.D.I. = Inward F.D 1 and Outward FD 1

1. A green field-investment, it is the establishment of a wholly new

operation in a foreign country.

2. Acquisition or merging with an existing firm in the foreign country.

Outflows of F.D.I. is the investment out of a country. Inflows of F.D.I.

is the investment into a country. Since W.W. II, the U.S. has been the
largest source country for F.D.I. Chinese firms have recently emerged as
major foreign investors.

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Most cross-border investments involve mergers and acquisitions

rather than Greenfield-investments. Acquisitions are attractive because.

They are quicker to execute than Greenfield investments. It is easier

and less risky for a firm to acquire desired assets than build them from the
ground up.

Firms believe they can increase the efficiency of an acquired unit by

transferring capital, technology and management skills.

F.D.I. has benefits as well

F.D.I. should be allowed only if the benefits out weigh the costs.

1. Access technology

2. Access management skills

3. Create-employment

4. Obtain resources and benefits

5. Contribute tax revenue

1. Benefits to the recipient country of F.D.I.’s

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F.D.I. is a major source of non debt financial resource for the eco-
develop of India.

2. Economic-growth:

The foreign companies invest funds in the host-country. This leads to

accelerating of economic growth in the country. More investment results in
more production and more G.D.P. growth.

3. Creation of job-opportunities:

The increase in production creates linkages. The local industry and

trade gets a positive push. The production gets maximized through the
working of multiplier.

4. Increased availability of modern technology:

The developed countries have taken a lead in the inventions and

innovations. This is resulting in the production of new goods and in the
improvement of methods of production which reduce cost of production.
The new technology leads to more efficiency i.e. better utilization of
resources takes place.

5. Contribution to tax revenues;

The foreign companies pay taxes to the local government on their

profits, which they earn in the host-country.

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F.D.I. India doubled to US$ 4.48 billion in Jan. 2015. The top 10
sectors receiving FDI include telecom. ($ 2.83 billion, services $ 2.64
billion, automobiles 2.04 billion comp. hardware etc. (1.30 billion dollar) $
pharma 1.25 billion. Govt. has amended the policy, regarding construction
development sector.
[2857.83 crore is equal to US$ 452.72 million)

India is regarded as the second most important F.D.I. destination for

F.D.I.’s.

F.D.I. in India has resulted in the following benefits.

1. The rate of economic-growth of Indian Economy increased.

Improvement in Standard of living of the people, this has resulted will
increased the competitive strength of Indian Industry.

2. There has taken place technological transfer into India (in some
selected area).

3. The managerial efficiency has also increased like to interaction of

local managers with global managerial skills.

4. Availability of goods in the country. Free flow of capital and increase

in the total capital employed.

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5. Global sourcing of factors research may be obtained from the best

source anywhere in the world.

6. Mauritius has been the largest investor in India

1. Mauritius - around 53 percent
2. Singapore - around 53 percent
3. U.S.A. - around 9 percent
4. U.K. - around 7 percent
5. Netherlands- around 5 percent
6. Japan - around 4 percent
Rest from: Cyprus, Germany, UAE and Frances

Impact of Globalization of Indian Economy:

1. Indian exports now finance over 80 percent of India’s imports. Earlier

Indian exports used to finance-over 60 percent. This is the impact of
economic reforms.

2. Indian’s share in the world trade which had fallen 0.53 percent in
1991 from 17.8 percent in 1950.

Now, this ratio has increased to 0.86 percent

3. India’s foreign exchange reserves were one billion dollars in 1991.

There was an increase in the reserves to 141 billion dollars in 2005.

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4. Export growth rate has increased to an 10 percent (however it has

coming down in the recent years.

5. India’s external debt used to increase at the rate of 8 billion a year.

The rate of increase in public debt has come down to 3 billion dollars.

6. India now enjoys confidence of foreign-investors. Foreign-investment

in has increased from 153 million dollars in 1991. This amount has gone up
to around 3200 dollars developing economies, to day, Brazil, China and
India have achieved rapid economic growth in the past years after they
have “liberalized” their economies to foreign capital.

Benefits of Globalization:

1. Due to the use of policy of globalization, India’s

2. Share in the world-export increased from 0.53 percent in 1991

to 1.60 percent in 2013.

3. Foreign- currency reserves increased from $ 1 billion in 1991 to

above approximately # 277.72 billion in October 2013.

4. FDI has an important impact on country’s trade balances,

increasing labour standard and skills etc.

All the benefits were made possible due to the various steps
implemented to Globalize the Indian-economy. Such a (De-valuation of

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Indian Rupees (ii) use of dis-investment policy in the public sector sector
units (U.S.U’s (iii) special policies to attract NRI schemes, and liberal
attitude towards foreign investors planning to invest in India. This may also
be called as entry of D.F.I. into India.

The globalization process is transmitted through international trade.

This is followed by financial flows and communications. The transmission of
globalization spreads through technological advances in transportation etc.
This requires population mobility.

Some basic-features of F.D.I. in India:

1. The sectors which attracted higher inflows were services,

telecommunication, construction activities and computer
software and hardware.

2. Mauritius, Singapore, U.S. and the U.K. were among the

leading source of F.D.I. in India.

3. The most attractive sectors for F.D.I’s are as follows:

Sectors Share (in percentages)

1. Software and IT services 31 percent
2. Automotive 18 percent
3. Financial services/ 11 percent
consumer products

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4. Communications/ 10 percent
construction
5. Health care/ transportation 9 percent
6 Chemicals and allied 9 percent
products

F.D.I.
Sector – wise arrivals of D.F.I. in India:
F.D.I. are not evenly distributed among the different sectors of the
economy. The following tables indicates the pattern of inflows of F.D.I’s in
India, as per data released for the months of April-June 2015.

$ Millions
1. Computer Software and hardware 2,556
2. Automobile Industry 1,094
3. Training 897
4. Services Sector 636
5. Telecom 395
6. Power 271
7. Chemicals fertilizers 251
8. Drugs and pharmaceuticals 215
9 Metallurgical 133
10 Construction development 34
11. Sector Wise distribution of F.D.I.’s in India (2014-15)
Financial Year 2014-15 ($ millions)
1. Computer Software and hardware 2200

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2. Automobile Industry 2570

3. Training 2761
4. Services Sector 3253
5. Telecom 2895
6. Power 657
7. Chemicals fertilizers 669
8. Drugs and pharmaceuticals 1523
9 Metallurgical 472

Dis-advantage of F.D.I.

1. Illusory technical benefits. Top of the line technology is not

transferred to recipient country. Foreign companies compete
with local industry and may destroy them.

2. It is due to lack of level playing field to local industry. This may

lead to destruction of Indian industries owned by Indians.

3. Drain on country’s National income of the host country towards

foreign countries.

4. Lop-sided development takes place because Investment is

made by foreigner’s in selected sweety sectors of the recipient
country.

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5. Foreign companies invest in India to take advantage of cheaper

wages and raw material, minerals etc.

6. Economic-slowdown of U.S.A. and Europe etc. has resulted in

slowing down economic progress in India. This was
theexperienced during 2012-13 and 2014.

Markets in India have started responding to the movements abroad.

Any unfavourable news abroad brings down the stock indices in India as
well. Rain in Washington requires use of umbrellas in Mumbai.

Thus, economies are prone to severe dislocation and collapse during

a downturn in international economic activity on the other hand internal
oriented economies are likely to be less damaged by and the slowdown in
world trade.
The govt’s shareholding of 53.29 % in select –run firms while while
retaining management control on case to case basis , this wil be brought

Down to below strategic level .

Govt. shareholding of 53.29 % in BHARAT PETROLEUN

CORPORATION LTD. [ NUMALIGARH TRFINANCES [TD. WIILREMAIN
A psu .

The centre will also sell its 63.74 % holding in SHIPPING

CORPORATION CORPORATION OF INDIA ALONG WITH TRANSFER
OF MANAGEMENT CONTROL TO A STRATEGIC BUYER.

IN CONTAINER CORPORATION CORPORATION OF INDIA , the

government will sell 30.8 % along with transfer of management control to
a strategic buyer.

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The CENTRE will sell its 74.23% holding in THDCIL along with transfer to
NTPC AND ALSO OFFLOAD its 100 % STAKE IN north eastern electric
power corporation limited to ntpc .

The target is to collect 1/06 lakh crore sale in stat run companies in the
current fiscal year , including srrategic stake sale which means the
government will sell a block of shares to a block of shares to a
corporate entity and hand over management control

F.D.1 Liberalization F.D.I

In India, in 2014-15,Gross-fixed capital was $ 587 billion, of which

F.D.I amounted to $ 30.93 billion or merely 5.27 percent.

By 2019, Japan plans to invest $ 35 billion, China $ 20 billion and the

U.K. $ 13 billion. Taiwans Foxconn, China’s Xiaomi and several others
have big plans to manufacture in India.

But some experts are of the view that F.D.I. is unlikely to be India’s
growth engine. The real engine will have to come from within.

How much of India’s total investment is composed of F.D.I. An

economy’s gross fixed-capital formation is often taken as proxy for total
investment.

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In 2014, the FDI flow into India amounted of its GDP in the same year
GDP into China was in absolute terms, total FDI in India was $ 28.3 billion
while China got $ 128.5 billion or more than four times what India received.

It has been commented that foreign inflows may increase job creation
in organized sector only. According to an estimate, out of the current 600
million, working population, only 7.8 percent of the work force is in
organized sector. More workers will move from unorganized-sector to
organized-sector.
Case Study: ease of doing business

India has a long way to go to ease of doing business.

Indian is lagging in many aspects. There is an urgent

requirement to reduce procedures and the time taken for the registration of
a company.

It has been observed that Indian states put a huge burden of

compliance on upcoming companies. For example, there are 33
procedures spanning over 191 days before a warehouse can be
constructed in India. Singapore has also a very good record in this context.
It takes just 26 days and 10 procedures.

There is an urgent requirement to reduce procedures and the time

taken for the registration of a company. Business in India have to interact
with multiple authorities with little co-ordination amongst-them.

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Environmental-clearance is a big issue in India. The multi-party panel of

parliament has also endorsed the above views.

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Unit D
D-4 Recent Scenario
Changes in the Policy of F.D.I. reforms:

(A) F.D.I. cap has been increased from 70 percent to 100 percent for
several sectors, including non-scheduled air transport service, ground
handling, credit info-firms and satellites.
S
(B) The govt. changed F.D.I. rules for 15 sectors. These are the
following:

1. Defence Sector: Foreign Institutional Investors (F.I.I.S.) venture

capital limit venture capital limit up from 24 percent to 49 percent. Now
overseas investors do not need to invest up to 49 percent .

2. Banking Sector: 74 percent foreign investment allowed.

3. Retail: Manufactures can enter retailing including e-commerce.

Single brand retailers such as Marks and spencer, Adidas, IKEA allowed
into e-commerce.

Companies such as apple-exempted from sourcing norms for single

brand retail business.

4. Plantations: 100 percent FDI allowed in sectors like tea, coffee,

rubber, cardamom, palm oil and olive oil.

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5. Construction Sector: Definition of real estate changed, to exclude

township development construction of residential and commercial
premises.

100 percent FDI allowed in management to townships and walls

Several other conditions have been eased, including lock-in clause for exit.

6. Aviation: 49 percent F.D.I. under automatic route for regional air-

transport service.

7. Media and Brod-casting:

(i) 49 percent FDI with Foreign Investment Promotion Board
(FIPB) not allowed for FM radio up linking of non-news
channels.

(ii) 100 percent under automatic route for up linking of non-news

channels and down linking of T.V. channels.

(iii) 100 percent F.D.I. allowed in DTH cable networks, mobile T.V.
and teleports without government approval upto 49 percent.

Foreign-investment promotion – board can clear proposals upto Rs.

5000 crores from earlier Rs. 3000 crore.

Thus, the decision to lift overseas investment ceiling in an apparent

move to turn India into a preferred destination for foreign investors.

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D.F. Investment Miscellaneous

Govt. simplifies defense rules to woo foreign co.

1. The govt. withdraw excise and custom duty exemptions enjoyed by

the ordinance factory board and defense P.S.U.’s. This will increase the
competitive power of foreign Co’s desirous of entering into India, Co’s like
Air-bus.

There are now 290 Central public sector enterprises, and asa many
as 45 of them sick units, with huge accumulated losses of over Rs.56,000
crores.

2. Eight loss making ITDC hotels are to be privatized. The flagship

hotel, the Ashok, is loss-making as well, but as a heritage building in the
capital, it makes sense to lease it out on long term management contract.

The govt. needs to sell the other seven ITDC properties. There is
need to fast forward of the winding up of such perennially loss making units
as HMT, scooters India and Hindustan Photo Films manufacturing Co.
Private Sector is to be used to constantly strengthen India’s long term
competitiveness.

Advanced-manufacturing whether in micro-electronics, aerospace,

telecom or new generation drugs, probably calls for the public sector to
take the initiative. This calls for boldness of imagination and political
creditability.

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The centres policy on dis-investment of ‘equity’ and ‘strategic’- sales

of public-enterprises seems to lack both strategy and foresight.

Govt. plans to privatize and off load equity in several loss-making

units like hotels.

Govt. targets Rs. 410 billion from stake sales in Co’s. Total stake
sales in 15-16 seen at Rs. 695 billion.
changes in Govt. policy:

1. 100 percent F.D.I. allowed in medical devices.

2. F.D.I. cap (upper-limit) increased in Insurance from 26 percent to 49
percent.
3. 100 percent allowed in the telecom sector
4. 100 percent F.D.I. in single brand retail.
5. F.D.I. limit of 26 percent in defense sector raised to 49 percent under
approval route.
6. Construction, operation and maintenance of specified activities of
Railway sector opened to 100 percent foreign direct-investment under
automatic-route.
7. Removal of restrictions in tea-plantation sector.

Sector—prohibited for F.D.I.:

1. Lottery and gambling etc.
2. Manufacturing of cigars, cigarettes, and other tobacco products etc.
3. Atomic-energy & railway transport

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4. Services, like legal, book keeping, accounting & auditing services.

F.D.I. has shown healthy growth since 2012-13 (data taken on

21.11.2015)
Years F.D.I. in flows
($ million) dollars
2011-12 35,121
2012-13 22,424
2013-14 24,299
2014-15 30,931

According to prevailing conditions, a drop in public and private

investments has been observed in Indian economy.

Weak capital investment has been a hurdle in India’s quest to realize

its growth potential and with factories running 30 percent below capacity
private firms are in no rush to investment in new- projects.

The policy makes are worried about declining investment. There is

decline in private sector as well as in public sector. Due to this S.B.I. has
cut its growth forecast for the current fiscal year to 7.4 percent from 7.6
percent.

Gross-Fixed Capital-Formation (in Rs. Lakhs Crores)

Years Earlier 33.6 percent
2011-12 29.7

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2012-13 31.4
2013-14 29.7
2014-15 28.7

Attempt is being made to invite more foreign-investment into India in

order to over-come the decline in domestic investment. Policies are being
undertaken to make India a more open-economy to attract foreign
investments. The government is trying to remove the regulatory and
administrative hurdles to business.

The government has implemented economic-reforms in the recent-

past (2014-15). Companies Act has been amended. Starting a business
has been made easier, by eliminating the minimum capital requirement and
the need to obtain a certificate to commence business operations, saving
entrepreneurs an unnecessary procedure and delay. As a result of the
above measures and few-other measures India has moved to 130 from 134
in Global-rank in the index of ease of doing business.

India’s Prime Minister visited U.K. He invited British companies to

invest more in India. His efforts have met with great success. Because
sector projects amounting to 9.2 billion pounds have been announced. This
will cover areas like energy, healthcare, education, finance, retail, IT and
Cyber logistics.

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Business case

India has improved upon position in the world trade competitiveness

index by 16 places to 55th position from 71st.

India is fast regaining its lost status as a foreign direct investments

hotspot, and new economy companies may have got a lot to do with this
turnaround. It sector received 40 percent of the total.

F.D.I. in April – June

India 31
China 28
US 27
UK 16
Mexico 14
Indonesia 16

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Case Study No.

Ease of doing business in a country

One of the factors hampering the inflow of foreign investment (F.D.I’s)

into India has been the hurdle known as.

On the basis of unsuitable “ease of doing business” India has

never enjoyed the strong liking of foreign-investors. This has been
regarded as a hurdle in the way of F.D.I. India has always been placed
quite low in the index of ease of doing business.

There is turn- around after many years in this context. the country
ranked 130 out of 189 countries in the survey conducted on the basis of
reforms implemented in these countries between June 2014 and June
2015. It is to be noted that India’s rank was 142 in the previous years
survey.

World Banks ease of doing business index 2016 known as Measuring

Regulatory Quality and efficiency, has taken note of economic reform
programme being pursued in India.

The government of India amended the companies Act starting a

business easier by eliminating the minimum capital requirement and need
to obtain a certificate to commerce business operations. This helps
entrepreneurs to cut unnecessary delays in starting business. For example
the procedure for getting an electricity connection has been made simpler.

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It is expected that more reforms are in the pipe line. So India’s rank
will further improve in the future. Institutional changes such as the National
company Law Tribunal commercial courts and bank bankruptcy law are in
the pipe line. Launch of National Single Window for trade may also help
India to improve its rank in the near future.
Countries East of doing Starting a business
business rank
Singapore 1 10
New-Zealand 2 1
Denmark 3 29
Korea, Rep. 4 23
Hong Kong 5 4
U.K. 6 17
U.S.A. 7 49
Sweden 8 18
Norway 9 24
Finland 10 33
Russia 51 41
India 130 155
China 84 136
S.Africa 73 124

The above figures include estimates for first half of 2015. However, the
area where investors want more reforms include tax-policy, labour laws,
cutting red-tape and issues linked to land-acquisition.

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In 2018 indias rank is 7 7 . it is now significantly simpler to get

construction permits and ship goods across the countrys borders .as well
as reforms in other regulatory and process approvals .

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Foreign Investment

Q.1 Critically examine the concept of foreign investment with type and
entry-mode. Substantiate your answer with the help of recent
examples?

Q.2 Critically examine the concept of foreign direct investments! Is F.D.I.

panacea for economic development? Substantiate your answer with
the help of recent experience.

Q.3 Explain the privatization and globalization policy of the Govt. of India.
How this policy has affected the Indian economy?

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