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Economic Environment

Board of Studies

Prof. H. N. Verma Prof. M. K. GhadoliyaVice- Chancellor Director, Jaipur National University, Jaipur School of Distance Education and Learning Jaipur National University, JaipurDr. Rajendra Takale Prof. and Head AcademicsSBPIM, Pune

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Subject Expert Panel

Dr. Daniel J. Penkar Vijayalakshmi R.HDirector, SBS, Sinhgad Subject Matter ExpertPune

___________________________________________________________________________________________

Content Review Panel

Shreya SarafSubject Matter Expert

___________________________________________________________________________________________Copyright ©

This book contains the course content for Economic Environment.

First Edition 2013

Printed byUniversal Training Solutions Private Limited

Address05th Floor, I-Space, Bavdhan, Pune 411021.

All rights reserved. This book or any portion thereof may not, in any form or by any means including electronic or mechanical or photocopying or recording, be reproduced or distributed or transmitted or stored in a retrieval system or be broadcasted or transmitted.

___________________________________________________________________________________________

I

Index

ContentI. ...................................................................... II

List of FiguresII. .........................................................VI

List of TablesIII. ........................................................ VII

AbbreviationsIV. .....................................................VIII

Case StudyV. .............................................................. 114

BibliographyVI. ........................................................ 118

Self Assessment AnswersVII. ................................... 121

Book at a Glance

II

Contents

Chapter I ....................................................................................................................................................... 1Economic and Non-Economic Environment ............................................................................................. 1Aim ................................................................................................................................................................ 1Objectives ...................................................................................................................................................... 1Learning outcome .......................................................................................................................................... 11.1 Introduction .............................................................................................................................................. 21.2 Objectives of the Study of Economic Environment ................................................................................ 21.3 Non-Economic Environment ................................................................................................................... 21.4 Technological Environment ..................................................................................................................... 41.5 Demographic Environment ...................................................................................................................... 41.6 Natural Environment ................................................................................................................................ 41.7 External Environment .............................................................................................................................. 5 1.7.1 Micro-environment .................................................................................................................. 5 1.7.2 Macro-environment ................................................................................................................. 51.8 Economic Environment ........................................................................................................................... 6 1.8.1 Various Components of Economic Environment ..................................................................... 61.9 Non-Economic Environmental Factors .................................................................................................... 6 1.9.1 Socio-cultural Environment ..................................................................................................... 7 1.9.2 Political-Legal Environment .................................................................................................... 81.10 Economic Planning ................................................................................................................................ 81.11 Need for Planning in Underdeveloped Countries .................................................................................. 91.12 The Structure of the Planning Commission of India ........................................................................... 10 1.12.1 Functions ...............................................................................................................................11 1.12.2 Functional Area .....................................................................................................................111.13 Objectives of Planning Commission .....................................................................................................111.14 Tenth Five Year Plan ............................................................................................................................ 12 1.14.1 Approach, Strategy and Policy Reforms during the Tenth Five Year Plan .......................... 13 1.14.2 Overview of Performance during the Tenth Five Year Plan ................................................ 13 1.14.3 Achievements during the Tenth Five Year Plan ................................................................... 141.15 Approach and Strategy for the Eleventh Five Year Plan ...................................................................... 141.16 Comparison between Tenth and Eleventh Five Year Plan ................................................................... 15Summary ..................................................................................................................................................... 17References ................................................................................................................................................... 17Recommended Reading ............................................................................................................................. 17Self Assessment ........................................................................................................................................... 18

Chapter II ................................................................................................................................................... 20Problems of Indian Economy .................................................................................................................... 20Aim .............................................................................................................................................................. 20Objectives .................................................................................................................................................... 20Learning outcome ........................................................................................................................................ 202.1 Introduction ............................................................................................................................................ 212.2 Current Population of India ................................................................................................................... 212.3 Population of India: Pre-Independence Era ........................................................................................... 212.4 Population: Post Independence Period ................................................................................................... 212.5 Present scenario: The Facts .................................................................................................................... 222.6 Implication of Growing Population in India .......................................................................................... 222.7 How to Combat Population Growth India? ........................................................................................... 232.8 Demographic Trends in India ................................................................................................................. 232.9 Causes of Rapid Growth of Population ................................................................................................. 232.10 Effect of Population Growth on Indian Economic Development ........................................................ 242.11 Poverty ................................................................................................................................................. 25 2.11.1 Poverty in India .................................................................................................................... 25

III

2.12 Unemployment ..................................................................................................................................... 26 2.12.1 Types of unemployment ....................................................................................................... 262.13 Parallel Economy ................................................................................................................................. 272.14 Balance of Payments (BoP) ................................................................................................................. 30 2.14.1 A Simple Three-Item Model of the Balance of Payments ................................................... 30Summary ..................................................................................................................................................... 32References ................................................................................................................................................... 32Recommended Reading ............................................................................................................................. 32Self Assessment .......................................................................................................................................... 33

Chapter III .................................................................................................................................................. 35Economic Policies ....................................................................................................................................... 35Aim .............................................................................................................................................................. 35Objectives .................................................................................................................................................... 35Learning outcome ........................................................................................................................................ 353.1 Introduction ............................................................................................................................................ 363.2 Objective of Policy ................................................................................................................................ 363.3 Growth Performance .............................................................................................................................. 373.4 Fiscal Policy .......................................................................................................................................... 38 3.4.1 Objectives of Fiscal Policy ................................................................................................... 38 3.4.2 Fiscal Policy Tools ................................................................................................................. 383.5 Monetary Policy .................................................................................................................................... 38 3.5.1 Objectives of Monetary Policy .............................................................................................. 393.6 Instruments of the Monetary Policy ....................................................................................................... 40 3.6.1 Liquidity Management .......................................................................................................... 40 3.6.2 Interest Rate Management .................................................................................................... 40 3.6.3 Foreign Exchange Management ........................................................................................... 413.7 Difference between Fiscal Policy and Monetary Policy ........................................................................ 41 3.7.1 Foreign Investment Policy ..................................................................................................... 41Summary ..................................................................................................................................................... 44References ................................................................................................................................................... 44Recommended Reading ............................................................................................................................. 44Self Assessment ........................................................................................................................................... 45

Chapter IV .................................................................................................................................................. 47Industrial Development and Industrial Policy ........................................................................................ 47Aim .............................................................................................................................................................. 47Objectives .................................................................................................................................................... 47Learning outcome ........................................................................................................................................ 474.1 Industrial Performance and Policies ...................................................................................................... 484.2 Problems Related to Industrial Growth (A Critical Analysis) ............................................................... 484.3 Policy Initiatives Taken .......................................................................................................................... 494.4 Indian Public Sector- Performance ....................................................................................................... 504.5 Financing Development ........................................................................................................................ 514.6 Equity and Social Justice ...................................................................................................................... 534.7 Meaning and Concept of Cottage and Small Scale Industries ............................................................... 544.8 Cottage and Small Scale Industries - The Underlying differences. ....................................................... 56Summary ..................................................................................................................................................... 57References ................................................................................................................................................... 57Recommended Reading ............................................................................................................................. 58Self Assessment ........................................................................................................................................... 59

IV

Chapter V .................................................................................................................................................... 61India: Foreign Trade Policy ...................................................................................................................... 61Aim .............................................................................................................................................................. 61Objectives .................................................................................................................................................... 61Learning outcome ........................................................................................................................................ 615.1 Introduction ............................................................................................................................................ 625.2 Regional and Bilateral Trade Agreements ............................................................................................. 625.3 World Bank Involvement ....................................................................................................................... 625.4 World Bank Reports ............................................................................................................................... 625.5 The IMF, World Bank and WTO ........................................................................................................... 635.6 How the IMF, World Bank and WTO Work Together? ......................................................................... 645.7 WTO, IMF and World Bank are Undemocratic ................................................................................... 655.8 Structural Adjustment Programs (SAPs) ............................................................................................. 655.9 WTO Trade Agreements ....................................................................................................................... 665.10 Sharing the World’s Resources and Decommissioning the IMF, World Bank ................................... 675.11 A Means to Improve International Trade ............................................................................................. 695.12 How Sharing Would Affect the Global Economy? .............................................................................. 69 5.12.1 Aid and Development ........................................................................................................ 69 5.12.2 International Trade .............................................................................................................. 69 5.12.3 International Finance .......................................................................................................... 70Summary ..................................................................................................................................................... 71References ................................................................................................................................................... 71Recommended Reading ............................................................................................................................. 71Self Assessment ........................................................................................................................................... 72

Chapter VI .................................................................................................................................................. 74Financial System in India: Structure and Evolution .............................................................................. 74Aim .............................................................................................................................................................. 74Objectives .................................................................................................................................................... 74Learning outcome ........................................................................................................................................ 746.1 Introduction ............................................................................................................................................ 756.2 Evolution of the Financial Environment ................................................................................................ 756.3 Financial Intermediation: Pattern and Institutions ................................................................................. 776.4 Financial Institutions .............................................................................................................................. 78 6.4.1 Commercial banks ................................................................................................................. 78 6.4.2 Other financial institutions ..................................................................................................... 786.5 Structure and Evolution of Financial Markets ....................................................................................... 79 6.5.1 Money Market ........................................................................................................................ 80 6.5.2 Credit market ......................................................................................................................... 82 6.5.3 Capital Market ....................................................................................................................... 836.6 Government Securities Market .............................................................................................................. 846.7 Foreign Exchange Market ...................................................................................................................... 85Summary ..................................................................................................................................................... 87References ................................................................................................................................................... 87Recommended Reading ............................................................................................................................. 87Self Assessment ........................................................................................................................................... 88

Chapter VII ................................................................................................................................................ 90Changing Role of Government ................................................................................................................. 90Aim .............................................................................................................................................................. 90Objectives .................................................................................................................................................... 90Learning outcome ........................................................................................................................................ 907.1 Introduction ........................................................................................................................................... 917.2 Role of Government in Capitalist Economies ...................................................................................... 92 7.2.1 Unrealistic Assumptions ........................................................................................................ 92

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7.2.2 Lacunae in Performance ....................................................................................................... 937.3 Pitfalls of Communism ......................................................................................................................... 94 7.3.1 Good produced not in line with consumer’s preferences ...................................................... 94 7.3.2 Difficulties in training martial balancing .............................................................................. 94 7.3.3 Outdated technologies ........................................................................................................... 957.4 Indian Experience ................................................................................................................................. 957.5 Emerging Consensus on the Changed Role of Government ................................................................. 96Summary ..................................................................................................................................................... 97References ................................................................................................................................................... 97Recommended Reading ............................................................................................................................. 97Self Assessment ........................................................................................................................................... 98

Chapter VIII ............................................................................................................................................. 100Structural Dimensions of Indian Economy ........................................................................................... 100Aim ............................................................................................................................................................ 100Objectives .................................................................................................................................................. 100Learning outcome ...................................................................................................................................... 1008.1 Introduction .......................................................................................................................................... 1018.2 Economic Growth and Development ................................................................................................... 101 8.2.1 Economic Growth ................................................................................................................ 101 8.2.2 Economic Development ....................................................................................................... 1028.3 Indian Economic Growth Experience .................................................................................................. 104 8.3.1 Growth Rate of NNP and NNP Per Capita .......................................................................... 104 8.3.2 Income and Per Capita Rate ................................................................................................. 1048.4 Basic Structural Changes in the Economy ........................................................................................... 1058.5 India’s Saving and Investment: Trends and Components .................................................................... 106 8.5.1 Savings Rate ........................................................................................................................ 106 8.5.2 Financial-Asset Structure of the Household Sector ............................................................. 106 8.5.3 Gross Domestic Capital Formation ...................................................................................... 1078.6 India’s Monetary and Price Trends ...................................................................................................... 107 8.6.1 Money Supply ...................................................................................................................... 107 8.6.2 Growth Rate: Principal Factors ............................................................................................ 1088.7 Other Structural Dimensions ................................................................................................................ 1098.8 Demographic Trends and Structure ..................................................................................................... 109Summary ....................................................................................................................................................111References ..................................................................................................................................................111Recommended Reading ............................................................................................................................111Self Assessment ..........................................................................................................................................112

VI

List of Figures

Fig. 1.1 Elements of non – economic environment ....................................................................................... 4Fig. 1.2 Macro-environment .......................................................................................................................... 6Fig. 1.3 Factors affecting economic environment.......................................................................................... 7Fig. 6.1 Structure of Indian financial system ............................................................................................... 75Fig. 8.2 M1, M2, M3 Money Supply Components .................................................................................... 108

VII

List of Tables

Table 2.1 Parallel economy estimates in developed countries ..................................................................... 27Table 2.2 Estimates of parallel economy in developing countries period: 1990-93 .................................... 28Table 3.1 Comparison between fiscal policy and monetary policy ............................................................. 41

VIII

Abbreviations

APR - Annual Review of PerformanceCSIR - CouncilofScientificandIndustrialResearchECAFE - Economic Commission of Asia and the Far EastFDI - Foreign Direct InvestmentFTA - Foreign technology agreementsGATS - The General Agreement on Trade in Services GATT - General Agreement on Tariffs and Trade GDP - Gross Domestic ProductIFIs - International Financial Institutions MIS - Management Information SystemsMOU - Memorandum of UnderstandingNMITLI - New Millennium Indian Technology Leadership Initiative SWOT - Strengths, Weaknesses, Opportunities and Threats TFYP - Tenth Five Year PlanTKDL - Traditional Knowledge Digital Library TNA - Training Need Analysis TRIMS - Trade Related Investment Measures WTO - World Trade Organisation

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Chapter I

Economic and Non-Economic Environment

Aim

The aim of this chapter is to:

explain various components of economic environment•

elucidate microenvironment and microenvironment•

explicate the various elements of non-economic environment•

Objectives

The objectives of this chapter are to:

defineeconomicplanning•

enlist the objectives of the study of economic environment•

explicate important economic policies•

Learning outcome

At the end of this chapter, you will be able to:

definethetenthandeleventhfiveyearplan•

identify the factors affecting economic environment•

understandtenthandeleventhfiveyearplan•


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1.1 IntroductionEconomic environment broadly covers the aspects relating to nature of the economy, anatomy of the economy, functioning of the economy, economic progress and programmes, economic policy statements and proposals, economic controls and regulations, economic legislations, economic problems and prospects and to understand all these, we should invariably discuss the concept of economic system.

1.2 Objectives of the Study of Economic Environment The main objectives of economic environment study are as follows:

Power functioning of an economy•Knowledge of new opportunities and resources•Study of environmental factors•Removal of obstacles and challenges•Optimum use of environment•Minimising ill-effects•

The survival and success of each and every business enterprise depend fully on its economic environment. The main factors that affect the economic environment are:

Economic conditions: The economic conditions of a nation refer to a set of economic factors that have great •influenceonbusinessorganisations and their operations.These includegrossdomesticproduct, per capitaincome, markets for goods and services, availability of capital, foreign exchange reserve, growth of foreign trade, strength of capital market, etc. All these help in improving the pace of economic growthEconomicpolicies:Allbusinessactivitiesandoperationsaredirectlyinfluencedbytheeconomicpoliciesframed•by the government from time to time. The government keeps on changing these policies from time to time in view of the developments taking place in the economic scenario, political expediency and the changing requirement. Everybusinessfirmhastofunctionstrictlywithinthepolicyframeworkandrespondtothechangestherein. The important economic policies are as follows:

Industrial policy: The Industrial policy of the government covers all those principles, policies, rules, �regulations and procedures, which direct and control the industrial enterprises of the country and shape the pattern of industrial developmentFiscal policy: It includes government policy in respect of public expenditure, taxation and public debt. �Monetary policy: It includes all those activities and interventions that aim at smooth supply of credit to the �business and a boost to trade and industryForeigninvestmentpolicy:Thispolicyaimsatregulatingtheinflowofforeigninvestmentinvarioussectors �for speeding up industrial development and take advantage of the modern technology.Export-Import policy (Exim policy): It aims at increasing exports and bridge the gap between expert and �import. Through this policy, the government announces various duties/levies. The focus now-a-days lies on removing barriers and controls and lowering the custom duties

The world economy is primarily governed by three types of economic systems, viz:Capitalist economy•Socialist economy and •Mixed economy•

1.3 Non-Economic EnvironmentThe various elements of non-economic environment are as follows:

Social environment: The social environment of business includes social factors like customs, traditions, values, •beliefs, poverty, literacy, life expectancy rate etc. The social structure and the values that a society cherishes haveaconsiderableinfluenceonthefunctioningofbusinessfirms.Forexample,duringfestiveseasonsthere

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isanincreaseinthedemandfornewclothes,sweets,fruits,flower,etc.Duetoincreaseinliteracyratetheconsumers are becoming more conscious of the quality of the products. Due to change in family composition, more nuclear families with single child concepts have come up. This increases the demand for the different types of household goods. It may be noted that the consumption patterns, the dressing and living styles of people belongingtodifferentsocialstructuresandculturevarysignificantlyPolitical environment: This includes the political system, the government policies and attitude towards the •business community and the unionism. All these aspects have a bearing on the strategies adopted by the business firms.Thestabilityofthegovernmentalsoinfluencesbusinessandrelatedactivitiestoagreatextent.Itsendsasignalofstrength,confidencetovariousinterestgroupsandinvestors.Further,ideologyofthepoliticalpartyalsoinfluencesthebusinessorganisationanditsoperations.YoumaybeawarethatCoca-Cola,acolddrinkwidely used even now, had to wind up operations in India in late seventies. Again the trade union activities also influencetheoperationofbusinessenterprises.MostofthelabourunionsinIndiaareaffiliatedtovariouspoliticalparties. Strikes, lockouts and labour disputes etc. also adversely affect the business operations. However, with the competitive business environment, trade unions are now showing great maturity and started contributing positively to the success of the business organisation and its operations through workers participation in managementLegalenvironment:Thisreferstosetoflaws,regulations,whichinfluencethebusinessorganisationsandtheir•operations. Every business organisation has to obey, and work within the framework of the law. The important legislations that concern the business enterprises include:

Companies Act, 1956 �Foreign Exchange Management Act, 1999 �The Factories Act, 1948 �Industrial Disputes Act, 1972 �Payment of Gratuity Act, 1972 �Industries (Development and Regulation) Act, 1951 �Prevention of Food Adulteration Act, 1954 �Essential Commodities Act, 2002 �The Standards of Weights and Measures Act, 1956 �Monopolies and Restrictive Trade Practices Act, 1969 �Trade Marks Act, 1999 �Bureau of Indian Standards Act, 1986 �Consumer Protection Act, 1986 �Environment Protection Act �Competition Act, 2002 �

Besides, the above legislations, the following are also form part of the legal environment of business.

Provisions of the Constitution: The provisions of the Articles of the Indian Constitution, particularly directive principles,rightsanddutiesofcitizens,legislativepowersofthecentralandstategovernmentalsoinfluencetheoperation of business enterprises.


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Political Factors

Economic Factors

Sociocultural Factors

Technological Factors

Fig. 1.1 Elements of non – economic environment(Source: http://www.ppm.net/wp-content/uploads/2009/05/pest.jpg)

Judicial decisions: The judiciary has to ensure that the legislature and the government function in the interest of the public and act within the boundaries of the constitution. The various judgments given by the court in different mattersrelatingtotradeandindustryalsoinfluencethebusinessactivities.

1.4 Technological EnvironmentTechnological environment include the methods, techniques and approaches adopted for production of goods and services and its distribution. The varying technological environments of different countries affect the designing of products. For example, in USA and many other countries electrical appliances are designed for 110 volts. But when these are made for India, they have to be of 220 volts. In the modern competitive age, the pace of technological changes is very fast. Hence, in order to survive and grow in the market, a business has to adopt the technological changesfromtimetotime.Itmaybenotedthatscientificresearchforimprovementandinnovationinproductsandservicesisaregularactivityinmostofthebigindustrialorganisations.Infact,nofirmcanaffordtopersistwiththeoutdated technologies, now-a-days.

1.5 Demographic EnvironmentThis refers to the size, density, distribution and growth rate of population. All these factors have a direct bearing on the demand for various goods and services. For example, a country where the population rate is high and children constitute a large section of population will have more demand for baby products. Similarly, the demand of the people living in cities and towns are different than the people of rural areas. The high rise of population indicates the easy availability of labour. These encourage the business enterprises to use labour intensive techniques of production.Moreover,availabilityofskilllabourincertainareasmotivatesthefirmstosetuptheirunitsinsucharea. For example, the business units from America, Canada, Australia, Germany, and UK are coming to India due toeasyavailabilityofskilledmanpower.Thus,afirmthatkeepsawatchonthechangesonthedemographicfrontandreadsthemaccuratelywillfindopportunitiesknockingatitsdoorsteps.

1.6 Natural EnvironmentThenaturalenvironmentincludesgeographicalandecologicalfactorsthatinfluencethebusinessoperations.Thesefactors include the availability of natural resources, weather and climatic condition, location aspect, topographical factors,etc.Businessisgreatlyinfluencedbythenatureofnaturalenvironment.Forexample,sugarfactoriesareset up only at those places where sugarcane can be grown. It is always considered better to establish manufacturing unit near the sources of input. Further, government’s policies to maintain ecological balance, conservation of natural resources etc. put additional responsibility on the business sector.

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1.7 External EnvironmentIt is now unquestionably accepted that the prospects of a business depend not only on its resources but also on the environment. An analysis of Strengths, Weaknesses, Opportunities and Threats (SWOT) is very much essential for the business policy formulation. The external environment consists of a micro-environment and a macro-environment.

1.7.1 Micro-environmentThe micro-environment consists of the factors in the company’s immediate environment that affects the performance of the company. It is quite obvious that the micro-environment factors are more intimately linked with, the company than the macro factors. These include the suppliers, marketing intermediaries, competitors, customers and the public:

Suppliers: An important force in the micro environment of a company is the suppliers i.e., those who supply •the inputs to the company. The importance of reliable source/sources of supply to the smooth functioning of the business. Uncertainty regarding the supply often compels companies to maintain high inventories causing cost increases. When compared to Japan with our countryMarketing intermediaries: The immediate environment of a company may consist of a number of marketing •intermediarieswhichare“firmsthatandthecompanyinpromoting,sellinganddistributingitsgoodstofinalbuyers”. The marketing intermediaries include middlemen such as agents and merchants who “help the company findcustomersorclosesaleswiththem”.Marketingintermediariesarevitallinksbetweenthecompanyandthefinalconsumers.Adislocationordisturbanceofthislinkorawrongchoiceofthelinkmaycostthecompanyvery heavilyPublics: A company may encounter certain publics in its environment. “A public is any group that has an actual or •potential interest in or impact on an organisation’s ability to achieve its interests”. Media publics, citizen’s action publics and local publics are some examples. Many companies are also affected by local publics. Environmental pollution is an issue often taken up by a number of local publics. Actions by local publics on this issue have caused some companies to suspend operations and or take pollution abatement measuresCustomers: As it is often exhorted, the major task of a business is to create and sustain customers. A business •exists only because of its customers. Monitoring the customer sensitivity is therefore a pre requisite for the business success. The choice of the customer segments should be made by considering a number of factors includingtherelativeprofitability,dependabilityandstabilityofdemand,growthprospectsandtheextentofcompetitionCompetitors:Afirm’scompetitorsincludenotonlythefirmswhichmarketthesameorsimilarproductsbut•also all those who compete for the discretionary income of the consumers. The competition amongst these productsmaybedescribedas‘desirecompetition’astheprimarytaskhereistoinfluencethebasicdesireofthe consumer. Such desire competition is generally very high in countries characterised by limited disposable incomeandmanyunsatisfieddesires.Iftheconsumerdecidestospendhisdiscretionaryincomeonrecreationhe will still be confronted with a number of alternatives to choose. “The competition among such alternatives which satisfy a particular category of desire is called generic competition”

1.7.2 Macro-environmentMacro environment consist large societal forces that affects all the factors in the company’s macro-environment – namely, the demographic, economic, natural, technological, political and cultural forces. Macro environment is again divided into two environments. They are:

Economic environment•Non-Economic environment•


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MICROENVIRONMENT

TECHNOLOGY

LEGAL&

POLITICAL

MACROECONOMY

NATURAL ENVIRONMENT

SOCIAL &DEMOGRAPHIC

Fig. 1.2 Macro-environment

1.8 Economic EnvironmentEconomic environment broadly covers the aspects relating to nature of the economy, anatomy of the economy, functioning of the economy, economic progress and programmes, economic policy statements and proposals, economic controls and regulations, economic legislations, economic problems and prospects and to understand all these, we should invariably discuss the concept of economic system. Economic environment of business refers to thebroadcharacteristicsoftheeconomicsysteminwhichabusinessfirmoperates.Aneconomicsystemdefinesthe institutional frame work of environment. Once we are fully conversant with the different aspects of economic systems, they provide us an overall view about the economic environment under which the business unit has to function.

1.8.1 Various Components of Economic EnvironmentAt present economic environment is a complex phenomenon. It deals with government policies optical, mainly marketing, household sector and foreign sector. The components of economic environment are as follows:

Economic conditions•Economic systems•Economic policies•International economic environment•Economic legislation•

All these components are closely related. Although, these are different, but even then they are mutually dependent and go on charging. Hence, economic environment is a wide and dynamic concept.

1.9 Non-Economic Environmental FactorsNon-economic environmental factors refers to social, political, legal, technological and cultural factors. Let us discussbrieflyaboutthosefactorswhichitselfinfluencethedecisionsofabusinessenterprise.

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Economic

Internal

NationalResources

Social andcultural system

TechnologyDev

Politicalsystem

MktgConditions

GovtPolicies

EconomicLaws

Transport andcommunication

Population

Ecological

Cultural

International

Ethical

Historical

Education

Technology

Legal

Political

Social

Physical

Non-economic

EducationSystem

Entrepreneurial and Innovation

InternationalCondition

Capital andMoney

HumanResources

External

Factors affecting Economic Environment

Fig. 1.3 Factors affecting economic environment

1.9.1 Socio-cultural EnvironmentBusiness must have a social purpose and business concerns must discharge social responsibility, social obligations and social commitment without which business cannot enjoy social sanction. The following aspects are:

Social institutions and system: The caste system, the joint family system, the child marriage etc. may be cited •as illustrations under this headSocialvaluesandattitudes:ThesearechangingveryfastinalmostallthenationsincludingIndia.Theinfluence•of western values of individualism has its bearing impact on the Indian population. The role of Indian women is notconfinedonlytohouseholdduties.Ontheotherhand,shehasbeencompetingequallywithhercounterpartinallthefieldssimilarly/choosingaparticularprofessionatpresentisnotbasedoncommunityorcasteasitwasEducation and culture: Under this, we may refer to the attitude towards education need for business education, •educational match with skill requirements of industry, business culture etcRoleandresponsibilityofgovernment:Theroleofgovernmentespeciallyinademocracyisverysignificant•in order to bridge the gap between the aspirations and achievements of the society. The government has a very responsible function of maintaining social order and harmony to protect the interests of the majoritySocial groups and movements: In a society individuals have groups basing on caste, creed, religion, language, •trade and profession, etc., which may have direct business interests consumerism, trade-unionism, co-operative movement, shareholders association, and Bank Depositors Association may be mentioned as examples under this head


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Socialproblemsandprospects:TheexcessivepopulationgrowthrateinacountrylikeIndiaisadefinitepotential•source of danger, as it results in growing. Unemployment and poverty, poor housing and incidence of social tensions. That is the reason why the business enterprise must consider the problems while they take business decisions

1.9.2 Political-Legal EnvironmentInthepresentworld,businessofanytypeandsizeisinfluencedbygovernmentpolicies,programmesandlegislations.The following aspects help us to understand more about the political-legal environment:

The form of government: Irrespective of the economy, government intervention in business activity all over the •worldisanexistenceinoneformortheother.Therefore,theformandstructureofgovernmentisverysignificant.Democratic government, Federal Form of Government etc. may be cited as examplesIdeologyoftherulingparty:Thisfactorinfluencesmuchonthemanagement,ownershipstructureandsizeof•business. If the ruling party has the rightist ideology, it usually formulates pro-business policies on the other hand if it is inclined towards leftist ideology, it will adopt measures like nationalisation and excessive centralisationStrengthofopposition:Inthedemocraticnations,theoppositionhastoplayasignificantrole.Thestrengthof•the opposition to a greater extent depends on whether or not opposition parties are invited or divided. Though, there may likely be ideological differences among different opposition parties. They must be united a judge the everymoreoftherulingpartycritically.Iftheoppositionisfair,firmandconsistent,itcaninitiateconstructivecriticism of the ruling party’s policies affecting business. As a result, the government cannot act irresponsibility with regard to the business sectorBureaucracy: In order to run the government administration without any break, bureaucracy has a pivotal role •to assume. It is meant to keep the continuity in government policy operations in connection with business andnon-businesssectors.Inasystemwhichisinfluencedmorebygovernmentcontrolsandregulationswithregard to business, bureaucracy is very powerful in enforcing government rules and regulations, systems and procedures, licenses and restrictionsPoliticalstability:Thisisanotherfactorwhichgovernsbusinessoperations.Businessflourishesinaneconomy•which ispolitically stable.Asweobserved,whenever thenationbecomespoliticallyunstable, theflowofforeign capital and enterprise is adversely affected and this sends wrong signals to the business both national and multi-nationalPlans and programmes of the government: The Government formulates and executes a variety of policies and •programmes.Ifthegovernmentfrequentlychangeitspoliciesonindustries,money,fiscalandothereconomicmatters, it adversely affects the business sector. On the other hand, if government policies are stable, the business unit can plan their activities accordingly

1.10 Economic PlanningTheconceptofeconomicplanningattractedtheattentionofmostofdevelopingcountriessinceitsfirstexperimentmade by then Soviet Union in 1928. Since then it was adopted by number of countries in various forms. For having enough understanding of the concept, it is felt essential to study its basic doctrine.

Definition of economic planningItisratherdifficulttogiveaconcisedefinitionofeconomicplanningwithafairdegreeofprecisionandacceptabilitytooneandall.Hence,differenteconomistshavedefinedeconomicplanninginavarietyofwaysbykeepinginmind the goals to be achieved and the techniques for achieving them. Apart from stating that planning is a method, a technique or a means to an end, the end being the realisation of clearly set targets, we discuss the number of definitionswhichintheirtotalityconveythefullmeaningandcontentofeconomicplanning.

Mrs.BarbaraWoottondefinesitas,“Economicplanningisasysteminwhichthemarketmechanismisdeliberatelymanipulated with the object of producing a pattern other than which would have resulted from its own spontaneous activity”.

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HermanLevydefinesitas,“Economicplanningmeanssecuringabetterbalancebetweendemandandsupplybyconscious and thoughtful control either of production or distribution”.

Dr. Dalton says, “Economic planning in the widest sense is the deliberate direction by persons in charge of large resources of economic activity towards chosen end.”

LewisLorwindefinesaplannedeconomy“asaschemeofeconomicorganisationinwhichindividualandseparateplants, enterprises and industries are treated as coordinate units of one single system for purpose of utilising all available resources to achieve for maximum satisfaction of the people’s needs within a given time”.

AccordingtotheNationalPlanningCommissionofIndia,“Planningunderademocraticsystemmaybedefinedas the technical co-ordination, by disinterested experts, of consumption, production, investment, trade and income distribution, in accordance with social objectives set by bodies’ representative of the nation. Such planning is not only to be considered from the point of view of economics and the raising of the standard of living but must include cultural and spiritual and the human side of life”.

Thus, planning comprises of the following essential features:Predeterminedandwelldefiedobjectivesorgoals•Deliberate control and direction of the economy by a central authority (e.g., the state) for economic planning•Optimum utilisation of natural resources and capital which may be scarce; and labour that may be abundant•The objectives are to be achieved within a given interval of time –5 years, 7 years, etc•The performance of the economic function of increasing production, maximising employment and controlling •population growth so that production outstrips population growth

1.11 Need for Planning in Underdeveloped CountriesPlanningisbeneficialforboththedevelopedandunderdevelopedcountries-forthedevelopedcountriestomaintainor accelerate growth already achieved and for underdeveloped countries to overcome poverty and to raise the standard of living. Unless the underdeveloped countries wake up and follow the planning, they will be left far behind in the race of economic well-being. The following arguments reveal an urgent need of planning in underdeveloped and developing countries:

Remove the poverty and inequalities: The economic vicious circle of poverty arising due to low income, low •savings and high propensity to consume, and further lower investment and low capital formation, low productivity, low income and poverty must be broken and it can be done only by planning. Planning is like a shot in the arm which enables a sick person to overcome his sickness. Planning alone can create more jobs and remove the wide spread unemployment and disguised unemployment which is a common feature of underdeveloped countries. It is the sovereign remedy for raising national and per capita income, for reducing inequities in income and wealth, for increasing employment opportunities and for achieving as all round rapid economic development. It is commonly said that the pendulum has swung too wide in favour of planning that is cannot swing back against planningDevelopment of agriculture and industrial sector: Planning alone can transform an agricultural and primary •producing economy into more balanced economy with heavy, medium and light industries. Agriculture and industry stimulate production in each other by creating demand for their products. Development of agriculture is also essential to supply the raw material to the industrial sector. Economic planning held in designing the plans of agricultural and industrial sectors of developing economiesDevelopment of infrastructure: Planning alone can help an underdeveloped economy to build up its infrastructure– •irrigation and power, transport and communication and schools and hospitals. The establishment of these social economic overheads is essential for an all-round harmonious and integrated development


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To increase the rate of economic development: One of the principle objectives of the planning in underdeveloped •countries is to increase the rate of economic development. In the words D.R.Gadgil, “Planning for economic development implies external direction or regulation of economic activity by the planning authority which in most cases identify with the government of state.” It means planning increases the rate of capital formation by raising the levels of income, saving and investment. A planned economy can revolutionise the economy by providingfinancialinstitutionsandbymobilisingsavingsandinvestmentsintheruralareas.Planningalonecan remove the imbalance in foreign trade which is generally unfavourable to the underdeveloped countries that are the exporters of primary produce and imports of produced goodsTo improve and strengthen market mechanism: The rationale for planning arises in such countries to improve •and strengthen the market mechanism. The market mechanism works imperfectly in underdeveloped countries because of the ignorance and unfamiliarity with it. A large part of the economy comprises the non-monetised sector. The product, factor, money and capital markets are not organised properly. The market mechanism is required to be perfected in underdeveloped countries through planningBalanceddevelopmentoftheeconomy:Intheabsenceofsufficiententerpriseandinitiative,theplanningauthority•is the only institution for planning balanced development in the economy. For rapid economic development, underdeveloped countries require the development of the agricultural and industrial sectors, the establishment of social and economic overheads, and the expansion of the domestic and foreign trade sectors in a harmonious way. All this requires simultaneous investment in different sectors which is only possible underdevelopment planningDevelopment of money and capital markets: Money and Capital market are underdeveloped countries are primary •stage. This factor acts as an obstacle to the growth of industries and trade. The planning authority which can control and regulate the domestic and foreign trade in the best interests of the economy

1.12 The Structure of the Planning Commission of India In the post-Independence era (i.e., after 1947), the Planning Commission was set up in India, drawing from the social premises of the Directive Principles of State Policy which directed that: “The State shall strive to promote the welfare of people by securing and protecting as effectively as it may, a social order, in which justice - social, economic and political - shall inform all institutions of national life.” And further that: “The State shall, in particular, direct its policy towards securing -

That the citizens, men and women equally, have the right to an adequate means of livelihood•That the ownership and control of the material resources of the community are so distributed as best to sub •serve the common goodThat the operation of the economic system does not result in the concentration of wealth and means of production •to the common detriment”

From this, the following functions were assigned to the Planning Commission:To make an assessment of the material, capital and human resources of the country, and to augment those •resourcesthatarefoundtobedeficientTo formulate a Plan for the most effective and balanced utilisation of the country’s resource after determining •the prioritiesTo indicate the factors those tend to retard economic development, and determine the conditions which should •be established for the Plan’s successful executionTo determine the nature of machinery this will be necessary for securing successful implementation of each •stage of the Plan in all its aspectsTo appraise from time to time the progress achieved in the execution of each stage of the Plan and recommend •for adjustments of policy and measures that such appraisal may show to be necessary

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OrganisationThe composition of the Commission has undergone a lot of change since its inception. With the Prime Minister as theex-officioChairman,thecommitteehasanominatedDeputyChairman,whoisgiventherankofafullCabinetMinister. Mr. Montek Singh Ahluwalia is presently the Deputy Chairman of the Commission. Cabinet Ministers with certain important portfolios act as part-time members of the Commission, while the full-time members as experts ofvariousfieldslikeEconomics,Industry,ScienceandGeneralAdministration.TheCommissionworksthroughits various divisions, which are of three kinds:

General Planning Divisions•Programme Administration Divisions•The majority of experts in the Commission are economists, making the Commission the biggest employer of •the Indian Economic Services

1.12.1 FunctionsThe functions of the Planning Commission are as follows:

Assessment of resources of the country•Formulation of Five-Year Plans for effective use of these resources•Determination of priorities, and allocation of resources for the Plans•Determination of requisite machinery for successful implementation of the Plans•Periodical appraisal of the progress of the Plan•To formulate plans for the most effective and balanced utilisation of country’s resources.•To indicate the factors which are hampering economic development?•To determine the machinery as it will be necessary for the successful implementation of each stage of plan•

1.12.2 Functional AreaThe functional areas of the Planning Commission are as follows:

Agriculture Division•Backward Classes Division•Communication and Information Division•Development Policy Division•Education Division•Environment and Forest Division•Financial Resources Division•Health, Nutrition and Family Welfare Division•Housing, Urban Development and Water Supply Division•Industry and Minerals Division•International Economic Division•

1.13 Objectives of Planning CommissionThe Planning Commission was set up by a Resolution of the Government of India in March 1950 in pursuance of declaredobjectivesoftheGovernmenttopromotearapidriseinthestandardoflivingofthepeoplebyefficientexploitation of the resources of the country, increasing production and offering opportunities to all for employment in the service of the community. The Planning Commission was charged with the responsibility of making assessment ofallresourcesofthecountry,augmentingdeficientresources,formulatingplansforthemosteffectiveandbalancedutilisationofresourcesanddeterminingpriorities.Pt.JawaharlalNehruwasthefirstChairmanofthePlanningCommission.


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ConstitutionIn the context of the formulation of Eleventh Five Year Plan (2007-2012), the following sector wise Working Groups/Steering Committees/Task Force have been set up by Planning Commission, to make recommendations on various policy matters.

Agriculture•Backward Classes•Communication and Information•Development Policy•Education•Environment and Forests•Financial Resources•Health and Family Welfare•Housing and Urban Development•Industry and Minerals•Labour, Employment and Manpower•Multi Level Planning•Power and Energy, Energy Policy and Rural Energy•Programme Evaluation Organisation•Rural Development•Social Justice and Women Empowerment•Science and Technology•State Plans•Tourism•Transport•Village and Small Enterprises•Voluntary Action Cell•Water Resources•Women and Child Development•International Economics•

1.14 Tenth Five Year PlanCouncilofScientificandIndustrialResearchhasestablishedanetworkofnationallaboratories/institutesinvariouspartsofthecountrytoundertakeresearchindiversefieldsofscienceandtechnologywithemphasisonappliedresearchandutilisationofresultsthereof.Thereare,atpresent,38researchestablishmentsincludingfiveregionalresearchlaboratories.Someoftheestablishmentshavesetupexperimental,surveyfieldstationstofurthertheirresearch activities and 39 such stations attached to 16 laboratories are functioning at present.

The guiding principle for CSIR during the Tenth Five Year Plan (TFYP) is inherent in its mission, i.e., to provide scientificindustrialR&Dthatmaximisestheeconomic,environmentalandsocietalbenefitsforthepeopleofIndia.CSIRactivitiesandprogrammesintheTFYPwereoperatedthroughfollowingsixschemesofwhichfivewerecontinuing from Ninth Plan and one scheme namely ICT Infrastructure & Renovation & Refurbishment (IRR) introduced as a new scheme in the Plan:

National Laboratorties•National S&T Human Resource Development•Intellectual Property and Technology Management•

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R&D Management Support•New Millennium Indian Technology Leadership Initiative (NMITLI), and•ICT Infrastructure Renovation & Refurbishment•Among these schemes, National Laboratories under which major R&D programmes/projects have been •undertaken was the major scheme accounting for more than 75% of CSIR Plan funds.

1.14.1 Approach, Strategy and Policy Reforms during the Tenth Five Year PlanThe activities and the role performed by CSIR were in conformity with the then prevailing economic, social, industrial, and R&D environment conditions nationally and internationally. The national target of GDP growth of 8% in Tenth Five Year Plan required organisations to re-examine their strategies and adopt innovative approach. CSIR, as a dynamic responsive organisation in the past, quickly responded to the need. The CSIR plans were drawn up based on the careful assessment of the needs and the opportunities, development of core competencies and R&D facilities.

The rationale for drawing programmes were based on the premise that pre-competitive research being public goods, needtobelargelyfinancedthroughpublicfunding.Intheselectionoftheprogrammestheguidingprincipleswerebased on:

High levels of novelty and innovativeness•Global competitive positioning in science and / or technology•Potential industrial, economic, strategic, societal benefits that could be captured and accrue to the Indian•economy

As CSIR has a well knit network of laboratories across multi disciplines, a conscious decision was taken to implement programmes in network mode through establishing synergy within the vast, often niche, and competencies available with the laboratories. The knowledge networking within and across CSIR laboratories was affected through identificationofnetworkprogrammesandprojects.Thenetworkprojects,thusevolved,fortheTenthFiveYearPlan period consisted of:

Target oriented core network R&D projects, and•Building of capabilities and facilities•

1.14.2 Overview of Performance during the Tenth Five Year PlanCSIRhasmadesignificantcontributionsduringthefirstfouryearsofTFYPinawidespectrumofactivities,whichspanfromcreationofpublicgoods,privategoods,socialgoodsandstrategicgoods.WhilemaidenflightofSARASwas a landmark in CSIR’s contributions to herald the civil aviation industry in the country, the discovery of a new molecule, as a potential drug for cure of deadly disease of tuberculosis, CSIR’s instant response to alleviation of hardships of Tsunami’s victims were a few of the major contributions in other spheres.

CSIRleadtheTeamIndiainitiativeforsettingupthefirsteverTraditionalKnowledgeDigitalLibrary(TKDL)toprovideasearchinterfacetoretrievaloftraditionalknowledgeinformationoninternationalpatentclassification(IPC)and keywords in multiple languages. Database has been created on traditional medicinal formulations comprising 13 million A4 size pages of data on transcribed 62,000 formulations in Ayurveda, 60,000 formulations in Unani, and 1300 formulations in Siddha. TKDL has been receiving wide international coverage.

As a socially conscious organisation CSIR continued its effort to provide the S&T needed for the masses. During the plan, it promoted employment generation on one hand and developed diverse technologies to add to the quality of life on the other hand. These technologies include: ceramic membrane based removal of arsenic and iron from contaminated ground water; pehsticide removal unit for producing potable water, free from organic pollutants; setting upofReverseOsmosis(RO)baseddesalinationplantsinvillages;handoperatedmicrofiltrationunits(with3litre/minutes discharge rate) capable of providing bacteria and virus free water; Ultra Filtration (UF) membrane based technology requiring no electricity and chemicals to remove germs, cysts, spores, parasites, bacteria, Cryptosporidium, endotoxin etc. low sodium salt from bitterns in place of pure sodium chloride; which is being recommended to patientssufferingfromhypertension;etc.CSIRresponsetoTsunamivictimshadshownitsscientificandtechnicalskills to mitigate the hardship of those survived.


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The initiatives taken by various CSIR laboratories could provide food, drinking water and shelter to the survivors.

1.14.3 Achievements during the Tenth Five Year PlanSome of the contributions from under the scheme during the Tenth Five year Plan are as follows:

During the Plan the Central Management Support has established Human Resource Development Centre for •organising and conducting of induction, orientation, and refresher and skill up-gradation training programmes for different categories of CSIR staffThe Centre, thus, conducted one-day interactive familiarisation programs in 32 laboratories including CSIR •Headquarters for familiarisation of new format for Annual Review of Performance (APR) for Group IV scientistsImprovement in quality and transparency in working, the Centre organised awareness-cum-implementation •programmeon ISO9001:2000QMScertification forHOD’s, senior scientists, administrationandfinancepersonnel from Headquarters and laboratoriesDevelopment of Management Information Systems (MIS) for its various HR activities, Training Need Analysis •(TNA), Creation of focused HRD groups in labs. Computer Based Training (e-training) etcA new organ called the Performance Appraisal Boards (PABs) was introduced to critically review the performance •of each laboratory once in every three yearsDuring the Tenth Plan, CSIR’s international programmes had a clear focus on joint collaborative projects rather •than on exchange programmes, as was the case in previous plansThe Unit for R&D in Information Products created to catalyse and mobilise packaging of information products •based on CSIR databases

1.15 Approach and Strategy for the Eleventh Five Year PlanIndia’s centralised planning process is governed by seven cardinal policy objectives: growth; social justice and equity; modernisation; self-reliance; food; productivity and employment.

These would continue to be the guiding principles for the Eleventh Plan (2007-12) which commences from 1stApril,2007.Averylargepartofourplanningisconcernedwithfiscalaspectsandphysicaltargets.Itmust,however,berecognisedthatitisthehumanandnaturalresources,scientificmethodsandtechnologieswhicharethefundamentalelementsinthecreationofwealthforhigherproductivity,increasedefficiencyandcompletelynew ways of doing things. The Eleventh Plan, therefore, would place emphasis on these components which have received inadequate attention in the past. Eleventh Plan would be the vehicle that would position the country to be a superpower-economically,strategicallyandscientifically.FortheEleventhFiveYearPlantheGovernmentofIndiais envisaging the economy to grow at an annual growth rate of 8.5%%. This implies that Agricultural Sector will have to grow at a rate of 3.9%, industry at 9.9%, services at 9.4%, and exports at 16%, while keeping the imports at a level of 12.1%.

The implicit growth of manufacturing sector which is a subset of industry is targeted for 12%. The above growth rates interwoven with each other, of course, would depend upon many factors. Some of these factors are internal to theIndianeconomyandsomeareinfluencedbytheexternalenvironment.Thegrowthintheagriculturalproductivitycan be sustained on a long term basis only through continuous technological progress and these calls for well structured strategies for research & development. Industrial sector has gained a lot over the past decade or so due to liberalisation and is gradually integrating with the world economy. Some of the sub-sectors like automobiles, pharmaceuticals, biotechnology products, specialty chemicals, and textiles have acquired unprecedented level of global competitiveness and need to be supported to maintain the present edge. The Eleventh Plan is also placing special emphasis on infrastructure and skill development, the two crucial and critical catalysts for growth.

The services sector is currently the fastest growing sector of economy accounting for about 54% of GDP. It is estimated that this sector has the potential for creating 40 million jobs and generating additional $ 200 billion annual income by 2020. In the Eleventh Plan, the government is placing special focus on this sector so that its potential to create employment as growth parameter is fully realised.

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Eleventh five year plan programmes and activitiesThe bold and the daring approach proposed for the XI Plan by the Planning Commission to achieve new vistas of growth, is expected to provide enough opportunities to convert growth potential of 8.5% into reality. This however calls for a total departure from the past practices in developmental planning and implementation, by working out new management strategies involving coordination and stronger linkages for more effective implementation.

Thefirstfivefollowingschemeswouldbethecontinuingschemeswithnewprogrammes/projects/tasksandactivities,the sixth scheme would be the new scheme:

National Laboratories•National S&T Human Resource Development•Intellectual Property & Technology Management•R&D Management Support•New Millennium Indian Technology Leadership Initiative and•Setting up of a Translational Research Institute•

1.16 Comparison between Tenth and Eleventh Five Year PlanThemainobjectivesofthetenthfive-yearplanwere:

Reduction of poverty ratio by 5 percentage points by 2007•Providing gainful and high-quality employment at least to the addition to the labour force•All children in India in school by 2003; all children to complete 5 years of schooling by 2007•Reduction in gender gaps in literacy and wage rates by at least 50% by 2007•Reduction in the decadal rate of population growth between 2001 and 2011 to 16.2%•Increase in Literacy Rates to 75 per cent within the Tenth Plan period (2002 to 2007)•Reduction of Infant mortality rate (IMR) to 45 per 1000 live births by 2007 and to 28 by 2012•Reduction of Maternal Mortality Ratio (MMR) to 2 per 1000 live births by 2007 and to 1 by 2012•Increase in forest and tree cover to 25 per cent by 2007 and 33 per cent by 2012•All villages to have sustained access to potable drinking water within the Plan period•Cleaningofallmajorpollutedriversby2007andothernotifiedstretchesby2012•Economic Growth further accelerated during this period and crosses over 8% by 2006•

The main objectives of the eleventh plan were:Income and Poverty

Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to double per •capita income by 2016-17IncreaseagriculturalGDPgrowthrateto4%peryeartoensureabroaderspreadofbenefits•Create 70 million new work opportunities•Reduce educated unemployment to below 5%•Raise real wage rate of unskilled workers by 20 percent•Reduce the headcount ratio of consumption poverty by 10 percentage points•

EducationReduce dropout rates of children from elementary school from 52.2% in 2003-04 to 20% by 2011-12•Develop minimum standards of educational attainment in elementary school, and by regular testing monitor •effectiveness of education to ensure qualityIncrease literacy rate for persons of age 7 years or above to 85%•Lower gender gap in literacy to 10 percentage points•Increase the percentage of each cohort going to higher education from the present 10% to 15% by the end of •the plan


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HealthReduce infant mortality rate to 28 and maternal mortality ratio to 1 per 1000 live births•Reduce Total Fertility Rate to 2.1•Provide clean drinking water for all by 2009 and ensure that there are no slip-backs•Reduce malnutrition among children of age group 0-3 to half its present level•Reduce anemia among women and girls by 50% by the end of the plan•

Women and ChildrenRaise the sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by 2016-17•Ensurethatatleast33percentofthedirectandindirectbeneficiariesofallgovernmentschemesarewomen•and girl childrenEnsure that all children enjoy a safe childhood, without any compulsion to work•

InfrastructureEnsure electricity connection to all villages and BPL households by 2009 and round-the-clock power•Ensure all-weather road connection to all habitation with population 1000 and above (500 in hilly and tribal •areas)by2009,andensurecoverageofallsignificanthabitationby2015Connect every village by telephone by November 2007 and provide broadband connectivity to all villages by •2012Provide homestead sites to all by 2012 and step up the pace of house construction for rural poor to cover all •the poor by 2016-17

EnvironmentIncrease forest and tree cover by 5 percentage points•Attain WHO standards of air quality in all major cities by 2011-12•Treat all urban waste water by 2011-12 to clean river waters•Increaseenergyefficiencyby20percentagepointsby2016-17•

Types of Data of Tenth Plan Contains no section on the unorganised sector or home-based workers•Laid down a three-fold strategy for empowering women•No reference to best practices•ContainsaspecificchapteronWomentitled‘WomenandChild.’•Only includes data from the Census of India•

Types of Data of Eleventh Plan Types of Data: Includes a section on the unorganised sector and home-based workers and female concentrations in both.

Usesafive-foldstrategytoempowerwomen:specificlocationsofwomenareidentified,andspecificissues•highlightedInclusion of Best Practice boxes throughout the document•Has renamed the chapter ‘Women’s Agency and Child Rights’ and includes a gender perspective across •sectorsIncludes data from the Census, UN bodies, academics and well-known civil society organisations•

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SummaryThe survival and success of each and every business enterprise depend fully on its economic environment.•The world economy is primarily governed by three types of economic systems.•The external environment consists of a micro environment and a macro environment.•The micro environment consists of the factors in the company’s immediate environment that affects the •performance of the company.Macro environment consists larger societal forces that affect all the factors in the company’s macroenvironment •namely, the demographic, economic, natural, technological, political and cultural forces.Non-economic environmental factors refer to social, political, legal, technological and cultural factors.•Theconceptofeconomicplanningattractedtheattentionofmostofdevelopingcountriessinceitsfirstexperiment•made by then Soviet Union in 1928.Planning isbeneficial forboth thedevelopedandunderdevelopedcountries for thedevelopedcountries to•maintain or accelerate growth already achieved and for underdeveloped countries to overcome poverty and to raise the standard of living.

ReferencesRamachandran, K.S., 2007. • Economic Environment of India:Lesson from Past and for the Future, Northern Book Centre.Callan, S. J. & Thomas, J.M., 2009. • Environmental Economics and Management: Theory, Policy and Applications, Cengage Learning.Economic Growth and Environment• [Pdf] Available at: <https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/69195/pb13390-economic-growth-100305.pdf>[Accessed11July2013].Global Economic Environment• [Pdf] Available at: <www.economics.gov.nl.ca/E2012/GlobalEconomicEnvironment.pdf‎>[Accessed11July2013].2012. The Economic Environment• [Video online] Available at: <https://www.youtube.com/watch? v=EWhRy4MaUeA‎>[Accessed11July2013].2011. Economic Environment• [Videoonline]Availableat:<https://www.youtube.com/watch?v=BEipiii-DlE‎>[Accessed 11 July 2013].

Recommended ReadingSmith, A., Richards, M., Heale, G. & Meer, N. V., 2008. • Economic Environment Level 3, Pearson Education South Africa (Pvt.Ltd).Pailwar, V. K., 2008. • Economic Environment of Business, PHI Learning Private Limited.Raj, R., 2008.• Economic Environment of Business and Environmental Management, 1st ed., Nirali Prakashan.


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Self Assessment 1. ________ includes government policy in respect of public expenditure, taxation and public debt.

Industrial policya. Fiscal policyb. Monetary policyc. Foreign investment policyd.

_________ environment include the methods, techniques and approaches adopted for production of goods and 2. services and its distribution.

Technologicala. Naturalb. Demographicc. Externald.

Which of the following statements is false?3. Technological environment include the methods, techniques and approaches adopted for production of goods a. and services and its distribution.Demographic environment refers to the size, density, distribution and growth rate of population.b. The natural environment includes geographical and ecological factors that influence the business c. operations.The political environment of business includes social factors like customs, traditions, values, beliefs, poverty, d. literacy, life expectancy rate etc.

Match the following4. 1. Suppliers A. An important force in the micro environment of a company.

2.Marketing Intermediaries B. Include middlemen such as agents and merchants who “help the companyfindcustomersorclosesaleswiththem”.

3.Social Values and Attitudes C. These are changing very fast in almost all the nations including India.

4. Social Institutions and System:

D. The caste system, the joint family system, the child marriage etc may be cited as illustrations under this head.

A.1-B, 2-C, 3-D, 4-Aa. B.1-A, 2-B, 3-C, 4-Db. C.1-C, 2-D, 3-A, 4-Bc. D.1-D, 2-A, 3-C, 4-Bd.

_____________aimsatregulatingtheinflowofforeigninvestmentinvarioussectorsforspeedingupindustrial5. development and take advantage of the modern technology.

Industrial policya. Fiscal policyb. Monetary policyc. Foreign investment policyd.

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Whodefined“Economicplanningmeanssecuringabetterbalancebetweendemandandsupplybyconscious6. and thoughtful control either of production or distribution”?

Barbara Woottona. Herman Levyb. Dr. Daltonc. Lewis Lorwind.

The implicit growth of manufacturing sector which is a subset of industry is targeted for _____.7. 8%a. 10%b. 12%c. 14%d.

The services sector is currently the fastest growing sector of economy accounting for about ____ of GDP.8. 12%a. 24%b. 32%c. 54%d.

Which of the following statements is true?9. The implicit growth of manufacturing sector which is a subset of industry is targeted for 12%.a. The explicit growth of manufacturing sector which is a subset of industry is targeted for 14%.b. The implicit growth of manufacturing sector which is a subset of industry is targeted for 18%.c. The implicit growth of manufacturing sector which is a subset of industry is targeted for 22%.d.

______ is another factor which governs business operations.10. Bureaucracya. Political Stability b. Plans and Programmes of the Government c. Strength of Oppositiond.


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Chapter II

Problems of Indian Economy

Aim


explain the current population of India•

elucidate demographic trends in India•

explicate the effect of population growth on Indian economic development•

Objectives


explain poverty•

enlist the causes of rapid growth of population •

explicate causes of poverty•

Learning outcome


describe balance of payments•

identify the types of unemployment•

understand parallel economy•

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2.1 IntroductionIndia is a complex land. On one aspect analysing the metropolitan cities of India one draws it to be a developing nationwithupgradedlifestyleandtradeefficiencybuttheothersaspectexplainsacompletelydifferentandafactualstory that majority of Indian’s are still rooted to villages making it an agricultural and rural nation. India has faced the worst consequences of such overpopulation in terms of poverty, malnourishment and illiteracy.

2.2 Current Population of IndiaAfter two centuries of coherent British colonial rule, India attained independence and became a sovereign secular nation on August 15, 1947.The Republic of India is spread over a vast area of 3,287,590 square kilometres making it marginallymorethanone-thirdthesizeoftheUnitedStates.Withauniquedistinctionofbeingrichanddiversifiedin its geographical presentation, religion and culture, India is a multilingual and multiethnic society. World’s major religions such as Hinduism and Buddhism have their roots of origin here. It is often referred to as an amalgamation of many countries tied together by a common destiny and the biggest yet strong and successful democracy. While it’s an emerging economic power but majority of life remains rooted to the rural areas. India has a vast population and isthe2ndcountrytocrossthe1billionpopulationfigure.PopulationofIndiaisabigproblemofIndianeconomicgrowth.

To access the detailed overview of population in India and its implications on the socio economic strata of the country and ways to combat such immense enhancement in population over the decades let’s get down to the categorised formofstateofIndiafirstly,asaBritishempoweredcolonyandsecondly,asasovereign.

2.3 Population of India: Pre-Independence EraIndia’s rapid rise of population was originated in the third decade of the 19th century which drew immense concern. Until 1920, India’s population was growing at snail pace owing to heavy loss of life due to famines, wars and epidemics.

According to census reports decline in population of the country within its present geographical boundaries took place between1911and1921by0.8millionduetohighmortalityinflictedbytheinfluenzapandemicof1918-1919.Thepopulationsteadilyincreasedsince1921becauseofscientificadvancementandtechnicalknowhowforepidemicandfaminecontrolandsanitationmeasuresundertakenbytheprovincialgovernments.Forthefirsttimesincetheinitiation of the systematic census in 1881, India’s population increased slightly by more than 10% in a decade with the 1931 census enumerating a population of 279.0 million. The interest and action from social reformers to combat thispopulationgrowthLanditsadverseeffectonwomenhealthissignificantincharacter.

2.4 Population: Post Independence PeriodWhen India attained independence on the dawn of august 15.1947, it faced a series of challenges in every aspect of a state-societal matrix, socio economic complications and defence. As a result of partition 8 million refugees had come into the country from what was now Pakistan. The people had to be found satisfactory standards of living education and employment thus this migration was a surplus population input to India.

India’s population in 1947 was large, almost 345 million the citizens of the vast land inhibited lingual, cultural and ethical difference and practiced different professions and ate different food. At the time of independence vast majority of population dwelled in rural areas with a marginal percentage of people residing in cities. Clearly, the new nation had to lift its masses out of poverty by increasing the productivity of agriculture and initiating setup of new industries.

Since independence, the population of India has more than tripled. Since 1950, India’s total fertility rate was 6 (children/woman) approx. Since 1952, India has made efforts to control its population growth. It was of prime necessity as check on population growth will enhance the country economic condition and will be a promoting step towards the eradication of poverty. In 1983, the goal of the country’s national health policy was to have a decremented value of total fertility rate of 2.1 by the year 2000 which proved to be hypothetical. During late 1980s, a goal of two children/couple by 2000 was declared but too ambitious to be achieved.


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India’s population crossed the 1 billion mark in 2000. In 2000, India established a new National Population Policy (NPP) to stem the growth of the country population having one of the primary aims to reduce the total fertility rate to 2.1 by 2010, But still unachieved it remains as high as 2.8.also set another goal of two-child family which led to unwanted results of increased abortion of female fetuses and preferences to male child. Many states joined in the program but few states like Haryana, Himachal Pradesh and Madhya Pradesh have withdrew because of cries from many segments of society.

AllfigureswithrespecttopopulationarelargeinIndia:2.7millionannualbirths;8.7millionannualdeathsand1.5million infant deaths. Population growth in India was viewed as a problem very early in 1947 but after numerous population policies and measures still the aims couldn’t be achieved and above all there has been immense enhancement in the population over the decades. In the most populated states Bihar and Uttar Pradesh, fertility still remains above four children per woman and is declining slowly but these states having the quarter of India’s populationhaveadefiningroletoplayforthereductionofpopulationbycontrolonfertilityrates.Anadditionalimportant aspect to India’s population policy is imbalance of the sex ratio at birth. The widespread strong preference of a male child over a female has resulted in abortion of female fetuses.

Population refers to total number of people residing in a place. Growth in population is considered to be favourable in certain countries like Australia because:

It provides work force to produce•It provides markets for the products produced•It may promote innovative ideas•It may promote division of labour and specialisation•

Growth in population is not desirable for countries like India because:There may not be adequate jobs to absorb all additional people•They put pressure on means of subsistence•They put pressure on social overheads (hospitals, roads, schools, etc.)•They may result in increased consumption and reduced savings and hence slow down capital formation•They may increase dependency.•

2.5 Present scenario: The FactsThe present scenario is discussed as below:

India with 1.22 billion people is the second most populated country in the world .India represents apparently •17.30%oftheworld’spopulation.Withpopulationgrowthrateflyingat1.58%it’spredictedtohavemorethan1.53 billion people by end of 2030More than 50% of India’s current population is below the age of 25.About 72% population lives in village while •the rest dwells in towns or urban agglomerationsThe birth rate per 100 people per year is 22.22 births/1000 populations•While, Death rate per 1000 individuals per year is 6.4 deaths/1000 populations•Fertility rate is 2.72born/woman•Infant mortality rate is 30.15 deaths/1000 live births•India has the largest illiterate population of the world•

2.6 Implication of Growing Population in IndiaIndia’s high count on population results in increasingly impoverished and sub standards for growing segments of the Indian populace. In the United Nations human development index in 2007, India ranked 126th which takes into account social educational and other human living aspects. Population growth bearing a direct impact on economy is a controversial debate

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2.7 How to Combat Population Growth India?Rapid reduction in population growth can be achieved through public awareness and emancipation of women through imparting knowledge and education to woman and people residing in the rural sectors of India. By meeting all felt needs for contraception and reducing the infant and maternal mortality and mortality so that desired reduction in fertility level is achieved.

2.8 Demographic Trends in IndiaFollowing are the demographic trends in India:Size of PopulationThe Size of Population is determined in terms of number of person. The population has risen from 23.84 crores in 1901 to 102.27 crores in 2001. Now, it is 111 crores (2005-06).India’s Population ranks 2nd in the World after China. India has about 2.4% of the World’s area and Less than 1.2% of the World’s Income but accommodates about 16.7% of the World’s Population. Every sixth person in the World is an Indian.

Birth rate and Death rateBirth Rate refers to number of birth per thousand of Population. Death Rate refers to number of Deaths per thousand of population. Birth Rate has declined from 39.9 in 1951 to 25.4 in 2001 and 23.8 in 2005.Death Rate has declined from 27.4 in 1951 to 8.4 in 2001 and 7.6 in 2005.

Density of populationDensity of population refers to the number of persons per square kilometre. It has increased from 117 in 1951 to 274 in 1991 and 324 in 2001.Density of Population is not same for all the states. Kerala, West Bengal, Bihar and U.P. have Density higher than the Average Density. Andhra Pradesh, Himachal Pradesh, Gujarat, Madhya Pradesh, Maharashtra, Rajasthan, Orissa, etc. have lower Density than the Average Density. West Bengal is the most densely populated State in the country with 904 persons living per sq. km. followed by Bihar with 880.Industrially well developed areas has higher density.

Sex ratioSex ratio refers to the number of females per 1000 males.Sex ratio has increased from 927 in 1991 to 933 in 2001.Kerala has the favourable sex ratio of 945 in 2001 which has decreased from 976 in 1991 and 984 in 1971.

Life-expectancy at birthLife expectancy refers to the mean expectation of life at birth. If death rate is high/death occurs at an early age; life expectancy will be low and vice-versa. Life expectancy has increased from 32.1 years in 1951 to 59.3 in 1991 and 63.8 in 2001.

Literacy ratioLiteracy ratio refers to numbers of Literates as a Percentage of Total Population. Literacy Rate has increased from 16.7 persons in 1951 to 43.6 in 1981 and 65.38 in 2001.Literacy is higher among Urban Population than Rural Population. Literacy Rates are different among the States. Kerala has the highest Literacy Rate of 90% followed by Goa with 82%, 77% in Maharashtra and Himachal Pradesh, 73% in Tamil Nadu, etc.

2.9 Causes of Rapid Growth of PopulationPopulation generally increases because of:

High birth rate•Relatively lower death rate•Immigration is more than emigration•

In India, population has mainly increased because of high birth rate and relatively low death rate.


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Causes of High Birth RateFollowing are the causes of high birth rate:

Pre-dominance of Agrarian Economy•Slow Process of Urbanisation•High Incidence of Poverty•Early Marriage of Women•Universal Marriage of Women•Role of Religion•Joint Family System•Illiteracy, Ignorance and Belief in Fate•Limited Spread of Family Planning•

Causes of Decline in Death RateCauses of decline in death rate are mentioned as below:

Control of Epidemics like Plague, Small Pox, Malaria, etc•Control of Famines•Improved Medical Facilities•Spread of Maternity Homes•Impact of Social Reforms•Impact of Economic Development (Improved Standard of Living, Improved Hygiene and Sanitation, etc.)•

2.10 Effect of Population Growth on Indian Economic DevelopmentIndia is passing through the stage of population explosion which is a transitory phase according to the Theory of Demographic Transition.

The consequences of population growth on Indian Economic Development:Growth of national income•Food supply•Unproductive consumers•Problem of unemployment•Capital formation•Ecological degradation•

Measures to solve population problemSpread of education•Increase in female wage employment•Provision of old age pension and social security•Reduction in infant mortality•Raising the marriage age•Family planning•Urbanisation•Removing economic reasons for preferring large families•Introducing incentives for people with small families•

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2.11 PovertyPoverty is divided into:

Relative poverty•Absolute poverty•

Relative povertyRelative Poverty refers to the income or asset position of one class or group of people in comparison with the other classes or groups, or of one individual vis-a-vis the others. The essential point here is that poverty of one is relative to the richness of the other. For example, an average middle class person is poor when compared to the upper middle class person, who in turn, may be poorer than the richer person and so on.

Absolute povertyIt is associated with a minimum level of living or minimum consumption requirements of food, clothing, housing, health, etc. All those people who fail to secure income or assets to have access to even these minimum consumption requirementsareclassifiedas‘Poor’.

2.11.1 Poverty in IndiaThe latest National Sample Survey 2004-05 shows that a percentage of people living below Poverty Line have reduced from 26% in 1999-2000 to about 22% in 2004-05.The Tenth Plan had set a target of Reduction in Poverty Ratio to 19.3% by 2007 and 11% by 2012. The targets for Rural and Urban Poverty in 2007 were 21.1% and 15.1% respectively.

Causes of povertyUnder developed Nature of the Indian Economy•Inequalities in income and assets distribution cause additional income from development to be cornered by a •few rich peopleRapidly growing population is a major cause of low per capita income and poverty in India•Large scale unemployment causes lowering of the Levels of Living of People•Inflationhasreducedpurchasingpowerofmoney.Thishasreducedrealincomeandthuspeoplecanbuyless•and consume less with giving Income. This has added to povertyRural character of India’s economy has also its bearing on rural poverty•Sociological reasons to have contributed to underdevelopment and poverty in India•

Measures to reduce povertyAgriculture and other rural vocations should be rapidly developed so as to eradicate rural poverty•Village and Small industries should be developed to create greater employment both in rural and urban areas•Programmes should be implemented that directly target the poor and help them increase their Income and •ConsumptionIncome Inequalities should be reduced:•

Labour legislation should ensure better Wages �Goods consumed by the poor should not be taxed �Goods required by the poor must be subsidised �Free health care and education should be provided to the poor �Persons belonging to poor families must be provided employment �

Rapid growth of population must be controlled and population growth rate brought down through family •planning, education, incentives, etc.


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2.12 UnemploymentUnemployment refers to the situation where the persons who are able to work and willing to work, fail to secure workoractivitywhichgivesthemincomeormeansoflivelihood.Thosewhoarefittoworkbutdonotwanttowork and hence do not actively seek work are not included among the unemployed persons.

2.12.1 Types of unemploymentFollowing are the types of unemployment:

Voluntary unemployment•Frictional unemployment•Casual unemployment•Seasonal unemployment•Structural unemployment•Technological unemployment•Cyclical unemployment•Chronic unemployment•Disguised unemployment•

Voluntary unemployment: People who are unwilling to work at the prevailing wage rate and people who get a continuousflowofincomefromtheirpropertyorothersourcesandneednottowork,suchpeoplearevoluntarilyunemployed. Voluntarily unemployment is a national waste of human energy, but it is not a serious economic problem.

Frictional unemployment: A temporary phenomenon which results from workers which are temporarily out of work whilechangingJobsoraresuspendedduetostrikesorlockouts.Frictionalunemploymentisduetodifficultiesingetting workers and vacancies together. For example, Big industries units and polluting industries have been moved out of the large towns and cities like Delhi.

Casual unemployment: In Industries, such as construction, catering or agriculture, where workers are employed on a day to day basis, there are chances of casual unemployment occurring due to short-term contracts, which are terminable any time.

Seasonal unemployment: Industries and occupations such as agriculture, the catering trade in holiday resorts, where production activities are seasonal in nature offer employment only for a certain period of time in a year. People engaged in such type of work or activities may remain unemployed during the off-season which is termed as seasonal unemployment.

Structural unemployment: Unemployment which arises due to change in the pattern of demand leading to changes in the structure of production in the economy is termed as structural unemployment. Example use of synthetic rubber is bound to reduce demand for natural rubber and lead to unemployment in rubber plantation. The only way to remove such unemployment is to retrain the unemployed in new vocations so that they learn new technologies and are thus absorbed in the expanding economic sectors

Technological unemployment: Due to introduction of new machinery, improvement in methods of production, labour-saving devices, etc., some workers tend to be replaced by machines. Their unemployment is termed as technological unemployment.

Cyclicalunemployment:Associatedwiththecyclicalfluctuationsineconomicactivity,especiallyintherecessionarydepressionary phases of trade cycle. mostly found in capitalist countries like the USA and Western European nations, etc. the solution for cyclical unemployment lies in measures for increasing total expenditure in economy, thereby pushing up the level of effective demand.

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Chronic unemployment: When employment tends to be a long-term feature of a country, it is called chronic unemployment. Underdeveloped countries suffer from chronic unemployment on account of the vicious circle of poverty, lack of developed resources and their under utilisation, high population growth, low capital formation, etc.

Disguised unemployment: Refers to a position where people may be working and apparently employed, yet their contribution to output may be zero. Hence, they seem to be employed, but technically they are unemployed because their marginal productivity is zero.

2.13 Parallel EconomyParallel economy means functioning of an unsanctioned sector in the economy whose objectives run parallel and in contradictionwiththeobjectivesofofficialorsanctionedorlegitimatesectorinthesameeconomy.Thisisvariouslyreferred to as ‘unaccounted economy’, ‘illegal economy’, ‘subterranean economy’, or ‘unsanctioned economy’. According to the D.K.Rangnekar, “If the ‘Parallel economy’ poses a serious threat to stability and growth of the officialeconomy,surelyitstemsfromthefactthatthemagnitudeof‘blackmoney’islargeandriggeddealsaregrowinginvolumeandcomplexityatanalarmingrate.Apartfromthewideramificationsofthe‘paralleleconomy’,one might also be alive to the fact that ‘black incomes’ are accentuating the inequalities in income and wealth and breedinganewclassof‘black’richinasocietywhichisalreadyharshlystratified.”

Illegal economy is tax evaded economy. It is possible to convert illegal economy or black money into white money and vice versa. For example, when a person manages to get the receipt from the shopkeeper by paying the sales tax for a commodity but does not purchase it actually, he generates black money as reimbursement is made to him against the receipt. The money not actually paid is the black money in such a case.

In such case, the shopkeeper sells the same commodity to another person without giving him any receipt for it. On the other hand, if a person purchases something (say, a scooter, or a VCR, etc.) and plays ̀ . 15,000 for it out of white money but gets a receipt of only `. 10,000, the balance of `. 5,000 becomes black money for the seller.

In this case, the white money becomes the black money. The parallel economy has political, commercial, legal, industrial, social and ethical aspects. There are wide confrontations between the objectives of the legitimate and illegitimate sectors under parallel economy. D.R.Pendse argued that there are two possible sources of black money. Firstly,itmayoriginatefromillegitimatesourceofincomearisingoutofillegalgratificationsuchaspaymentof‘Selami or Pagri’ or income from smuggling, bribery etc. Secondly, it may originate from legitimate and legal sources of income but concealed from tax authorities out of tax evasion.

The basic objectives of this paper are to analyse the causes of parallel economy, its impact on the economy and various initiatives of Indian government for solving this problem.

International experienceParallel economy or black economy is existing in both developed and developing countries. There is an abundance of literature available upon measurement techniques and about estimates of parallel economy. A variety of methods have been used and the different methods appear to generate widely divergent estimates. This is summarised in Table 2.1.

Country Parallel Economy (as % of GDP)Greece, Italy, Spain, Portugal and Belgium 24 - 30%Sweden, Norway, Denmark, Ireland, France, The Netherlands, Germany and Great Britain 13 - 23%

Japan, USA, Austria and Switzerland 8 - 10%

Table 2.1 Parallel economy estimates in developed countries(Source: http://www.crisil.com/youngthoughtleader/winners/topic4_Jyoti_Agarwal_IIm_CAL.PDF)


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Table below shows that parallel economy exists in various developed countries all though their various initiatives have been taking governments. The estimates of parallel economy in the context of some of the developing countries are presented in table below

Country Parallel Economy (as % of GDP)

AfricaNigeria and Egypt 68 - 76%Tunisia and Morocco 39 - 49%Central and South AmericaGuatemala, Mexico, Peru and Panama 40 - 60%Chile, Costa Rica, Venezuela, Brazil, Paraguay and Colombia 25 - 35%

AsiaThailand 70%

Philippines, Sri- Lanka, Malaysia and South Korea 38 - 50%

Hong Kong and Singapore 13%

Table 2.2 Estimates of parallel economy in developing countries period: 1990-93(Source: http://www.crisil.com/youngthoughtleader/winners/topic4_Jyoti_Agarwal_IIm_CAL.PDF)

Indian experienceVarious attempts have been made to assess the black money in India from time to time. Major few of them are as presented here:

Kaldor’s estimate: Although the Taxation Enquiry Commission had examined the structure of Indian Taxation, a review by Prof. Nicholas Kaldor was desired by the Government in late 1955 “in view of the larger dimensions assumed by the problems of resources for the plan since the commission reported (Important Events 1946-61)”.

Prof. N. Kaldor in his report on Indian Tax Reform estimated the non-national income:Wages and salaries •Income of self-employed•Profit,interestandrent•

After making the rough adjustments, according to Wanchoo Committee, “the estimated income on which tax has been (black income) would probably be ̀ . 700 crores and ̀ . 1000 crores for the years 1961-62 and 1965-66 respectively. Projecting this estimate further to 1968-69 on the basis of percentage increase in national income from 1961-62 to 1968-69, the income on which tax was evaded for 1968-69, the income on which tax was evaded for 1968-69 can beestimatedatafigureof`. 1800 crores” (Datt and Sundharam, 2004, 378-379)

Wanchoo committee’s estimate: Shri K.N.Wanchoo, retired Chief Justice of the Supreme Court of India, as chairman explainedwhatthetermblackmoneymeantinitsfinalreportsubmittedinDecember,1971.Thiscommitteeestimatednon-salary income for 1961-62 of amounting `. 2686 crores and non-salary income actually assessed to tax as `. 1875 crores, thus, tax escaped for ̀ . 811 crores. Therefore, in 1961-62, black money was of amounting ̀ .700 crores which rose to `. 1000 crores in 1965-66 and further `. 1400 crores in 1969-70. Very lately it was accounted to be 4.4 percent of GNP (Dhar, 2003,719).

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Rangnekar’s estimate: D.K. Rangnakar as a member of the Wanchoo Committee submitted his report in 1982 (India Today, 2005). According to Rangnekar, tax evaded income for 1961-62 was the order of ̀ . 1,150 crores, as compared to the DTEC estimate of `.850 crores. For 1965-66, it was `. 2,300 crores, as against `. 1,216 crores estimated by DTEC. The projections of black money for 1968-69 and 1969-70 were ̀ . 2,833 crores and ̀ . 3,080 crores respectively (Datt and Sundharam, 2004, 378).

Chopra’s estimate: A Committee under O.P. Chopra was formed in 1982 for measuring black money in India (India Today, 2005). O.P.Chopra prepared a series of estimates of black income where it increased from `. 916 crores (6.1 percent of GDP) in 1961-62 to `. 8098 crores (10.5 percent of GDP) in1976-77 (Dhar, 2003). The study showed that a buoyant economy offers more opportunities for unaccounted income. During periods of recession, it may bedifficultforproducerstoexactunaccountedmoney.Chopraalsocorroboratesthehypothesisthattaxevasionismorelikelythehighertherateoftax.Hisfindingsalsosupportthehypothesisthatincreaseinpricesleadstoanincrease in unaccounted income. Further, he found that funds are diverted to agriculture to convert unaccounted (black) income into legal (white) income (Datt and Sundharam, 2004, 379).

Gupta’s estimate: Government of India formed a committee under Poonam Gupta and Sanjeev Gupta in 1981 for calculating black money in India. They used Feige’s method of transaction income ratio to estimate black money in a country. They used average of three years viz. 1949-50, 1950-51 and 1951-52 as the bench mark for estimating black money for the year of 1967-68 to 1978-79.

They estimated that it was 19.8% of GDP at market price. The black money increased for `. 3034 crores in 1967-68 to `.46867croresin1978-79.Themainfindingsofstudiesonblackmoneywere:

A buoyant economy offers more opportunities for unaccounted income•The ratio of unaccounted income to assessable non-salary income has gone up after 1973-74•Increase in prices leads to an increase in black money•Funds are diverted to agriculture to convert black money into white money•One per cent increase in overall taxes leads to more than 3 percent increase in the black•economyrelationtotheofficialeconomy(Lekhi,2003,192)•

The National Institute of Public Finance and Policy estimated that in 1985 amount of black money in India was nearly `. 1,00,000 crore, which is approximately 20 percent of the national income. In 1996, the estimated black money was believed to be more than `. 4, 00,000 crore (The Hindustan Times, January 20, 1997).Most of India’s black money - estimated to be about US$1 trillion (Dh3.67tn) - is believed to be parked in bank accounts in Switzerland. According to the Swiss Bankers Association, Swiss law and tax agreements prohibit third countries from general searchesforpossibletaxevaders,or“name-fishing”.TheIndiangovernmenthopesthatsituationwillchangeafterits tax treaty with the country is revised (Chopra, 2010).

Impact of Black Income on the Indian EconomyGeneration of black income and thereby establishment of parallel economy has been creating the following serious impacts on the social and economic system of the country.

Black income has been causing underestimation of GDP in India as an enormous volume of income is diverted •to this unaccounted sector resulting in growing continuation of parallel economy of the countryThe direct effect of black income is the loss of revenue to the state exchequer as a tax evasion. Black money •has resulted in the diversion of resources for the purchase of real estate and luxury housing. Black money has resulted in transfer of funds from India to foreign countries through clandestine channels (Dhar, 2003, 721)The availability of black incomes with businessmen and capitalists and the consequent inequalities of income •place a large amount of funds at their disposalA part of the black incomes is held in cash and as a result there is an abundance of liquidity which becomes •available through the addition of savings held in the form of cash, bullion, gold, silver, etc Money evaded by illegitimate way is spent in undesirable and vulgar manner. Virtues like hard work and honesty •are underestimated. Thus the existence of parallel economy has totally distorted and disrupted the planning of the economy of the country


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2.14 Balance of Payments (BoP)The balance of payments is the record of a country’s transactions with the rest of the world. It consists of three main parts:thecurrentaccount,thecapitalaccount,andofficialreservessettlementbalance.Thesumofthethreemainparts sum to zero. All transactions must be recorded somewhere. The key is where.

Letting CAt be the current account, KOt the capital account, and ORTttheofficialreservessettlementbalance,theBalance of Payments can simply be written as:CAt + KOt + ORTt = 0. (1.1)

Ifthesumofthethreeaccountsisequaltozeroitishardtospeakofabalanceofpaymentsdeficit.WhenpeoplespeakofaBalanceofPaymentsdeficittheyarereferringtothesumofthecurrentandcapitalaccount.Iftheseareindeficit,asurplusisrequiredinofficialsettlements.From(1.1)wecanseethatORTt = CAt + KOt. The difference is made up by the loss of foreign reserves, often gold.

This may not be sustainable. So while technically the Balance of Payments is always in balance, when we speak ofaBalanceofPaymentsdeficitweautomaticallyreacttothisbythinkingofthesumofthecurrentandcapitalaccount.

The basic idea behind Balance of Payments accounting is straightforward: any transaction that gives rise to a receipt from the rest of the world is recorded as a credit, while any transaction that gives rise to a payment is a debit in the Balance of Payments. One simple way to think about the Balance of Payments is that if you need dollars to pay for the transaction it is a credit. If you need foreign currency it is a debit item. The question is where are they allocated.

2.14.1 A Simple Three-Item Model of the Balance of PaymentsIt is useful to start with a simple three-item model. The key point to remember in this example is that when people buy goods across countries they have to pay for it somehow. Suppose that our economy has net exports of goods and services to ROW equal to 100, and assume that these are paid for in the following way:

80comefromimportsoffinancialassetsinexcessofexports,and20comesfromgold.Thatis, thesurplusintrade is paid for in part by accumulating foreign assets, and in part by accumulating gold. Our simple Balance of Payments looks like:

Category Net ExportsGoods and Services 100Financial Claims -80Gold -20Total 0

Whatdoesitmeantohavenegativenetexportsoffinancialclaims?SupposethatdomesticresidentsissueanIOUto foreigners. Foreigners would be crediting us now in exchange for payments in the future. With these credits we could buy goods and services in the foreign country. In our example, foreigners are issuing more credits to us then wearetothem;hence,therearenegativenetexportsoffinancialassets.Noticefurther,thatifforeignerswerenotable to borrow from us, and if their sales of goods and services (i.e., our imports from them) were less than our sales to them, they would have to pay the difference somehow. All is left in our simple model is to transfer some other asset; gold. The key point of our simple example is that the sum of the three components equal zero. It does not matter exactly how they balance out, but it is critical that the sums do. Notice that in this example, we are selling more goods and services to the rest of the world than we are purchasing. This excess must be paid for somehow.

The three categories of our simple example correspond to the three main parts of the Balance of Payments. The CAB refers to the balance on net exports of goods and services, including net interest income on foreign assets and unilateral transfers. The second category corresponds to the balance on the capital account, and the third category corresponds to net imports of international reserves.

Our simple example abstracts from the double entry aspects of the Balance of Payments, focussing only on the net flows.Butitisenoughtocapturethegeneralprinciples.

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Current account: The current account is the measure of the economy trade in goods and services with the rest of the world, including unilateral transfers. A good way to think of it is precisely as current items. Hence, it included investment income, tourism, payments to military personnel, as well as exports and imports. What is excluded from the current account is trade in assets. This is what makes up the capital account balance? In the current account visible and invisibles are typically distinguished. The former refers to merchandise which can be seen and touched; thelattertotourismandotherflowsofprofessionalserviceswhichcreateremissions,butnotangiblegood.

Interest and investment income is an especially important item. It is important to note that the payments for the services of capital, investment income, appear in the current account. The purchase of the good itself appears in thecapitalaccount.Forexample,theprofitsfromafactoryinCanadawouldbeinthecurrentaccount,whiletheinvestment to build the factory shows up in the capital account. The current account balance also corresponds, as we havealreadyseen,thenetacquisitionofassetsbytheeconomy.IftheCA>0itmeansthattheeconomyhasreceivedmore in receipts than we have made payments. Hence, the difference must have been acquired by the economy. This canhappenintwowayseitherthroughasurplusinthecapitalaccountorinofficialreserves.

Capital account balance: The capital account balance refers to all inter-national asset transactions, excluding the onesmadebythemonetaryauthorities.WhenUSresidentspurchaseGermanbondsthatrepresentsanoutflowinthecapitalaccounts.AGermanresident’spurchaseofUSassetswouldrepresentacapitalinflow.Ifthecapitalaccountbalanceisinsurplusitmeansthatthereisanetinflowofresources.

Thecapitalaccountcontainsthreemaintypesofflows.First,thereisdirectforeigninvestment;forexample,thefactory built in Canada. Second, there is long-term portfolio investment, which would include purchases of securities and long-term bank loans. Of course, purchases of securities are somewhat arbitrary one can speculate on 10 year bondsjustaseasilyason3-monthTbills.Shorttermcapitalflowsarethethirditem,andrefertopurchasesofsecuritieswithmaturitieslessthanoneyear.Becauseoftheambiguityoverflows,theUSnowbreaksdownportfolioinvestment into bank related and securities rather than short-term and long-term. But other countries still stick to the maturity distinction.


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SummaryIndia has faced the worst consequences of such overpopulation in terms of poverty, malnourishment and •illiteracy.India’s rapid rise of population was originated in the third decade of the 19th century which drew immense •concern.Population refers to total number of people residing in a place.•India with 1.22 billion people is the second most populated country in the world. India represents apparently •17.30% of the world’s population.Rapid reduction in population growth can be achieved through public awareness and emancipation of women •through imparting knowledge and education to woman and people residing in the rural sectors of India.In India, population has mainly increased because of high birth rate and relatively low death rate.•Relative poverty refers to the income or asset position of one class or group of people in comparison with the •other classes or groups, or of one individual vis-a-vis the others.Absolute poverty is associated with a minimum level of living or minimum consumption requirements of food, •clothing, housing, health, etc.Unemployment refers to the situation where the persons who are able to work and willing to work, fail to secure •work or activity which gives them income or means of livelihood.Parallel economy means functioning of an unsanctioned sector in the economy whose objectives run parallel •andincontradictionwiththeobjectivesofofficialorsanctionedorlegitimatesectorinthesameeconomy.The balance of payments is the record of a country’s transactions with the rest of the world. It consists of three •mainparts:thecurrentaccount,thecapitalaccount,andofficialreservessettlementbalance.The current account is the measure of the economy trade in goods and services with the rest of the world, •including unilateral transfers.The capital account balance refers to all inter-national asset transactions, excluding the ones made by the •monetary authorities.

ReferencesJain, T. R, Trehan, M. & Trehan, R., 2010.• Indian Economy, Revised ed., V.K. Publications.Singh, R., 2011. • Indian Economy, 3rd ed., Tata McGraw Hill Education Private Limited.Current Economic Scenario• [Pdf]Available at: <164.100.47.134/intranet/Currenteconomicscenario.pdf >[Accessed 11 July 2013].Outlook for the Indian Economy• [Pdf] Available at: <www.icra.in/Files/ticker/ICRA%20Macro%20and%20Policy.pdf‎>[Accessed11July2013].2011. Indian Economy: The Road Ahead• [Video online] Available at: <https://www.youtube.com/watch? v=BqyGaT0RCt0‎>[Accessed11July2013].2012. The Economy of India• [Videoonline]Availableat:<https://www.youtube.com/watch?v=mwBrsP61U9I‎> [Accessed 11 July 2013].

Recommended ReadingKapila, R. & Kapila U., 2004. • Indian Economy, Academic Foundation.Gupta, K.R. & Gupta, J.R., • Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.Jain, T.R., Trehan, M., Trehan, R. & Uppal, R., 2010. • Indian Economy, V.K.Publications.

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Self Assessment India attained independence and became a sovereign secular nation on ___________.1.

26 January 1950a. 26 August 1950b. 15 August 1947c. 26 January 1947d.

In Which year India crossed the 1 billion population mark?2. 2000a. 1991b. 1996c. 1980d.

Which of the following is not an important part of 3. Balance of Payment?Current accounta. Capital accountb. Officialreservessettlementbalancec. Recurring accountd.

Whichofthefollowingisdefinedasthemeasureoftheeconomytradeingoodsandserviceswiththerestof4. the world, including unilateral transfers?

Current account a. Capital accountb. Officialreservessettlementbalancec. Recurring accountd.

Which of the following refers to all inter-national asset transactions, excluding the ones made by the monetary 5. authorities?

Current accounta. Capital accountb. Officialreservessettlementbalancec. Recurring accountd.

When employment tends to be a long-term feature of a country, it is called _________________.6. Structural unemploymenta. Technological unemploymentb. Cyclical unemploymentc. Chronic unemploymentd.

Which of the following refers to a position where people may be working and apparently employed, yet their 7. contribution to output may be zero?

Structural unemploymenta. Technological unemploymentb. Disguised unemploymentc. Seasonal unemploymentd.


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____________ has reduced Purchasing Power of Money.8. Unemploymenta. Inflationb. Povertyc. Populationd.

What do you mean by density of population?9. Number of Persons per square kilometer.a. Number of Persons per thousand kilometers.b. Number of Persons per square meter.c. Number of Persons per square feet.d.

In which year India has started making efforts to control its population growth?10. 1950a. 1947b. 1952c. 1964d.

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Chapter III

Economic Policies

Aim


explain economic policies•

elucidate the objectives of policy•

explicatefiscalpolicy•

Objectives


explain monetory policy•

enlisttheobjectivesoffiscalpolicy•

explicate objective of monetory policy•

Learning outcome


describe instruments of monetary policy•

comparefiscalandmonetarypolicy•

understand foreign investment policy•


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3.1 IntroductionA particular objective of this chapter is to provide the total perspective in which some of the recent initiatives in India’s economic policy need to be viewed. These initiatives, usually characterised by the catchall phrase “economic liberalisation”, have been the special focus of international attention directed at India. They are certainly important, but they must be seen as once element of the total economic policy package, addressed especially at improving performance in the industrial sector. Economic policy must also deal with many other aspects of performance where the key issues do not relate to economic liberalisation. It is also important to distinguish the Indian policy initiatives form the classical “liberalisation packages” which are ardently advocated in many quarters. There are important differences in approach and perhaps also in underlying philosophy and these differences are brought out in this chapter.

3.2 Objective of PolicyBoth performance and policy are in some sense best judged in terms of the objectives of development policy, the more so in an economy in which objectives have been consciously set in successive national plans. The broad objectives which have guided India’s development strategy are listed below. Some of them are obviously common to all developing countries, but others are not so, at least not to the same extent.

Achievement of a high rate of economic growth leading to a sustained improvement in the levels of living of •the population. This is obviously a common objective of all developing countriesReduction in inequalities and more especially an accelerated effort to remove poverty at a pace faster than would •be achieved solely through the normal growth processDevelopment of a mixed economy with a strong public sector, especially in key areas of the economy. The •creation of a public sector could be viewed as an instrument for achieving broader objectives of growth with equity, but India’s development strategy has accorded such special importance to the public sector that t could properly be described as an independent objective of policy. The creation of a public sector was viewed not merely as an instrument to achieve other objectives. There was a more basic and widely shared socio-political commitment to the creation of a mixed economy, in which the state has a substantial direct control over important production sectorsAchievement of a high order of “self-reliance” has been an important independent objective. The term itself is •usedintowsenses.Inonesense,self-reliancehasmeantthatdevelopmentmustbefinancedasfaraspossiblefrom domestic savings, avoiding excessive dependence upon external assistance. Self-reliance has also meant a conscious effort at developing a broad domestic production base and an indigenous technological capacity, both of which were felt to be essential requirements for building a strong industrialised economyPromotion of balanced regional development, with a narrowing of economic difference across regions. This has •tendedtobeviewednotjustasmatterofpromotingeconomicgrowthbutalsomorespecificallyasamatterofregional balance in the degree of industrialisationFinally, these social and economic objectives were to be pursued in the framework of a constitutional •democracy

These broad objectives have been evident from the very early stages of Planning in India. Over time they have taken more concrete shape as distinct objectives. It is evident that some of these objectives involve a potential conflictortrade-offwithgrowth,atleastintheshortterm.Thepossibilityofsuchtrade-offsintheshortrunwasalways consciously recognised, though of course it is always relevant to ask whether in practice the trade-off was optimised.

How has the economy performed in terms of these objectives? A summary assessment is offered in the following sections, focusing especially on recent performance and identifying some key aspects of policy and future priorities as they emerge from recent experience.

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3.3 Growth PerformanceThe rate of growth of the economy is the most commonly used measure of overall performance and it is appropriate to begin with this indicator. Up to about the mid-seventies, India’s trend growth rate of G.D.P ignoring yearly fluctuationsseemedfirmlyanchoredatabout3.5percentperyear,unforgettablycharacterisedbythelateprofessorRaj Krishna as “the Hindu rate of growth”. There is clear evidence that the economy broke through this constraint sometime in the mid-seventies. The growth rate over the past ten years or so averages about 4.5 percent and this is an average over a period in which growth was accelerating. The underlying growth rate of the economy in the mid-eighties is nearer 5 percent per year. This is not high compared with growth rates achieved in earlier decades by the better-performing developing countries. Some countries have achieved annual growth rates as high as 10 percent over sustained periods, and many have grown at rates between 6 percent and 7 percent in the sixties and early seventies. But this comparison is not wholly fair in assessing recent economic performance in India.

An obvious point which has to be noted is that India is a relatively large economy and also among the group of low-income countries of the developing world. The size of the economy ensures that a process of averaging must be at work. India’s “growth potential” cannot therefore be presumed to be equal to the fastest-growing developing countries, but closer to the average. More important, India’s recent performance should not be assessed by comparing it with growth rates achieved by developing countries in an earlier period when the international environment was especially conducive to rapid growth. The growth potential of the developing world as a whole has slowed down since the mid-seventies, and when due allowance is made for this factor, India’s recent growth performance and current growth prospects appear in a much better light.

In the period up to the mid-seventies India’s growth rate of around 3.5 percent per year was much lower than the average of about 6.0 percent achieved by the developing countries as a whole. In the past ten years, however, India’s growth rate has accelerated, while growth rates in most of the developing world have decelerated. India’s growth rage in the period 1981-86 was almost 5 percent, when all developing countries taken together grew by only 2.5 percent. Admittedly the low growth of developing countries as a group was partly due to negative growth rates in the oil-exporting countries, but even if these countries are excluded, the category of non-oil-developing countries shows a growth of only 3.5 percent per year in this period. In fact, India’s growth performance in the eighties is exceeded only be some of the fast-growing East Asian economies and China.

This raises the question whether the acceleration in growth is a temporary phenomenon or indicative of a more basic improvement in the economy’s growth potential. The theme explored in this chapter is that India had indeed experienced a permanent acceleration in growth, accompanied by an increase in its underlying growth potential. A degree of structural maturity has been achieved in both agriculture and industry, which not only has laid the foundation for sustained growth at 5 percent but also holds out the prospect of higher growth in future. The elements of this transformation and the policy framework in which it took place are discussed in the subsequent sections of this chapter.

The governments of all countries are expected to promote the economic growth and economic welfare to improve the standard of living of the citizens. Governments are also expected to maintain law and order and ensure security of the country. Economic growth is generally measured in terms of GDP (Gross Domestic Product). GDP is the total value of goods and services produced in a country. An increasing GDP indicates increasing economic activity, which in turn generates more income. When employment and income of the citizens increases, their standard of living also increases. The policies that governments pursue to encourage economic growth and welfare are called economicpolicies.Thesepoliciescanbebroadlyclassifiedinto:

Fiscal policy •Monetary policy •


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3.4 Fiscal Policy Thispolicyseekstopromotetheeconomicgrowthandtooffsetfluctuationsinemploymentandincomethroughproactive management of public expenditure, investments, taxation, and borrowings. The sources of funds of the government are tax receipts and borrowings. The major expenditures of the government are salary and administrative expenses on maintaining the government machinery for tax collection, law and order, and defence of the country. Paymentofinterestandrepaymentsoftheexistingborrowingsaremajoroutflowsincaseofgovernmentsthathavebeenspendingmorethantheirtaxincomeorrunningdeficitbudgets.Progressivegovernments,therefore,trytolimittheprecedingoutflowsandinvestthesurplusinaugmentinginfrastructureandotherfacilitatorsofeconomicgrowth.

Thegovernmentsalsotrytodirectlyinfluencethegrowthofcertainregions,industries,orvulnerablesectionsofcitizens by providing incentives in the form of tax concessions and subsidies. In addition, governments also enlarge the welfare initiatives like health care and education. Governments draft relevant policies and implement them through various ministries. However, these policies are coordinated by the Finance ministry, which is responsible for raising resources and allocating the required resources to the various ministries. The policies formulated by various ministries and coordinated by the Finance ministry through the budgeting process are called Fiscal policies.

3.4.1 Objectives of Fiscal Policy Theobjectivesoffiscalpolicyarenotspecified,theymaydifferfromcountrytocountry.Followingarethemainobjectivesoffiscalpolicyinthedevelopingcountries.

Desirable levels of prices: The desirable level of prices can be achieved with the change in rate of taxes. Higher •taxes are imposed on luxury goods and lower on consumer goodsDesirable level of employment: The desirable level of employment is the level of full employment, which can •be obtained with the increase in constructional and developmental, works in the countryDesirable level of income distribution• : Higher income taxes are imposed on rich people so that there may be equal distribution of wealth in the countryDesirable level of consumption: Desirable level of consumption is achieved by imposing higher duties on foreign •products and less duties on national product, so that domestic industries may be developed

3.4.2 Fiscal Policy ToolsThelegislativeandexecutivebranchesofgovernmentcontrolfiscalpolicy.IntheUnitedStates,thisisthePresident’sadministration(mainlytheTreasurySecretary)andtheCongressthatpasseslaws.Policy-makersusefiscaltoolstomanipulate demand in the economy. For example:

Taxes: If demand is low, the government can decrease taxes. This increases disposable income, thereby stimulating •demandSpending:Ifinflationishigh,thegovernmentcanreduceitsspendingtherebyremovingitselffromcompeting•for resources in the market (both goods and services). This is a contractionary policy that would lower prices. Conversely,whenthereisarecessionandaggregatedemandisflagging,increasedgovernmentspendingininfrastructure projects would lead to higher demand and employment

Both toolsaffect thefiscalpositionof thegovernment i.e., thebudgetdeficitgoesupwhether thegovernmentincreasesspendingorlowerstaxes.Thisdeficitisfinancedbydebt;thegovernmentborrowsmoneytocovertheshortfall in its budget.

3.5 Monetary Policy Pricesofgoodsandservicesareinfluencedprimarilybyfactorsofdemandandsupply.Thesekeepfluctuatingonaconstant basis. The changes in price level are measured by the government by average prices of a basket of goods and services both at the wholesale level and individual consumer level. Price indicators are known as Wholesale Price Index and Consumer Price Index.

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Wildfluctuationsinpricescanbeverydisruptiveasitwillaffectthefortunesofindustriesand,therefore,impactthe life of those engaged by the industries. It is the responsibility of the government to ensure reasonable stability of prices. Similarly, ensuring stability of exchange rate of the country vis-a-vis the international currencies such as US dollar and Euro is also essential to ensure orderly growth of industries. Fluctuations in exchange rates can cause fluctuationinthegeneralpricelevel,whichinturncoulddestabilisetheeconomy.Hence,animportantgoalofthegovernment is to ensure reasonable stability of exchange rate of the currency of the country.

The policies pursued for managing liquidity, interest rates, and prices are together known as the monetary policy. This policy is shaped and administered by the Reserve Bank of India [RBI]. RBI announces policy stance every 6 months. The policy statements of RBI cover more than liquidity and interest management. It covers all functions of RBI, such as, monetary management, regulation of banking system, exchange rate management, and their role as bankerstothegovernment,namely,managingthefinancesandborrowingprogrammesofthegovernment.

3.5.1 Objectives of Monetary PolicyThebasicobjectivesofthemonetarypolicyaretoinfluencepricelevelandinvestments,whichdetermineeconomicgrowth. This policy seeks to achieve these objectives by proactive management of:

Price level •Money supply •Interest rates •Foreign exchange rate •

Relevance of price level Agradual increase inprice levelhaspositive influenceonsentiments.However, runaway increase inpricesorinflationhasdamaginginfluenceonbothinvestorsandsavers.Stridentincreaseinpricesincreasesuncertaintyandgenerates a sense of insecurity both among the savers and investors. Therefore, one of the important objectives of themonetarypolicyistolimitincreaseinpriceleveltoacceptablelevelsalsoknownasinflationtargeting.Whatisthe acceptable level depends on the situation prevailing in the country. The RBI and the government seem to have accepted an increase of up to 5% in a year in price level as acceptable.

Relevance of money supply OneofthefactorsthatinfluencespricelevelandisunderthecontrolofRBIismoneysupply.Themeasuresofmoney supply are:

M1: Currency with public and demand deposits with banks and RBI, both available for immediate spending.•M2: M1 plus savings deposits with banks•M3:M2plusfixeddepositswithbanks•M4:M3plustotaldepositswithpostoffices•

Thegovernmentinfluencesmoneysupplyorliquidityinthefollowingmanner:Government spending and investments increase money supply •Collection of taxes and borrowings from the market reduce money supply till it is spent or invested. •Deficitfinancingleadstoanincreaseinmoneysupplybecausedeficitsexceedexpenditurefundedbyborrowing•from RBI

Relevance of interest rate If funds are available at affordable interest rates, it leads to higher investments on personal as well as business front. The increased availability of retail credit at affordable rates leading to growth of automobile, housing and consumer goods industry in India is a good example of relevance of interest rates. Higher investments lead to higher employment and income, which in turn fuels demand and encourages further investments.


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Increasing interest rate dampen demand for money for investments from individuals and business. Decline in inventory build up and investments lead to lower employment and lower income. Higher interest may also divert funds from consumption to savings leading to reduction in demand. This further leads to reduction in price level, and in turn dampens business sentiments and fresh investments.

Relevance of Foreign Exchange Rate If rupee becomes cheaper (more rupees per dollar), then Indian goods will become cheaper abroad which will lead to increase in exports. Investment in export-oriented industries will increase. Conversely, imports will become costlier and import dependent industries will be affected. Other industries, which are consumers of the import dependent industry, will also be impacted negatively. In an import dependent economy like India, which depends on oil imports, tradedeficitwillincreaseresultinginfurtherreductionincompetitiveness.

Indiahasalwayshadatradedeficit,buttheimbalanceintradeisbeingmadegoodbyinwardremittancesfromIndiansabroadandinvestmentflowssuchasForeignDirectInvestment[FDI]andForeignInstitutionalInvestor[FII]. Exchange rates impact prices, interest rates, and economic growth. Therefore, smoothening exchange rate fluctuationsandmanagingitsrangeanddirectionofmovementisanimportantelementofthemonetarypolicy.

3.6 Instruments of the Monetary PolicyThe instruments at the disposal of the RBI for managing money supply, interest rates and exchange rates are:

3.6.1 Liquidity Management

Cash Reserve Ratio: Banks reserve liquidity through their power to create credit. Presently in India, banks are •required to maintain the following reserves:

Cash Reserve ratio: 8.25% of demand and time deposits (w.e.f. 24.05.2008) �Statutory Liquidity ratio: 25% of demand and time deposits �

Justasadditionalcashinflowsenablethebankingsystemtocreatecredit,anyincreaseinCRRwillrequirethebanking system to contract credit by a large amount

SLR (Statutory Liquidity ratio) is a requirement peculiar to India. In addition to ensuring that banks can fall back on the readily saleable government deposits in the event of a run on the bank, it was a prescription to divert bank deposits to meet government investment expenditureOpenMarketOperations:Banksaswellasotherfinancialinstitutions,suchasinsurancecompanies,mutualfunds•and corporate with surplus cash are big investors in government securities. When RBI wishes to inject liquidity into the market, it has another option of buying government securities. When RBI offers to buy the securities at a rate that is better than the rate prevailing in the market, some of the investors can sell their holdings and thecashinflowwouldleadtocreditcreationofalargemagnitude.Similarly, when RBI sells government securities at a higher rate than market rate, RBI absorbs funds and the banking system contracts credit by a large magnitude to reduce liquidity. This is known as open market operation Managing Credit Expansion: CRR and OMO reduce liquidity in the system and reduce the ability of banks to •createcredit.RBIalsocontrolssectorspecificexpansionofcreditbyspecifyingmaximumamountsthatcanbelent, minimum margins to be maintained and higher risk weights. When RBI feels that banks have overextended themselvestocertainsectors,theflowofcredittocertainsectorsisleadingtoanimbalancedgrowthoftheeconomy or it wants to control the price of certain commodities by preventing hoarding by wholesalers with borrowedfunds,RBImakessectorspecificorcommodityspecificinterventions

3.6.2 Interest Rate Management Repo rate: Repo rate or repurchase rate is a swap deal involving the immediate sale of securities and simultaneous purchase of those securities at a future date, at a designated price. It could also be an overnight deal with sale taking place on day one and repurchase on day two. The repurchase price is adjusted for the interest payable for the use of funds for the period of contract. Reverse repo involves the immediate purchase and future sale of those same securities. RBI uses repo and reverse repo to control liquidity on a day-to-day basis.

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Bankrate:RBIprovidesrefinancetobanksagainstfundsdeployedbybanksinspecifiedsectorssuchasexport•financeportfolioofthebanks.Inthepast,thebankrateusedtobetheprimaryinterestratetoolofRBI.Butover a period of time the repo rate has presently emerged as the primary interest rate tool and bank rate has lost much of its relevance. Changes in the bank rate are a signal to the market regarding the direction in which the RBI would like interest rates to move Rates paid on government securities:• RBI, as a banker to the government, helps government to borrow from the market by selling their securities. RBI also determines the timing, size, and rate paid on the issues. Rates offeredbyRBIongovernmentsecuritiesarebothareflectionofthemarketandalsoanindicatortothemarketon the direction of interest rate movements

3.6.3 Foreign Exchange Management

Tweaking the basket of currencies: The exchange rate of rupee is calculated by RBI based on the exchange •ratesofbasketofcurrenciesofcountrieswithwhichIndiahassignificanttradetransactions.RBImaintainsconfidentialityabouttheweightagegiventoeachcurrencyinthebasketandwhenRBIwishestomanagetheextent of volatility in the exchange rate of rupee, RBI adjusts the weightages properly Market intervention: Large balance of payment surpluses and build up of Forex reserves are bound to strengthen •the rupee in the exchange market. This market force cannot be counted by RBI for long periods of time. However, by intervening in the market by offering to buy any amount of foreign currency at a particular rate, RBI can prevent the sudden strengthening of rupee. RBI seeks to smoothen the movement of rates in either direction so than importers and exporters have time to adjust to the changing exchange rate scenario and are not caught by surprise by violent rate movements, which could cripple them

3.7 Difference between Fiscal Policy and Monetary PolicyDifferencebetweenfiscalpolicyandmonetarypolicyisdiscussedasbelow:

Fiscal Policy Monetary Policy

Principle:

Manipulating the level of aggregate demand in the economy to achieve economic objectives of price stability, full employment, and economic growth.

Manipulating the supply of money to influenceoutcomeslikeeconomicgrowth,inflation,exchangerateswithothercurrenciesand unemployment.

Definition:Fiscal policy is the use of government expenditure and revenue collection to influencetheeconomy.

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.

Policy Tools: Taxes; amount of government spending

Interest rates; reserve requirements; currency peg; discount window; quantitative easing; open market operations; signalling

Policy-maker:

Government (e.g. U.S. Congress, Treasury Secretary) Central Bank (e.g., U.S. Federal Reserve)

Table 3.1 Comparison between fiscal policy and monetary policy

3.7.1 Foreign Investment PolicyA particularly striking feature of India’s foreign investment regime since the 1990s has been that it encourages the adoptionofforeigntechnologybydomesticfirmswhileatthesametimeopeninguptheseindustrysectorstoforeigninvestors. So liberalisation consists of two distinct components:


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Foreigndirectinvestment(FDI),definedbytheInternationalMonetaryFundasaforeignfirmtakingatleasta10%stakeinadomesticfirm.Foreigntechnologyagreements(FTA),more‘arm’slength’transactionsinwhichaforeignfirmentersintopartnershipwithadomesticfirm.Therelativeimportanceofthetwocomponentscanbegaugedbythe fact that in the post-reform period (between August 1991 and January 2005 in this study), the number of FDI projects approved by the Indian government was nearly 19,000 and the number of FTAs approved was just over 7,600.Unlike in many East Asian countries, Indian policy-makers have resisted the temptation to offer subsidies to foreign investors (at least until very recently). Instead, they have pursued a two-pronged strategy of inviting FDI fromforeignfirmsaswellasencouragingFTAsbydomesticfirms.

PreviousresearchhasshownthatincreasingFDIleadstogreatercompetitioninindustrieswherefirmscompetewith each other at a single stage of the production process. The effect of increased competitive pressure is to lower themark-upsthatdomesticfirmsareabletocharge,therebyreducingtheirmeasuredproductivity.Thisistypicallynotoutweighedbyanyproductivitybenefitstodomesticfirmsfromobservingandcopyingthetechniquesusedbyforeignfirms–whatareknownas‘technologyspillovers’.Forfirmsintheseindustriestogainsignificantlyfromtechnology spillovers, they need to be technologically advanced or close to the ‘technology frontier’.

But invertically integrated industries (wherefirmsoperate atmore thanone stageof theproductionprocess),previous research suggests that the effect of FDI on productivity is positive. This implies that both domestic and foreignfirmsbenefitfromtechnologyspillovers.

Chawla’sresearchfindsthat liberalisationof theforeigninvestmentregimeinIndiahassignificantlyimprovedtheperformanceofmanufacturingfirms.Thisissurprisingasthesamplemainlyconsistsoffirmsthatcompeteat a single stage of production. What seems to have happened is that the policy of encouraging FTAs has had an effectequivalenttotechnologyspillovers,movingdomesticfirmsclosertothetechnologyfrontier,albeitthroughdifferent means. Since the industries studied were simultaneously subjected to both FDI and FTA liberalisation, it is not easy to distinguish between the effects of two policies. To do this, the research looks in detail at the motor vehicleindustry.Itfindsthatinthissectoratleast,thetwoelementsoftheforeigninvestmentregimehavebeencomplementaryintheirpositiveimpactonfirms’productivity.

India’sexperiencesareoftencomparedwithChina’s,andwhilethelatterhasattractedgreaterFDIinflowsthantheformer since the early 1990s, India has attracted greater portfolio investment and the ratio of market capitalisation ofitslistedfirmstoGDPhasbeenhigher.What’smore,IndianfirmsnowinvestsomuchabroadthatFDIoutflowsalmostmatchFDIinflows.ThefactthatIndia’sforeigninvestmentliberalisationtreatsforeigntechnologyanddirectinvestment as inseparable is important here. Such a policy is bound to have effects beyond the simple enumeration ofFDIinflowfigures.Atleastoneimportantimplicationofthispolicyisitspositiveeffectontheproductivityofmanufacturingfirms.ArunishChawlaisanoccasionalresearch.

New dimensions of Foreign Investment PolicyOne of the new dimensions of foreign investment policy is investment in infrastructure. The contours of this policy have been dictated by three main factors. First, India’s infrastructural needs are huge. The quantum of infrastructural gaps and the resource requirements has been estimated by the India Infrastructure Report (1996). Second, the public sector is no longer in a position to meet the requirement all by itself. Third, India needs to have latest technologies in order to have modem infrastructural facilities. Technological up gradation in the rest of the economy can be facilitated only with modernisation of infrastructure. Accordingly, private sector participation (domestic as well as foreign) has been a key element of the policy for infrastructure development. It has taken some years to evolve definitivepolicyframeworkandhasnotbeenwithouthitches,whicharoseoutoflackofnecessaryunderstandingoftheprinciplesthatguideprivateinvestmentininfrastructure.However,thepolicythathasfinallyevolvedisamix of international trend in foreign participation in infrastructure and the country’s long-term perspective.

The policy permits:100 per cent foreign investment in power, roads and highways, construction of airports and ports and •49 per cent foreign equity in telecom •

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There is lack of clarity, or rather indecisiveness, about foreign investment in the railways and civil aviation. In the case of railways, it is not clear whether foreign investment is welcome or not, and if welcome, what is the permissible extent of foreign equity. This sector has also managed to escape any kind of debate. But the civil aviation sector has been a controversial one. Foreign equity participation up to 40 per cent, subject to approval, is what the government may be willing to consider, but so far it has not been possible to establish it as a matter of general policy. On the whole, it can be said that though the government welcomes foreign investment in infrastructure, the policy is rather sectoral than general in character.

Investmentinfinancialsectorisanothernewdimensionofforeigninvestmentpolicy.Likeinfrastructure,thissectorwas also closed to the private sector, but has been subjected to gradual reform since 1991. So far, there is nothing thatcanbecalledacomprehensiveforeigninvestmentpolicyforfinancialsector,butthreedistinctpolicychangeshave been undertaken. First, the foreign banks are given liberal permission to open subsidiaries and expand branches, besideswideravenuesintheareaofbankingoperations.Second,foreignnon-bankingfinancialcompanies(NBFCs)have been allowed to start operations in India, mostly in joint ventures with the Indian NBFCs, though there is lack of clarity as to the extent of foreign equity participation. The interest is primarily on capital adequacy and protection of investors’ money, rather than equity. Third, the FIIs are allowed to invest in the equities of listed Indian companies totheextentof30percent.Thesearethebroadaspectsofforeigninvestmentpolicyinthefinancialsector.Thequestion of foreign investment in the insurance sector has been a subject of considerable debate, but lack of necessary political support has been a major obstacle to reform. The doors are closed even to the domestic private sector.


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SummaryA particular objective of this chapter is to provide the total perspective in which some of the recent initiatives •in India’s economic policy need to be viewed.Both performance and policy are in some sense best judged in terms of the objectives of development policy, •the more so in an economy in which objectives have been consciously set in successive national plans.The rate of growth of the economy is the most commonly used measure of overall performance and it is •appropriate to begin with this indicator.Fiscalpolicyseekstopromotetheeconomicgrowthandtooffsetfluctuationsinemploymentandincomethrough•proactive management of public expenditure, investments, taxation, and borrowings.Thelegislativeandexecutivebranchesofgovernmentcontrolfiscalpolicy.•Pricesofgoodsandservicesareinfluencedprimarilybyfactorsofdemandandsupply.Thesekeepfluctuating•on a constant basis. Thebasicobjectivesof themonetarypolicyare to influenceprice leveland investments,whichdetermine•economic growth.Repo Rate or repurchase rate is a swap deal involving the immediate sale of securities and simultaneous purchase •of those securities at a future date, at a designated price.RBIprovidesrefinancetobanksagainstfundsdeployedbybanksinspecifiedsectorssuchasexportfinance•portfolio of the banks.Foreigndirectinvestment(FDI),definedbytheInternationalMonetaryFundasaforeignfirmtakingatleasta•10%stakeinadomesticfirm.One of the new dimensions of foreign investment policy is investment in infrastructure.•

ReferencesCoeure, B. & Jacquet, P., 2010. • Economic Policy:Theory and Practice, Oxford University Press.Dixit, A.K., 1996.• The Making of Economic Policy:A Tansaction-Cost Politics Perspective, The MIT Press.Economic Policy Reforms 2013• [Pdf] Available at: <http://www.oecd.org/inclusive-growth/Economic%20Policy%20Reforms%202013%20Going%20for%20Growth.pdf>[Accessed11July2013].Economic Policy Reforms 2013• [Pdf]Availableat:<arhiv.mm.gov.si/vlada/temp/OECD2012.pdf‎>[Accessed11 July 2013].2011. Indian Economy: The Road Ahead• [Video online] Available at: <https://www.youtube.com/watch?v= BqyGaT0RCt0‎>[Accessed11July2013].2011. Economic Environment• [Videoonline]Availableat:<https://www.youtube.com/watch?v=BEipiii-DlE‎>[Accessed 11 July 2013].

Recommended ReadingSterner, T., 1996. • Economic Policies for Sustainable Development, Kluwer Academic Publishers.Acocella, N., • Economic Policy in the Age of Globalisation, Cambridge University Press.Krueger, A.O., • Economic Policy Reforms and the Indian Economy, The University of Chicago Press, Chicago.

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Self AssessmentWhat do you mean by GDP?1.

It is the total value of goods and services produced in a country. a. It is the total value of goods and services produced in the whole world.b. It is the total volume of goods and services produced in a country.c. It is the total volume of goods and services produced in the world.d.

The policies that governments pursue to encourage economic growth and welfare are called _____________.2. social policiesa. economic policiesb. financialpoliciesc. employment policiesd.

Which of the following is a swap deal involving the immediate sale of securities and simultaneous purchase of 3. those securities at a future date, at a designated price?

Repo Ratea. Bank Rate b. Interest Ratec. Rates paid on government securities.d.

RBI announces policy stance every ___ months.4. 3a. 6b. 12c. 9d.

Whichofthefollowingpolicyseekstopromotetheeconomicgrowthandtooffsetfluctuationsinemployment5. and income through proactive management of public expenditure, investments, taxation, and borrowings?

Fiscal policya. Monetary policyb. Social policyc. Financial policyd.

Whatdoyoumeanbyinflationtargeting?6. Limit increase in GDP.a. Increase in price level of goods.b. Limit increase in price level.c. Increase in GDP.d.


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WhichofthefollowingisoneofthefactorsthatinfluencespricelevelandisunderthecontrolofRBI?7. Relevance of Money supply.a. Relevance of Interest rate.b. Relevance of Foreign Exchange Rate.c. Relevance of Liquidity management.d.

Banks reserve liquidity through their _____ to create credit.8. Capacitya. Powerb. Profitc. Balanced.

Which of the following do not falls under liquidity management?9. Repo ratea. Cash Reserve Ratiob. Managing Credit Expansionc. Open Market Operationsd.

Investment in __________ sector is another new dimension of foreign investment policy.10. technologya. financialb. telecomc. housingd.

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Chapter IV

Industrial Development and Industrial Policy

Aim


explain industrial performance•

elucidate problems related to industrial growth•

explicate Indian Public Sector- Performance•

Objectives


explain the concept of cottage and small scale industries•

enlist the industrial and trade policies•

explicate privatisation•

Learning outcome


describe liberalisation•

compare cottage and small scale industries•

understandfinancingdevelopment•


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4.1 Industrial Performance and PoliciesRapid industrialisation has long been viewed as the key to sustained growth and modernisation of the economy. However, industrial policies were not framed solely by the immediate requirements of growth maximisation. They werealsoinfluencedbyactivegovernmentinterventioninpursuitofsomeoftheotherdevelopmentalobjectiveslisted earlier in this chapter.

The results present a mixed picture. In some respects the industrial sector can be said to have achieved the objectives set for it. A substantial public sector presence has been created, laying the foundations for a mixed economy. A high degreeof“selfreliance”hasbeenachievedinthesensethatahighlydiversifiedindustrialbasehasbeencreated,catering to the domestic needs of the economy in a very wide variety of products. The entrepreneurial base of the economy has also been widened greatly, with the emergence of a number of new large and medium-scale industrial houses and a profusion of small-scale entrepreneurs. Finally, industrial has spread into regions where industry did not exist earlier and into which it probably would not have gone for many more years but for government intervention.

4.2 Problems Related to Industrial Growth (A Critical Analysis)Against these achievements there are some obvious shortcomings. Industrial growth has not been as rapid as was expected.Afterapromisingearlyperiodinthefiftiesandearlysixties,industrialgrowthsloweddownconsiderably,and from 1964-65 to 1975-76 the index of industrial production showed a growth rate of only 4 percent per year and value added in industry grew at 3.5 percent per year. There is evidence of a gradual acceleration after the mid-seventies,throughwithconsiderableyear-to-yearfluctuations.Inthemostrecentperiod1981-82to1986-87,theindex of industrial production (using the new index base 1980-81=100) shows an average growth rate of around 7 percentperyearwhilevalueaddedgrowthisabout6percent.Thisisdefinitelyanimprovementonpastperformance,but it still falls short of what is needed to take the economy beyond the current 5 percent growth of GDP. For the future, India should be aiming at an industrial growth rate of around 9 percent to 10 percent, with value added in the industrial sector growing at 8 percent to 9 percent.

Another major shortcoming in India’s industrial sector is its lack of international competitiveness and consequent poor export performance. Export performance is obviously important in a situation in which the continued growth andmodernisationoftheeconomyrequiresasubstantialinflowofimportedcapitalgoodsandotherinputsintoproduction. The industrial sector, which absorbs a large percentage of total resources available to the economy, must be able to earn the foreign exchange it needs from exports. This has not yet happened to the extent needed, and one of the major constraints is clearly lack of competitiveness in terms of both cost and quality.

These shortcomings of slow industrial growth and a high-cost uncompetitive industrial sector have been widely recognised in India and have led to critical reexamination of the industrial policy structure to see what corrective steps are necessary. The blame for slow industrial growth cannot, of course, be laid on policy alone. For example, it could be argued that the key to faster industrial growth lies in a more rapid pace of expansion in agriculture which would provide the stimulus for faster growth in industry. While this is undoubtedly true, a consensus has also emergedthatthesystemofregulatorycontrolthathasevolvedovertimeisnotconducivetoindustrialefficiencyand dynamism.

Anumberofofficialreportsandacademicstudieshavedocumentedthatproblemscreatedbyacontrolsystemconsisting of detailed, often multiple, regulation and scrutiny. This system has operated in a manner which hampered the ability of industrial units to take rational investment decisions, limited their ability to modernise existing capacities and even discouraged expansion of production beyond licensed capacity. It has also restricted competition which would have been a spur to improved quality and lower cost. Much of the problem arises because of the multiplicity of objectives to which industrial policy has been tailored, each involving an intervention which has an economic cost.

The catalogue of criticisms of the industrial policy is well-known. The original rationale for industrial licensing was to direct private investment into desired areas and also to avoid wasteful over investment. In practice, strict licensingoftenhadtheeffectoflimitingexpansionbyefficientunitsorentrybypotentialnewunitsontheground

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thatadequatecapacityhadalreadybeenlicensed.Inefficientproducerswerethereforeeffectivelyshieldedfromdomestic competition. The objective of limiting concentration of economic power led to especially strict scrutiny and regulation of the expansion or investment plans of larger houses, with a view to ensuring that their activities wererestrictedtohigh-priority,technicallymoredifficultindustries.Considerationofmaintainingregionalbalanceoften led to fragmentation of capacity, with a consequent loss of economies of sale. There was a tendency to license a larger number of small units spread over many States, where a single economic-scale plant would have been more efficient.

Theseandothersourcesofinefficiencyundoubtedlycontributedtotheemergenceofahigh-costindustrialstructurewhich slowed growth and reduced export competitiveness. Such a structure would obviously not have been sustainable in a more open economy, which allows competition from imports, but the trade policy permitted very little room forimportcompetition.Theobjectiveofself-relianceshouldhavemeantself-reliancewithefficiency.Inpractice,however, domestic production was protected from external competition with little regard to domestic resource costs. Protection, which should have been viewed as giving initial support for infant industries, which would in time outgrowtheneedforit,typicallycontinuedasanindefinitecrutch,supportingindustrieswhosecostsofproductionwere far out of line with international prices.

4.3 Policy Initiatives TakenTheseproblemspromptedtheestablishmentofvariousofficialcommitteesintheearlyeightiestoexaminethestructureof industrial and trade policies and make recommendations for change. On the basis of their recommendations a series of policy initiatives were taken in 1985 and 1986. The most important of these were the following:

The coverage of industrial licensingwas reduced by relicensing twenty-five industries and eighty-two•pharmaceutical productsWherelicensingremainedinoperation,proceduresweresimplifiedandindustriallicensingwasmuchmore•liberallyoperated.Furthermore,greaterflexibilitywasprovidedtoproducerstoexpandcapacitywithinexistinglicensed capacity. Provisions for allowing automatic expansion in licensed capacity, which existed earlier, were liberalised. For a number of products, licenses were “broad banded” so as to cover similar products, thus allowingflexibilityinvaryingtheproductmixThe minimum size of assets beyond which a unit is declared a “large house” and subjected to especially rigorous •scrutiny in licensing was increased from `. 200 million to `. 1,000 millionTwenty-seven industries were added to the list of industries for which large houses are exempted from the •special scrutiny normally required Alistof industrieswasnotifieswhereeconomiesofscaleareimportant,andfor theseindustriesminimum•economicscalesofplantwerespecified.Existingunitsbelowthesesizeswillbeallowedtoexpandfreelyupto the minimum economic size, and new units will be licensed only for these of higher sizes Anumberofitemswereearlierreservedforproductioninthesmall-scalesector,definedintermsofunitswith•investment in plant and machinery below `. 35 lakhs. In many cases, this investment limit was too low for efficientproductionofthereserveditems.Thelistofreserveditemshasbeenreviewed,andanumberofitemshavebeendeleted,orinsomecasesredefined,toenablelarger-scaleinvestmenttobemadefortheproductionof a large number of itemsIn the area of trade policy, the Government accepted the principle of shifting from quantitative controls to tariff •controls. Implementation, however, was left to be determined in the light of practical possibilities. Some tariff adjustments have indeed been made along these lines Nomajorchangewasmadeinthedegreeofimportliberalisationin1985and1986,butitwasreaffirmedthatthe•liberalisationthathadearliertakenplaceoverthefirsthalfoftheeightieswouldstayinplace.Theaffirmationthat import policy would not be reversed was an important signal in a situation where the balance of payments was beginning to show strain Amajorstepwastakentowardsrationalisationoftheindirecttaxsystemin1986byintroducingamodified•value-added tax, covering a wide range of commodities. The system provides for adjustment of the duties paid on inputs against the tax due on output. Although tax rates on outputs were simultaneously raised to avoid any net reduction in effective taxation in the initial stages, it was nevertheless an important reform. The total


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burden of excise taxation on a commodity is now more apparent since earlier-stage duties are adjusted against the tax. This paves the way for restructuring of indirect taxation in the future. The Government has indicated that restructuring of indirect taxes will be attempted industry by industry Steps have also been taken to rationalise the structure of customs duties. The range of variation of tariffs for •capital goods has been reduces. Tariffs were raised on a number of items earlier allowed at 55 percent duty and lowered on others where the tariff was 101 percent, and all these items now face a uniform duty of 85 percent (inclusive of a 15 percent countervailing duty which offsets the 15 percent domestic excise duty on capital goods). In addition, the customs duty structure for components and raw materials has been both lowered, and rationalised, for selected sectors. It has also been indicated that such restructuring will continue to be made sector by sector Finally, a number of measures were taken to improve the competitive position of exporters. The procedures for •giving exporters access to imports at international prices were further improved in several ways and direct tax incentives for income from exports were strengthened. Some of these measures are applicable to all exporters, but others were aimed at particular export sectors. The customs duties on capital goods for certain industries deemed to have export potential (gems and jewelery, garments, leather, etc.) were reduced to 35 percent in an effort to bring the cost of production in these industries more in line with world prices

It is too early to evaluate quantitatively the effect of the 1985 and 1986 measures on actual industrial performance. However, there is no doubt that they have contributed to a spurt of investment proposals in these years. The volume of industrial licenses approved in 1985 and 1986 increased very substantially and there was also a large increase in industrial investment proposals in the relicensed category as measured by the number of registrations. Moreover, because of the more liberal approach to technological modernisation and import of capital goods for this purpose, the more recent investment proposals embody better technology than has been allowed in the past. Many of them also represent plant sizes which are nearer to economic levels of scale. The full impact of this investment boom and the associated qualitative improvements should be evident in the next few years when the capacities to be created by these investments come on-stream.

4.4 Indian Public Sector- Performance An important determinant of industrial performance in India is the performance of the public sector. The creation of a large public sector presence in the Indian economy was one of the explicit objectives of India’s development strategy and the success in achieving this objective is evident. Public sector output today accounts for about 45 percent of the output of the organised industrial sector and 30 percent of total industrial output. Its alone ensures that an overall acceleration of industrial growth would require an improvement in public sector performance. This is all the more so since the public sector occupies a dominant position in key infrastructure industries such as power generation, coal, steel and crude oil production, and performance in these areas is crucial to the general level of industrialefficiency.

There can be no doubt that very considerable improvement is needed in public sector performance. The logic of undertaking large investments to create a public sector with a commanding presence implies that it will generate thenecessarysurplusestobeabletoreplacecapitalandfinanceinvestmentforfuturegrowth.Therecordinthisrespect has been disappointing. There are heartening examples of very good performance by individual enterprises, but, equally, there are many cased of large and chronic loss makers. The overall generation of resources from this sector is well below the level assumed in the Plan. If the resources contributed by the oil sector are excluded, the performance of the other public sector organisations appears in a much poorer light.

There is no easy solution to the problem of improving public sector performance. Many of the public sector enterprises suffer from earlier noneconomic decisions, which are not always the fault of management. No simple formula will overcome these problems. Many are heavily overmanned, and it is not easy to lay off surplus labor. Some suffer from wrong technology choices or product mix decisions made earlier which impose a continuing burden on the enterprise. In some cases, public sector projects become unviable even before they commence production because capital costs are allowed to escalate to unreasonable levels on account of delays in implementation, usually because the unit was short of funds at the early stages. Still other loss-making enterprises in the public sector are actually formerprivatesectorunitswhichhadbecomefinanciallyunviableandweretakenoverbytheGovernmentonlytoprotect employment. Each of these pathologies obviously calls for its own solution.

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However, a consensus is emerging on one important issue, and that is the need to give management autonomy to publicsectorenterprisesasakeyrequirementforefficientfunctioning.Thereisnoinherentreasonwhyapublicsectorcorporationshouldbeinefficient, if it isrunlikeacorporation.Inparticular, itmustnotbesubjectedtocontinuous interference from the Government or bureaucracy who demoralises public sector management and dilutes accountability. Government should set out the corporate objectives of the enterprise and top management must be given the full degree of autonomy needed to achieve these corporate objectives. With this autonomy there must also be accountability. The performance of top management must be judged in terms of the achievement of agreed objectives. The Sengupta committee, which examined the functioning of public sector enterprises and submitted its report in 1985, had recommended that the objective of ensuring autonomy and accountability could be achieved by introducing a Memorandum of Understanding (MOU) which would be jointly agreed between the Government and the top management of the enterprises each year. The MOU would set out the objectives according to which the management performance would be judged and it would also specify actions expected by the public sector enterprise from the Government. As an experiment, the system of MOUs is being implemented for six major public sector enterprises beginning in 1987.

Itisimportanttonotethatthe“privatisation”whichisoftenrecommendedastheanswertopublicsectorinefficiencyisnotontheagenda.Proponentsofprivatisationobviouslyregardthepublicsectorasinherentlyinefficient.Nosuchassumption underlies the policy reform being attempted in India. On the contrary, the basic approach is that a public sectorenterprisecanbeasefficientasanyothercorporatesectorunitcanbemadetoapproximatetherelationshipbetween shareholders and a corporation.

The policy initiatives described above for improving industrial performance involve a considerable measure of deregulation and therefore may be called economic liberalisation but they obviously differ in important respects from the usual liberalisation packages often prescribed for developing countries and also undertaken in some cases (though with varying success). The familiar liberalisation package focuses heavily on foreign trade liberalisation and rationalisationofprotection.Theusualformulaistorecommendafirststageconsistingofaswitchfromquantitativeto tariff controls, followed by a phased reduction in both the variation in degrees of protection across sectors and also the average level of protection. The whole process is usually expected to be underpinned by exchange rate depreciation. Often it includes a conscious policy of privatisation of the public sector to overcome problems of public sectorinefficiency.ThedifferencesintheIndiancaseareevident.Indianpolicyreformhasfocusedmuchmoreondomestic industrial liberalisation rather than foreign trade liberalisation. There is considerable internal deregulation aimedatstrengtheningthemoreefficientdomesticfirmsandencouragingthemtoinvestandexpand.Thisisexpectedto inject much more competition into the system, creating incentives for reducing costs. The internal liberalisation hasbeenaccompaniedbyapolicyofmaintainingasufficientlyopenaccesstoimportstopermitmodernisationandtechnological upgrading in Indian Industry, which again will reduce costs and promote international competition. As far as foreign trade liberalisation is concerned, a broad direction has been given about the desirability of switching from quantitative controls to tariffs, but the movement in this area is limited and certainly does not include imports offinalconsumergoods.However,significanttariffrationalisationmeasureshavebeenimplementedinseveralsectors. Finally, there is no question of privatisation of the public sector. The focus is on management and institutional reformofthepublicsectortoimproveitsefficiency.

An important feature of the process of policy reform under way in India is that it is gradualist. The system is being subjectedtoomuchstrongerpressuresforefficiencyandmodernisation,butatacontrolledpace.Therationaleforthis gradualist approach lies in the perception that the system should be subjected to pressure commensurate with its ability to respond. Pressures beyond this point are only disruptive.

4.5 Financing Development An important aspect of performance, which has a direct bearing on the longer-term growth potential of the economy, is the ability to mobilise resources for investment. India’s recent performance in this dimension is commendable. The rate of gross domestic investment in the economy, which increased only marginally from 17 percent in 1960-61 to 18 percent in 1970-71, then increased sharply thereafter to reach 24.7 percent in 1980-81. It has stayed at that level in the eighties. This investment rate is not high compared with rates achieved in the more rapidly growing middle-income countries, but it is much higher than the rates achieved in all the other low-income countries except


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China.Whatismore,thehighrateofinvestmentisbeingfinancedalmostentirelyfromhigherdomesticsavings,testifyi9ng to the success of self-reliance in this sense of the term. The gross domestic savings rate, which was 17 percent in 1970-71, had increased to 23 percent by 1985-86.

There is certainly need and scope for further increased the rate of savings and thereby also the rate of investment. Butthelevelsalreadyachieved,andtheirevidentsustainability,reflectonimportantstructuraltransformationintheeconomy in terms of its resource mobilisation capability. Even if the investment rate is only maintained at around 24-35 percent, it should be possible not only to maintain the present 5 percent growth rate, but perhaps even to achieve some further acceleration. This is because all available evidence suggests that the incremental capital-output ratioishigherinIndiathaninothercountries.Thesepointstothescopeforincreasedefficiencyinresourceuse,apossibilitywhichisconfirmedbyrecentstudiesoftotalfactorproductivitysuchasAhluwaliaandGoldarwhichshow slower growth in these indices of industrial productivity in India compared with other developing countries.An important feature of the increase in the aggregate savings rate is that it has occurred entirely because of the rapid growth in private household savings as a percent of GDP. The ratios of private corporate sector savings and public sector savings to GDP have remained more or less constant at 2 percent and 3 percent of GDP respectively, while private sector savings increased from 12 percent of GDP in 1970-71 to 18 percent of GDP in 1985-86. This rapidgrowthreflectsthecumulativeimpactofaconsciouspolicyofgivingstrongincentivesforprivatehouseholdsavings,especiallyintheformoffinancialassets.FollowingnationalisationoftheIndiancommercialbanksin1969(foreign banks were not nationalised) there was a massive expansion of the banking system spreading bank branches toallpartsofthecountry,includingalsoruralareas.Thespreadofbankbranchesdefinitelyhelpedtomobiliseprivate savings for investment in the organised sector. Interest rate policy was also geared to encourage household savings and for the past ten years or so, rates paid on term deposits with banks and other government-sponsored small savings schemes have yielded positive real rates of return for savers, especially for maturities of three years and above. More recently positive real rates of return have been available even for shorter maturities.

Thisfavorableinterestratepolicywasreinforcedbyfiscalincentivesforsavingsbuiltintothedirecttaxstructurewhichprovidedeductionsfromtaxableincomeof theinterestearnedonawiderangeoffinancial instruments.For certain types of long-term savings instruments, a deduction is aloes allowed for a part of the amount invested. These incentives, which have been steadily strengthened and expanded in the past ten years, have had the effect of raisingtheeffectivepretaxreturnoneligiblefinancialinvestments.Theycertainlyencouragedtheflowofsavingsinto these investments and on the whole probably also stimulated total savings.

The institutional mechanisms for mobilising household savings for productive investment have been further strengthened in the eighties by the remarkable development of the domestic capital market. Until about 1980 the volume of funds sought to be raised directly from the capital market through equity and bonds was only about `. 500 crores per year. By 1986-87 this had increased more than tenfold. This is an impressive rate of expansion by any standard and is indicative of a structural transformation taking place in animportantarea,whichwouldhaveveryimportantimplicationsformobilisingcapitalandallocatingitefficiently.The process is as yet far from complete. The capital market remains thin and vulnerable to manipulation. It lacks adequate depth in terms of the existence of large numbers of active participants, including institutional investors. It is also inadequately regulated in terms of rules for full disclosure and restrictions on trading malpractices, including, in particular, insider trading. These limitations are fully recognised and a number of initiatives have been taken to overcome these problems. The Unit Trust of India, until now the only mutual fund operating in India, and hitherto a conservativeincome-orientedoperationatthat,floatedasecondfundaimedatcapitalappreciation.TheStateBankofIndiaistofloatasecondmutualfundtocompletewiththeUnitTrust.Thetermlendingfinancialinstitutions,which up to now have played only a limited role in the capital market, have been more active in it in the past two years. The 1986 and 1987 budgets liberalised the treatment of long-term capital gains on sale of shares so that the maximum tax on capital gains on shares is only 20 percent for shares held for more than one year. The Government also proposes to set up a National Securities and Exchange Board which will serve as an agency supervising the functioning of the stock markets and setting clear rules on issues such as disclosure, insider trading, etc, to protect the investor. It will also serve as a forum for the development and implementation of ideas aimed at developing a healthy capital market.

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In the area of resource mobilisation therefore, the economy has shown a reasonably good performance with important structuralchangestakingplacewhichhavestrengtheneditscapabilitytomobiliseandallocateresourcesefficiently.The principal weak area has been the generation of investable surpluses forms the public sector. This weakness has been widely recognised and it is to be hoped that the various measures being taken to improve public sector performance will correct this problem.

4.6 Equity and Social Justice Considerations of equity and social justice have been extremely important in India’s development objectives and policies and any evaluation of performance must include these dimensions also. This is not an easy task because of the multidimensional nature of the equity and social justice objective. The concern with income inequality and the need to increase incomes and levels of living for the poorest sections of the population is the most commonly discussed aspect of this objective. However, there are several other dimensions also, which call of distinct policy interventions. These include provision of basic or “minimum needs” for the build of the population (not just the poor) relating to health, education, drinking water and sanitation, removal of social disparities arising from caste, providing equality of opportunity at various levels of education to promote vertical mobility, and reduction in regional disparity, avoiding concentration of economic power within the private sector.

A major problem in assessing performance in reducing inequality is the lack of reliable time series data on the distribution of income. The only robust conclusions which can be asserted are that the distribution of income in India, as measured by the usual indicators of inequality, is among the more equal in the developing world. There is also no evidence of any increase in income inequality over time. Data on the distribution of consumption are more readily available and these show a decline up to the mid-seventies followed by a period in which there is year-to-yearfluctuationbutnotrend.

Success in reducing poverty is in many respects more important than trends in relative inequality, and this subject has been extensively investigated in the Indian literature, especially in the context of rural poverty, which is the bulk of the problem. A broad consensus is emerging. Studies have shown that up to about the mid-seventies the percentageoftheruralpopulationlivingbelowthepovertylinehasfluctuatedovertime,butwithoutanyunderlyingtrend. The percentage appears to have increased in years of poor agricultural performance (allowing for appropriate lags) and to have declined in response to good agricultural performance. It has also been argued that the behavior ofpricesandinflationhasanimportantimpactontheextentofpovertywithrisingpricesbeingassociatedwithanaccentuation of poverty. Although a clear trend does not emerge from the available data up to the mid-seventies, the more recent performance is more encouraging. There was perceptible drop in the late seventies in the percentage of population living below the poverty line and this appears to have continued into the eighties. The Planning Commission has estimated that the percentage of the rural population in poverty declined by 10 percent points in the Sixth Five-Year Plan period (1980-85) from 47 percent to 37 percent. The pattern of no trend up to the mid-seventies followed by an improvement can be attributed to two factors. One is probably the acceleration in agricultural and nonagricultural growth which took place from the mid-seventies onward. In the earlier period, overall growth, and especially agricultural growth, was so low that after allowing for population growth, there was only a very modest growth in per capita incomes. Per capita income in the rural areas probably grew at no more than 0.5 percent per year up to the mid-seventies. With per capita incomes growing so slowly it is not surprising that rural poverty was not much reduced. In the second period, growth in rural per capitaincomeswasdefinitelyhigher.Ifmorerapidgrowthinnonagriculturalincomeearnedbyruralhouseholdsis allowed for, the growth in per capita incomes in rural areas in the more recent period could well be in the range of1.5percentorso.Thesegrowthratesarestillonlymodest,buttheyrepresentadefiniteimprovementontheearlier pattern. The regional pattern of growth in the eighties also indicates a shift which would have helped reduce poverty. There is acceleration in growth in some old the very areas where poverty has been most concentrated, e.g., Uttar Pradesh and Bihar.


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These developments suggest that the twin strategy of relying on accelerated growth, especially in agriculture, together withspecialprogramsaimedatdirectlyhelpinghouseholdsbelowthepovertyline,canproducesignificantresultsin a reasonable period of time. The Planning Commission has estimated that the percentage of the population below the poverty line will have declined to 25 percent by 1989-90. The next decade should see a further sharp decline if not virtual eliminated in poverty as measured by the standard that has been used thus far.

As noted above, progress in other dimensions of equity and social justice is not so easily documented because of lack of data. But there is no doubt that there has been commensurate growth in most of the other indicators of minimum needs and living standards also. Perhaps the most important recent initiative in this area is the announcement of a New Education Policy aimed at upgrading the quality of education at all levels and accelerating the spread of education. A beginning in implementing this policy is being made in 1987-88 with a massive increase of almost 120 percent in Central Government expenditure on educational programmes. The special focus on education, including adult education, has direst relevance not only for productivity of the labor force but also for equity and poverty removal. Industry, with present levels of the rate of investment or modest improvements therein. The policy initiatives being taken in the industrial sector will help to bring about this outcome.

4.7 Meaning and Concept of Cottage and Small Scale IndustriesCottageandsmallscaleindustriesaredefinedintermsofinvestmentinplantandmachineryundersectionIIBofIndustries (Development and Regulation) Act 1951. The limit is revised from time to time to offset the impact of inflationandtomeetthetechnologicalneeds.

Cottage industry is the one which is run by an individual with the help of his family members with very little capital. Most of the cottage industries do not use power. According to the Fiscal Commission (1949-50) “cottage industry is an industry which is run either as whole- time or part-time occupation with the full or partial help of the members of the family”. These industries are mostly run by the artisans in their own homes. The use of power and machines in these industries are very limited. The products produced in cottage industries are usually to satisfy the local demands. Number of hired-labour in this sector is very limited and the capital investment is also small. They are mostly located in villages and rural areas.

According to the Economic Commission of Asia and the Far East(ECAFE) “cottage industries are those industries which are run fully or partially with the help of family members”1. In the words of Dharand Lydall2 “cottage industries are mainly traditional industries which produce traditional goods with the traditional techniques”. Examples of cottage industries are khadi industry, handicrafts, handlooms, cane and bamboo base industries, pottery, blacksmith etc.

InIndia,thefirstofficialcriterionforsmallscaleindustrydatesbacktothesecondFiveYearPlanwhenitwasdefinedintermsofgrossinvestmentinland,building,plantandmachineryandthestrengthofthelabourforce.In1955SmallScaleIndustriesBoarddefinedsmallscaleindustryas“Aunitemployinglessthan50persons,ifusingpowerandlessthan100personswithouttheuseofpowerandwithcapitalassetsnotexceedingrupeesfivelakhs”3.TheMinistryofCommerceandIndustriesmodifiedtheabovedefinitionin1960ontherecommendationoftheSmallScale Industries Board. According to it “small industries will include all industrial units with a capital investment of notmorethanrupeesfivelakhs,irrespectiveofthenumberofpersonsemployed”4.Thus,thisrevisionhasenlargedthe scope of employment opportunities in small scale sector, but the investment ceiling remains unchanged.

In 1972, the Government of India constituted Committee for drafting legislation for small-scale industries, which suggestedthatthesmall-scaleindustriesmightbeclassifiedintothefollowingthreecategories.

TinyIndustry:Tinyunitsarethoseinwhichtheinvestmentsinfixedassetsarelessthan• `. 1 lakh or `. 4000/- per worker and the annual turn-over does not exceed `. 5 lakhSmallIndustry:Smallindustryisoneinwhichcapitalinvestmentinfixedassetsdoesnotexceed• `. 7.5 lakh irrespective of the number of persons employedAncillary Industry: An ancillary unit is the one rendering services and supplying or proposing to render 50 •percent of its production or total services, as the case may be, to other units for production of other articles. Moreover,suchaunitshouldnotbeownedorcontrolledbyanyundertaking.Thelimitforinvestmentinfixedassetsofsuchanindustryisfixedat`. 10 lakh

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The Industrial Policy of 1980, announced on July, 23 has revised the ceiling limits of investment in plant and machinery for small-scale industries. According to the Industrial Policy resolution of 1980, the investment limit in small scale industries has been increased with a view to develop these industries. In case of small ancillary industries, the limit has been revised from `. 15 lakh to `. 25 lakh and for tiny industries it has been raised to `. 12 lakh from `. 1 lakh.

In March 1985, the Government has again revised the investment limit of small scale undertakings to ̀ . 35 lakh. As per the Industrial Policy Resolution of 1990, the investment limit in plant and machinery for small scale industries has been raised to `. 60lakh and correspondingly for ancillary units from `. 45 lakh to `.75 lakh. In 1997, on the recommendation of Abid Hussain Committee, the Government has raised the investment limit in plant and machinery for small units and ancillaries from `. 60/75 lakh to `. 3 crore and that for tiny units from `.5 lakh to `. 25 lakh. In 2000, the Union Government has reduced the investment limit in plant and machinery for small scale units from `. 3 crore to `.1 crore. However, the investment ceilings for tiny industries remain unchanged to `. 25 lakh.

In accordance with the provision of Micro, Small and Medium Enterprise Development (MSMED) Act, 2006. The micro,smallandmediumenterprisesareclassifiedintotwoclasses-

Manufacturing Enterprises - The enterprise engaged in the manufacture or production of goods pertaining to •anyindustryspecifiedintheFirstScheduletotheIndustries(DevelopmentandRegulation)Act,1951.ThemanufacturingenterprisesaredefinedintermsofinvestmentinplantandmachineryServiceSector-Theenterprisesengagedinproducingorrenderingofservicesandaredefinedin termsof•investment in plant and machinery. The limit for investment in plant and machinery for manufacturing and service enterprises are given in table 3.1& table 3.2

INVESTMENT LIMIT IN MANUFACTURING SECTOR

Enterprises Investment in plant and machinery

Micro - enterprises Doesnotexceedtwentyfivelakhrupess

Small- enterprises Morethantwentyfivelakhrupeesbutdoesnotexceedfivecrorerupees.

Medium - enterprises Morethanfivecrorerupeesbutdoesnotexceedtencrore rupees.

(Source: Micro, Small and Medium Enterprises Development (MSMED) Act, 2006)

Thedefinitionofsmallscaleindustrieshasundergonechangesovertheyearsintermsofinvestmentlimitstoboostup the development of this sector.


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CHANGES IN THE DEFINITION OF SMALL SCALE INDUSTRIES IN TERMS OF INVESTMENT LIMITS

Sr. No Year Investment limits in plants and machinery Additional Conditions

1 1955 Up to `. 5 lakhs Less than 50/100 persons with/without power

2 1960 Up to `. 5 lakhs No conditions3 1966 Up to `. 7.5 lakhs No conditions4 1975 Up to `. 10 lakhs No conditions5 1980 Up to `. 20 lakhs No conditions6 1985 Up to `. 35 lakhs No conditions7 1991 Up to `. 60 lakhs No conditions8 1997 Up to `. 3 crores No conditions9 2000 Up to `. 1 crores No conditions10 2006 Up to `. 5 crores No conditions

Source:CompliedfromvariousActsandNotifications

4.8 Cottage and Small Scale Industries - The Underlying differences.The Fiscal Commission remarks over the distinction of cottage and small scale industry is that “Cottage industries are normally associated with agriculture in rural areas and provide part-time employment to the agricultural labourers, while small scale industries are established in urban and sub-urban areas and provide full time employment to the labourers”.

The main difference as mentioned in First Five Year Plan (1951-56) between cottage and small scale industries are:

Cottage industries are mainly located in villages although they are scattered all over the country while small-•scale industries are mostly located in urban and suburban areasCottage industry normally do not employ hired-labour as these units are primarily run by the members of the •family at their own premises while small-scale industries produce goods with partially or wholly mechanised equipment employing outside labourers. Negligible or no capital is invested in cottage industries and production is done by hand with simple toolsA small scale industrial unit employ wage earning labour and production is done by the use of modern techniques •which involves capital investmentsSmall-scale industrial units use modern sophisticated machines run by power while in cottage industries the •production is done by hand without the use of powerThe products of cottage industries usually meet local demands and supply ancillary goods to small-scale industries •while the products of small-scale industries meet the demands for a larger areaSmall scale industries are located as separated establishment but cottage industries are located in the homes of •the artisansTraditional goods like khadi, mattress, shoes, candle, cane and bamboo products are produced in cottage industries •while small-scale industries produces many modern goods like radio, television, mixer-grinder etc

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SummaryRapid industrialisation has long been viewed as the key to sustained growth and modernisation of the •economy.In the most recent period 1981-82 to 1986-87, the index of industrial production (using the new index base •1980-81=100) shows an average growth rate of around 7 percent per year while value added growth is about 6 percent.The industrial sector, which absorbs a large percentage of total resources available to the economy, must be able •to earn the foreign exchange it needs from exports.The original rationale for industrial licensing was to direct private investment into desired areas and also to •avoid wasteful over investment.An important determinant of industrial performance in India is the performance of the public sector.•Public sector output today accounts for about 45 percent of the output of the organised industrial sector and 30 •percent of total industrial output.It is important to note that the “privatisation” which is often recommended as the answer to public sector •inefficiencyisnotontheagenda.An important feature of the process of policy reform under way in India is that it is gradualist.•The rate of gross domestic investment in the economy, which increased only marginally from 17 percent in •1960-61 to 18 percent in 1970-71, then increased sharply thereafter to reach 24.7 percent in 1980-81.An important feature of the increase in the aggregate savings rate is that it has occurred entirely because of the •rapid growth in private household savings as a percent of GDP.A major problem in assessing performance in reducing inequality is the lack of reliable time series data on the •distribution of income.Progress in other dimensions of equity and social justice is not so easily documented because of lack of data.•CottageandsmallscaleindustriesaredefinedintermsofinvestmentinplantandmachineryundersectionII•B of Industries (Development and Regulation) Act 1951.According to the Fiscal, Commission (1949-50) “cottage industry is an industry which is run either as whole- •time or part-time occupation with the full or partial help of the members of the family”.The Fiscal Commission remarks over the distinction of cottage and small scale industry is that “Cottage industries •are normally associated with agriculture in rural areas and provide part-time employment to the agricultural labourers, while small scale industries are established in urban and sub-urban areas and provide full time employment to the labourers”.

ReferencesCallan, S. J. & Thomas, J. M., 2009. • Environmental Economics and Management: Theory, Policy and Applications, Cengage Learning.Kiado, A., 1979. • Industrial Development and Industrial Policy.Industrial Policy-2013• [Pdf] Available at: <http://www.midcindia.org/Lists/Policies%20Circulars%20and%20Notification/Attachments/88/Industrial%20Policy%20of%20Maharashtra%202013.pdf> [Accessed 11 July2013].Industrial Policy of Maharashtra 2013-Highlights• [Pdf] Available at: <http://www.midcindia.org/Lists/Policies%20Circulars%20and%20Notification/Attachments/87/Industrial%20Policy%20of%20Maharashtra%202013%20-%20Highlights.pdf‎>[Accessed11July2013].2013. What is Industrial Policy• [Videoonline]Availableat:<https://www.youtube.com/watch?v=BqyGaT0RCt0‎>[Accessed 11 July 2013].2013.What hope for Industrial Policy• [Video online] Available at: <https://www.youtube.com/watch?v= veIpUWF6bd8‎>[Accessed11July2013].


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Recommended ReadingBianchi, P. & Laboy, S., 2011. • Industrial Policy after the Crisis:Seizing the Future., Edward Elgar Publishing Limited.Bianchi, P., 2006. • International Handbook on Industrial Policy, Edward Elgar Publishing Limited.Pathak, B., 2007. • Industrial Policy of India: Changing Facets, Deep and Deep Publications Pvt. Ltd.

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Self AssessmentRapid ______________ has long been viewed as the key to sustained growth and modernization of the 1. economy.

Globalisationa. Glocalisationb. Industrialisationc. Civilisationd.

India should be aiming at an industrial growth rate of around _______ percent.2. 9-10a. 7-8b. 5-6c. 8-9d.

Which of the following industry is the one which is run by an individual with the help of his family members 3. with very little capital?

Oila. Cottageb. Cementc. Telecomd.

What does ECAFE stands for?4. Economic Conditions of Asia and Far Easta. Economic Conditions of Africa and Far Eastb. Economic Commission of Africa and Far Eastc. Economic Commission of Asia and Far Eastd.

The Industrial Policy of _______, has announced revised the ceiling limits of investment in plant and machinery 5. for small-scale industries.

1960a. 1970b. 1980c. 1990d.


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Match the following6.

1. Small Enterprises A. .Morethanfivelakhrupeesbutshouldnot exceedfivecrorerupees

2. Micro Enterprises B. Doesnotexceedtwentyfivelakhrupees

3. Medium Enterprises C. Morethanfivecrorerupeesbutshouldnot exceed ten crore rupees.

4. Government of India constituted Committee for drafting legislation for small-scale industries

D. 1972

A-1,B-2,C-3,D-4a. A-2,B-3,C-4,D-1b. A-3,B-1,C-2,D-4c. A-1,B-3,C-2,D-4d.

Which of the following statements is false?7. The products of cottage industries usually meet local demands and supply ancillary goods to small-scale a. industries while the products of small-scale industries meet the demands for a larger area.Cottage industry is the one which is run by an individual with the help of his family members with very b. little capital. Most of the cottage industries do not use power.The Planning Commission has estimated that the percentage of the population below the poverty line will c. have declined to 25 percent by 1989-90.The performance of top management must not be judged in terms of the achievement of agreed d. objectives.

When was the nationalisation of Indian Commercial Banks done?8. 1959a. 1979b. 1969c. 1999d.

In March ______, the Government has again revised the investment limit of small scale undertakings to 9. `. 35 lakh.

1985a. 1981b. 1983c. 1984d.

The cottage industries are mainly located in which part of the country?10. Urbana. Sub-urbanb. Villagesc. Metropolitian citiesd.

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Chapter V

India: Foreign Trade Policy

Aim


explain• Regional and Bilateral Trade Agreements

elucidate World Bank Involvement•

explicate IMF and World Bank Corporate Links•

Objectives


explain WTO•

enlist World Bank Reports•

explicate IMF•

Learning outcome


describe• WTO Trade Agreements

identify Structural Adjustment Programs•

understand the role of UN•


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5.1 IntroductionAlthough India has steadily opened up its economy, its tariffs continue to be high when compared with other countries, and its investment norms are still restrictive. This leads some to see India as a ‘rapid globalizer’ while others still see it as a ‘highly protectionist’ economy.

Till the early 1990s, India was a closed economy: average tariffs exceeded 200 percent, quantitative restrictions on imports were extensive, and there were stringent restrictions on foreign investment. The country began to cautiously reform in the 1990s, liberalising only under conditions of extreme necessity. Since that time, trade reforms have produced remarkable results. India’s trade to GDP ratio has increased from 15 percent to 35 percent of GDP between 1990 and 2005, and the economy is now among the fastest growing in the world. Average non-agricultural tariffs have fallen below 15 percent, quantitative restrictions on imports have been eliminated, and foreign investments norms have been relaxed for a number of sectors.

India however retains its right to protect when need arises. Agricultural tariffs average between 30-40 percent, anti-dumping measures have been liberally used to protect trade, and the country is among the few in the world that continue to ban foreign investment in retail trade. Although this policy has been somewhat relaxed recently, it remains considerably restrictive. Nonetheless, in recent years, the government’s stand on trade and investment policyhasdisplayedamarkedshiftfromprotecting‘producers’tobenefiting‘consumers’.ThisisreflectedinitsForeign Trade Policy for 2004/09 which states that, “For India to become a major player in world trade .we has also to facilitate those imports which are required to stimulate our economy.” India is now aggressively pushing for a more liberal global trade regime, especially in services. It has assumed a leadership role among developing nations in global trade negotiations, and played a critical part in the Doha negotiations.

5.2 Regional and Bilateral Trade AgreementsIndia has recently signed trade agreements with its neighbors and is seeking new ones with the East Asian countries and the United States. Its regional and bilateral trade agreements or variants of them are at different stages of development:

India-Sri Lanka Free Trade Agreement•Trade Agreements with Bangladesh, Bhutan, Sri Lanka, Maldives, China, and South Korea•India-Nepal Trade Treaty•Comprehensive Economic Cooperation Agreement (CECA) with Singapore •Framework Agreements with the Association of Southeast Asian Nations (ASEAN), Thailand and Chile•

Preferential Trade Agreements with Afghanistan, Chile, and Mercosur (the latter is a trading zone between Brazil, Argentina, Uruguay, and Paraguay).

5.3 World Bank InvolvementAs a number of research institutions in the country provide the Government with good, just-in-time, and low-cost analytical advice on trade-related issues, the World Bank has focused on providing analysis on specialised subjects at the Government’s request.

In the last three years, the Bank has been working with the Ministry of Commerce in a participatory manner to help the country develop an informed strategy for domestic reform and international negotiations. Given the sensitivity oftradepolicyandnegotiationissues,theBank’srolehasbeenconfinedtoprovidingbetterinformationandanalysisthan was previously available to India’s policymakers.

5.4 World Bank ReportsOver the last two years, the World Bank has completed two reports:

Sustaining India’s Services Revolution: Access to Foreign Markets, Domestic Reforms and International •Negotiation: The study concludes that to sustain the dynamism of India’s services sector, the country must address two critical challenges: externally, the problem of actual and potential protectionism; and domestically, the persistence of restrictions on trade and investment, as well as weaknesses in the regulatory environmentFromCompetitionatHometoCompetingAbroad:TheCaseofHorticultureinIndia:Thisstudyfindsthatthe•

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competitivenessofIndia’shorticulturesectordependscriticallyonefficientlogistics,domesticcompetition,and the ability to comply with international health, safety and quality standards. The study is based on primary surveysacrossfifteenIndianStates

A third study, dealing with barriers to the movement of professionals is under preparation. The Bank has also held a number of workshops and conferences with a view to providing different stakeholders with a forum to express their views on trade-related issues. The WTO, IMF and World Bank have been major counterparts in the creation and management of the modern world economy. Their activities are endorsed by economically dominant governments andcorporationswhofavourneoliberalpoliciesandfree-marketsolutionsofdebt-basedfinanceandinternationaltrade as the route to poverty reduction.

Together these institutions encourage economic structural adjustment, privatisation and market liberalisation in emerging markets. Within the competitive global framework, developing countries are left with little choice other than to comply with the neoliberal agenda. As a result these countries are often left with crippling debt and a fragile economy.Meanwhile,foreigninvestorsandmultinationalcorporationsgaincontrolofasignificantportionoftheworld’sresources,finance,services,technologyandknowledge.Whilstthesemultinationalsreportrecordprofits,around 50,000 people die each day from poverty.

In order to create balanced trade, stable international finance and effective development in poorer countries,the regulation of the global economy must be returned to United Nations. The global public must, through their governments, demand cooperative control over those resources which are essentials to life and should be shared internationally according to humanneed - not corporate profit.Sharing resources can also reduce the level ofcorporate controlled trade, debt accumulation and wasteful development projects. As the remit of the international financialinstitutionsisreduced,theycanbeprogressivelydismantled.

5.5 The IMF, World Bank and WTO Created by the US and British Governments at The Bretton Woods Conference after World War II (1944 Hampshire, USA), The International Monetary Fund (IMF) and The World Bank (WB) were designed to ensure economic and corporate sustainability in countries affected by the war - mainly in Europe. The World Trade Organisation was established more recently, in 1995, to replace the General Agreement on Tariffs and Trade (GATT). The WTO aims to lower tariffs and non-tariff barriers in order to increase international trade.

Since the 1970’s the World Bank has steadily increased its original mandate of providing long term loans for reconstruction, to funding multimillion dollar infrastructure projects in developing countries. It is the single largestsourceofdevelopmentfinanceintheworld,lendingforbroadstructuralandeconomicchanges,long-termdevelopment and poverty reduction, building roads, dams, pipelines, extracting natural resources etc. It is an especially importantsourceoffinanceforverylowincomecountriesthatareunabletoacquirecommercialloans.Inthiswaythe World Bank has a direct effect on the lives of millions living in the majority world. The IMF was created to maintain global monetary cooperation and stability by making loans to countries with balance of payment problems, stabilising exchange rates and stimulating growth and employment. There have been many changes in the global economy since then, such as the divorce of exchange rates from the stable ‘anchor’ of gold, massive growth in the global economy and a dramatic increase in destabilising, speculative movements of capital between nations. As a result the IMF has shifted its focus and now mainly intervenes in economically vulnerable nations, particularly in the south.

The WTO fosters ‘free-trade’ between nations. It does this by liberalising markets, which means ‘opening them up’toglobalcompetition.Thiscreatesafreemarketwheretheunrestrictedflowofgoodsandservicescansharpencompetition,motivateinnovation,createprofitandbreedsuccess.Mostoftheworld’stradingnationsaremembers,and as members they have to ratify WTO trade agreements within their governments. The WTO clearly states that theserules,althoughbindingongovernments,areprimarilyforthebenefitofthebusinesscommunitythatproduce,import and export goods and services. In effect, the WTO overrides a government’s sovereign right to regulate its economy,andplacescorporateinterestsfirst.


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5.6 How the IMF, World Bank and WTO Work Together?The underlying theory that these International Financial Institutions (IFIs) propagate is that of ‘economic growth’ and ‘free-markets’ as the only means of generating wealth for development and poverty reduction. This neoliberal ideologynowdominatestheglobaleconomyandhasproventobeextremelyprofitableforcorporationsandfinanciers.Meanwhile, these policies have increased levels of poverty and inequality in developing countries. Given their financialinsecurity,developingnationsareleftwithlittleoptionbuttoparticipateandcompeteintheglobaleconomyin the hope that they can increase their economic output (GDP). However, the competitive free-market is inherently biased,andcountriesthatentertheplayingfieldwithlesswealthandundevelopedindustriesarehandicapped.

Developingcountriesfindthemselvesinapositionwheretheydonothaveenoughforeigncurrencyreservestoinvest in growth-promoting policies as they may have spent their reserves on imports and debt repayments. They mightthenlentmoneybytheWorldBanktofinancelargedevelopmentprojectsinthehopethatsuchprojects(suchas extracting oil) will facilitate economic growth and have a knock-on effect on development. The World Bank hassignificantconnectionswithcorporations(mainlyintheUS)whotheycontractfortheselucrativeprojects.Whilstthesecorporationsearnhugebenefitsfromthesecontracts,thecountryinquestionoftenfindsitselfwithan additional debt burden, a loss of control over key natural resources or services and a loss of revenue from these resourcesasprofitsarerepatriatedabroad. Faced with possible bankruptcy, which would ostracise them from other potential investors this, the country has little choice but to turn to the IMF for a loan. The IMF clearly states that it is not a development bank and is not concerned with poverty reduction. It is, however, closely allied with Wall Street bankers and the US Treasury, and ensuresthateconomicpoliciesareimplementedthatbenefitprivateinvestorsandfinancialspeculatorsinthefree-market. It lends to governments on the strict condition that they prioritise the repayment of the loan (over and above domestic welfare needs). Countries must also agree to adjust domestic economic policies to ensure that their balance of payment problems do not occur again. Once these conditions have been implemented and the loan approved, the international investment community is informed. This reassures private investors of the country’s potential profitability,andadditionalfundscomefloodingin.

Withrestrictionsonthemovementofcapitalrelaxed,aperiodofdestabilisingfinancialspeculationandcapitalflightoftenresults,furtherbenefitingwealthyforeigninvestorsandspeculatorswhilstoftenbankruptingdomesticcompanies. This same IMF/World Bank enforced agenda has devastated many developing economies in East Asia and Latin America over the past 20 years. The WTO’s trade agreements work alongside the IMF and World Bank measures, ensuring all barriers to trade and domestic restrictions on how to manage foreign investment are lifted. This enables foreign corporations to purchase and control everything from water, heath-care and education facilities to agricultural technology and indigenous plants and knowledge. All in all, there is a huge migration of control and financialresourcesawayfromlocalenterprisesandindustriesthatwouldotherwisebenefitsocietyandstrengthenlocaleconomies.Instead,theseresourcesmigratetothelargecorporationswhosemajorshareholdersprofithandsomely.Foreign ownership of domestic resources, services and production compromises local initiative and industry, and undermines the sovereign and democratic rights of local people and governments.

The combined effects of trade liberalisation and IMF/World Bank policies are insidious, devastating numerous aspects ofsocialandeconomiclifeindevelopingcountries.ItisclearthattheultimatebeneficiariesoftheIFIs’policiesand actions are wealthy private investors, corporations and speculators. These small groups of private individuals ultimately end up holding the reigns to the majority of the world’s natural resources, agriculture facilities, technology, services,intellectualpropertyandfinancemechanisms.TheirbusinessesareinvariablybasedintheUSandEU,ensuring that the economic output, or GDP of their host countries remains high.

Revelling in theireconomic‘profit’,G8governments increasingly towthecorporate line,using their influencewithin the IFIs to further the neoliberal ideology that appears to be prospering their nation. As a result, governments have readily given away rights over public assets to corporations. They also continue (through the agency of the IFIs) to denying the rights of developing countries to participate in the formation of international development andfinancestrategies,multilateraltradeagreements,orindeedtheirowndomesticeconomicpolicies.Inthisway,wealthy governments are guaranteeing their continued economic dominance within a competitive, market-based global economy.

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Whilst economic growth increases, the level of global inequality and marginalisation also increases. This phenomenon is not restricted to developing countries, but is common place in wealthy nations. For example, in 2004 there were 5.4 million more Americans living in poverty than in 2000. Although the US is also one of the richest nations on earth, withaGDPof12.41trilliondollars,aboutafifthofglobalGDP,ithasthelargestinequalitygapofanyindustrialisednation. It also pursues neoliberal economic policies to a greater extent than other countries. This added much weight tothesignificantbodyofevidencethatsuggeststhepursuitofcompetitiveeconomicgrowthforreducingextremepoverty is largely ineffective and unable to reduce inequality. 5.7 WTO, IMF and World Bank are Undemocratic Both the World Bank and IMF criticise recipient governments for their lack of transparency, widespread corruption and undemocratic regimes, insisting on the reform of these aspects as a pre-condition to granting loans and debt relief. However these same issues haunt the World Bank and IMF which are widely regarded as not transparent, undemocratic and unaccountable. Corruption within these organisations is rife, and millions of dollars unaccounted for both institutions are based in Washington USA, and are owned by their 184 member countries. The majority (40%) of all votes are held by just 7 countries (the G7). The US holds the largest share at 18%, which grants them theabilitytovetopoliciesthatdonotserveUSinterests.Votesareallocatedaccordingtofinancialstrength(‘onedollaronevote’),resultinginthosefinanciallypowerfulcountries(andthecommercialintereststhatinfluencethem)determining the monetary, economic and development architecture of the global economy. Thus the existing global economic system places developing countries squarely at the mercy of G7 foreign interests.

The WTO is, constitutionally, a democratic organisation with an equal share of votes distributed to all member nationsregardlessoftheireconomicpower.Yetthepoorernationsstillfindthemselvesunabletoexercisetheirdemocratic rights in WTO global trade negotiations. The dominant economic powers- USA, Canada, the EU and Japan (also known as the ‘Quad’ or ‘Quartet’) very clearly establish the agenda before a round of trade talks. The Quad then invite a selected group of poorer nations to a ‘Green Room’ meeting where the key decisions are made about which issues will be open to negotiation in the formal talks, and a declaration is drafted. During the formal talks, nations can only agree with or block the predetermined proposals.

Thisstructureeffectivelyexcludesthemajorityworldfrominfluencingtheinternationaltradeagenda.Throughoutthese negotiations, even within the green room talks, poorer nations (given their reliance upon international aid, IMF and World Bank assistance) are at the behest of the Quad and are often unwilling to contest the declaration in fearofeconomicorfinancialconsequences.Overall,theglobalsouth’sabilitytomaketradeworktotheirbenefitisseverelycompromised.Thebiasanddisquietofthesenegotiationsisreflectedbythefrequentcollapseoftradetalks in, the eventual submission by developing countries to further open their markets to the dominant nations and the systematic inability of ‘quad’ nations to live up to their pledges to remove their own protectionist measures. Without democratic representation within these bodies, and cooperation with the south, The WTO, IMF and World Bank will remain unaccountable to the very people they claim to be assisting. In light of the failures of the WTO, World Bank and IMF to address poverty and inequality, global protests continue to gain momentum, citizens and nationsarecallingfora‘groundup’processofglobalisationthatisnotcontrolledby,andforthebenefitof,theruling elites. 5.8 Structural Adjustment Programs (SAPs) Whenadevelopingcountryrequiresurgentfinancialassistancetoavoideconomiccatastrophe,itusuallyturnstothe IMF. Although this assistance constitutes a crippling debt for the borrower, the IMF also insists on economic reform as a condition to the loan. In effect the IMF takes this opportunity to render the struggling economy ‘free-market friendly’. Prioritising debt repayment, market liberalisation and privatisation allow corporations and private interests to capitalise on these reforms. The economic consequences for the developing country are often dire.

The IMF, working in conjunction with Wall Street bankers and the US Treasury, has effectively forced many emerging economiestoliberalisetheirfinancialmarkets.ThishappenedtomanycountriesinEastAsiaandLatinAmericainthe1980’sand90’s.Oftenthisexposedthemtomassivefinancialspeculationwhichin-turndevaluedtheircurrencies,andcreatedrecessionandfinancialcrisis.Bolivia’spercapitaincomeislessthanitwas25yearsago,with63%of Bolivians living in poverty. Argentina is another well documented recent example, as is Thailand, South Korea, Indonesia, the Philippians, Russia and Poland. In essence structural adjustments involve the following measures:


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Reducing social spending, government budgets, programs and subsidies for basic goods: This allows a rapid mobilisation of currency to repay the loans (debt). Meanwhile schools and hospitals are forced to introduce/increase fees which in turn increase illiteracy rates, disease and death rates and perpetuate the poverty cycle. Eliminatingforeignownershiprestrictionsandincreasinginterestrates:Thesemeasuresincreaseprofitabilityforforeign investors and enable corporations to take control of domestic resources. Meanwhile local producers and businesses are destroyed, not being able to afford essential credit; unemployment goes up, and control of their resources shifts to wealthy countries. Income is transferred out of the developing country further damaging its people and economy. Eliminatingimporttariffsandswitchingfromsubsistencefarmingtoexporteconomies:Thesemeasuresbenefitforeign export markets and eliminate local competition. Low cost foreign goods including luxury items out-compete domestic producers, putting them out of business. Food insecurity and malnutrition increases as production shifts to cash crops for export and countries are forced into dependent relationships with northern suppliers. Increased resource exploitation creates environmental degradation and pollution.

SAPs have recently been replaced by Poverty Reduction Strategy Papers (PRSPs) as part of an effort to address the issue of ‘government ownership’ of structural adjustment policy, and to focus on strategies to relieve the debt of Highly Indebted Poor Countries (HIPCs). Unfortunately little progress has been made; strategies are still broadly imposed on governments and are still subject to conditions that increase income disparities

Not surprisingly, the neoliberal, open-market model preached by the IMF and Wold Bank was not the model adopted by all existing economic powers during their industrialisation and development. Instead they protected their own markets from foreign goods and investment and continue to do so, donating huge subsidies to domestic business. Indeed, the US and EU remain, to this day, highly protected economies. The hypocrisy of liberalising emerging markets is evidently in the self interest of economically dominant countries. Enforcing these policies on developing countries is akin to economic imperialism. 5.9 WTO Trade Agreements Since its creation, the WTO has promoted market access for corporations with trade agreements. These agreements circumvent the democratic national rights of a country to determine domestic policies regarding trade, natural resources and service provision. The General Agreement on Trade in Services (GATS) was agreed at the World Trade Organisation (WTO) in 1994. Its aim is to remove any restrictions and internal government regulations in the area of service delivery that can be+ considered “barriers to trade”. Such services include everything from marine fishingtoprovisionsforhealthandeducation.Theagreementaffectivelyabolishesagovernment’ssovereignrightto regulate, subsidise and provide essential national services on behalf of its citizens.

The WTO’s Trade Related agreement on International Property Rights (TRIPS), forces developing countries to extend property rights to seeds and plant varieties. The agreement will even allow corporate property rights over individual plant genes, thereby impacting on agricultural practices that two thirds of the worlds rely upon for their livelihoods. It undermines thousands of years of indigenous control over local knowledge and production of food and livestock. Six corporations now own 70% of patents on staple food crops, allowing them to set the market price for them and block competition for 20 years.

Another serious infringement on democratic rights are the Trade Related Investment Measures (TRIMS) which opendomesticfinancetocorporatecontrol,eliminatingacountry’sabilitytoshapetheirpoliciesrelatingtoforeigninvestment and capital controls. The evidence suggests that market liberalisation and intellectual property rights hinder development in poor countries and serve the economic interests of dominant countries. In 2000, an UNCTAD confirmedthisinareportwhichconcludedthatneoliberaltrademeasuresprimarilybenefitcorporateinterests.Eventhe European Commission doesn’t shy away from stating that trade agreements are primarily instruments for the benefitofbusiness.

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Effectively,controlover resources, services,policiesandfinancearegranted tocorporate interests through theGATS, TRIPS and TRIMS framework. Meanwhile, developing countries continue to resist the imposition of WTO agreements, and recently this resulted in the collapse of the Doha Round of trade talks (2006).

Corporate Lobbying at the WTOMultilateral trade rules are agreed behind closed doors between the US, EU and major trade partners. 80% of corporations reside in the US and EU, and through their lobbyists they enjoy privileged access to government policy makers who partake in trade talks. Over 30,000 corporate lobbyists are based in Washington and Brussels, vastly outnumbering the US Congress and European Commission staff that they lobby. The vast majority of lobby groups represent business interests, who spend billions of dollars annually advocating their cause, typically market access in emerging economies.

Many developing countries on the other hand do not have the resources to send enough, if any, representatives to argueforfairertradepracticesthatwouldbenefittheirowneconomicdevelopment.Inaddition,thesenegotiationsare undemocratic, with the public denied access to or information about these discussions. The same is not true of corporate lobby groups such as the European Services Forum (ESF) and many US corporations who can directly affect and have access to Trade Committees. Unsurprisingly then, corporate interests form the basis of WTO agreements. The corporate imperative is to have commercial access to all markets in all countries – whether goods, services or intellectual property. Unsurprisingly, the vast majority of the world, whose basic human needs are not met, are unlikely to ever have them met within the biased framework of the existing global economy.

IMF and World Bank Corporate LinksTo qualify for World Bank loans and expertise a country must agree to implement Structural Adjustment Programs (SAPs). These programs attract massive private investment into the country. Foreign direct investment now exceeds $1 trillion per year for projects such as the privatisation of public utilities and the creation of banking systems. The overallresultisthemarginalisationofgovernmentcontroloveritsownaffairsandanincreasedflowofcapitaloutof the developing country to private investors and corporations, usually based in the north.

World Bank projects in Chad, Somalia, Rwanda, Mozambique Ghana, Brazil and the Philippines are well documented as having a strong commercial bias. Generally they have provided corporate welfare at the expense of critical, non-profitabledevelopmentprojectssuchashealthandeducation.InrecentyearstheIMFhasbeenvociferouslybackedby multinational corporate interests when applying for extra funding for expansion. This support was in response to the IMF bailing out big banks and foreign investors which had made bad loans to developing countries. For example, in 1995, the IMF gave almost $18 billion to Wall Street interests who stood to lose billions with the peso devaluation. It also bailed out foreign investors in Russia with an $11 billion package and orchestrated a massive bailout of the big banks that made bad loans to Asian countries in the 90’s.

TheWorldBanksandIMF’sinterrelationship,financialopportunism,corporatemandateandUSbackingisbestexemplifiedbytheireconomicoccupationofIraq.Sincetheoccupationbegan,Iraq’sentireeconomyhasbeenfashioned by the IMF and World Bank to suit (mainly US) foreign investors and corporate interests. The Paris Club of creditors, through the IMF, quickly approved the cancellation of 80% of Iraq’s debts, approximately $39 billion. Using this as leverage, neoliberal structural changes were swiftly enacted including the privatisation of assetsandstateownedenterprises.Theseundemocraticeconomicadjustmentsresultedincapitalfight,hugelevelsof unemployment and unaffordable increases in utility costs, sparking widespread protest.

5.10 Sharing the World’s Resources and Decommissioning the IMF, World Bank An alternative model of economic and financial stability The IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT - predecessor to the WTO) were created at the end of the Second World War. Given the circumstances at the time, the US was in a strong position to secure its economic dominance, and these three institutions were the means through which it could achieve this. AlternativeproposalstocreateamorebalancedtradeandfinancesystemwererejectedbytheUSattheBrettonWoods conference, and Britain and Europe’s dependence on the US economy during and after the war meant the US had its way.


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One such alternative was John Maynard Keynes’ proposal for an ‘International Clearing Union’ (ICU). The ICU was able to create monetary equilibrium between nations and prevent the accumulation of economic and political power to creditor nations. Similarly, an International Trade Organisation was proposed as a mechanism to protect against corporate dominance and ensure workers rights and employment. The GATT was adopted instead, and after considerable corporate pressure, this was later replaced by the WTO which had the power to enforce undemocratically decided trade rules upon member governments.

Since their inception, these organisations have indeed been very effective at securing economic strength for the US.Theirinfluenceovertheworldeconomyandtheirtieswithcommercialinterestshasalsogrown.However,as described in the above analysis, the past 20 years have provided ample evidence that the IMF, World Bank and WTO impede poverty reduction and economic development in poor countries. It is clear that the global economy needs to be urgently overhauled if poverty and inequality are ever to be resolved.

Inareformedworldeconomy,commercialactivityshouldberegulatedbyademocraticbodytoensurethatitbenefitsthe public good. Natural resources of common heritage and services that are essential to meet basic human needs must not be allocated by corporations through existing trade structures. Guaranteed access to these resources is a fundamental right according to the internationally adopted Universal Declaration of Human Rights. This right must be exercised by the global public.

The Role of the UN Given the corporate agenda of the WTO, World Bank and IMF, and their inherent bias since their creation, their mandates must be transferred back to the United Nations. The UN system was originally intended to be the key regulatory mechanism for the world economy, and the IMF, World Bank and GATT were originally intended to function as part of this system. Sadly, funding for the UN agencies has been massively restricted in recent years, mainly be the US. One of the reasons for this is the UN’s inherent emphasis on development friendly economics an approach which is at odds with the US’ more hegemonic intentions. Funding has instead been lavished on the internationalfinancialinstitutions(IFIs)whichsharetheneoliberalideology.

UN agencies such as the Economic and Social Council (ECOSOC), The UN Conference and Trade and Development (UNCTAD) and the United Nations Development Program (UNDP) have the necessary knowledge, information and experience to re-establish their regulatory hold on the global economy and render it more equitable. Importantly, these UN agencies are naturally democratic and representative, unlike the IFIs.

Alongside restoring democratic control of the global economy to the UN, there must be a strengthening of the UN in general. In order to render the UN democratic, the Security Council must be dissolved, and any rights to veto decisions abolished. The General Assembly must take its place as a truly representative world body. The UN must alsobegivengreaterfinancialpower.ThiscanbeachievedthroughanumberofpossiblemechanismssuchasaTobin taxes, taxes on arms, taxes on pollution, or a combination of these.

Mostimportantly,theUNmustadopttheprincipleofsharinginordertofulfilitshumanitarianmandateandsecurebasic human needs across the world. A new economic system based on sharing essential resources, such as land, food, water and medicine needs to be urgently implemented to achieve this objective. We propose the creation of anewUNagency,whosespecifictaskwouldbetofacilitatethisprocess,theUNCouncilforResourceSharing(UNCRS). A system of sharing would exist alongside an overhauled market based economy that can continue to produce and supply all ‘non essential’ resources.

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5.11 A Means to Improve International TradeSharing resources requires that the global public claim their communal ownership over essential goods and services. In general, these will be all resources that are naturally occurring, such as land, water, oil and minerals, all produce that is essential for life such as basic agricultural produce and energy, and essential services such as access to clean water, healthcare and education.

One of the main reasons for sharing the world’s resources is to prevent unnecessary death from poverty, by guaranteeing universal access to food, water, healthcare and other essential goods and services. The saving of some 50,000 lives each day in this way will hasten international development efforts and thereby have a positive impact on the global economy. This will not only be the result of the investment in human capital that sharing creates, but also by strengthening local industry. When countries are able to develop their own economies, they are better placed to be active within the global economy.

Withinthissystemofsharing,essentialresourceswouldbesharedfirstlyaspartofaUnitedNationsEmergencyRedistribution Program (UNERP), designed to rapidly mobilise essential food, water and healthcare to people and nations who are experiencing extreme poverty, malnutrition and unnecessary death. Thereafter, a more comprehensive system of sharing can be implemented that can ensure basic human needs are always prioritised and met by the global community. To achieve this, the UNCRS would create a Global Sharing Network (GSN) which could monitor the ever changing levels of production and consumption of essential resources across the globe. The GSN would then beabletocoordinateanefficientglobalredistributionoftheseresourcesaccordingtoneed.Resourceswouldbeproducedandconsumedlocallywhereeverpossible,thensharedregionally,andfinallysharedinternationally.

5.12 How Sharing Would Affect the Global Economy?Global public ownership and cooperative management of these resources will mean that they are no longer directly involvedinfinancialmarketsascommercialproducts.Excessproductionofessentialresourceswouldnotbetradedor exchanged. They would instead be held in trust by the UNCRS, on behalf of the global public, and distributed towheretheyaremosturgentlyrequired.Thiswillhaveasignificantimpactonexistingsystemsoftrade,financeand development, and thereby directly affect the activity of the WTO, IMF and World Bank.

5.12.1 Aid and Development Sharing essential resources in this way would replace all existing aid and development efforts. Redistributing resources to alleviate poverty will replace the existing export oriented model of competitive economic growth for poverty reduction. The majority of these resources must be transferred from where they are in excess in global north towheretheyaremosturgentlyrequiredintheglobalsouth.Amongstotherthings,thiswillentailasignificanttransferoffinance,food,technologyandlabouroveranumberofyearsinordertocreateaglobaleconomicandsocial safety net.

Unlike existing development loans provided by the World Bank, sharing must not constitute a loan or incur a debt. It would be necessary for the UNCRS to work closely in conjunction with existing UN development agencies and internationalNGOs,toensurethatdevelopmentoccursinaneffective,sustainableandefficientmanner.Overtime,the World Bank will be rendered largely redundant and any remaining development projects can be administered through the United Nations Economic and Social Council (ECOSOC) and UN Development Program (UNDP). The World Bank can then be progressively dismantled.

5.12.2 International Trade A system of sharing would mean that the majority of commodities and goods that are currently traded would instead be cooperatively owned and distributed by the global public through the UNCRS. Such resources would include energy supplies and the provision of utilities such as water, essential agricultural produce required for food, cotton for clothing, essential healthcare services, equipment and medication, essential knowledge and technology and resources for providing education. As a result, international trade in commodities and their derivatives will be significantlyreduced,andconfinedtononessentialgoods.


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Sharing will ensure that essential domestic needs are largely met at the local level, reducing dependency on foreign imports of essential goods. As a consequence, there would be less need for developing countries to agree to prohibitive trade agreements, whether multilateral or bilateral. This will free the population to develop their own industry and economy enabling them to compete on an equal footing with wealthier nations in the global economy. Potentially, when enough countries can effectively compete with the economic superpowers, a powerful incentive will be created for these superpowers to adopt a more cooperative approach.

Agreements relating to remaining international trade should, where necessary, be democratically agreed through the UN Conference on Trade and Development (UNCTAD). The remaining international trade, under the auspices of UNCTAD, should utilise an inherently balanced mechanism similar to the International Clearing Union (ICU) mentioned above. The combination of these factors will allow the WTO to be progressively dismantled over a period of time.

5.12.3 International Finance Sharingessential resources insteadof trading themwillmean that these resources aredivorced fromfinancialmarkets.Thiswillclearlyhaveasignificantimpactuponthesemarkets,dramaticallyreducingtheamountofstockandfinancialderivativesrelatedtothestocks,whicharetraded.Thisinitselfwillhelptoreducetheglobalfinancialinstabilitythatmanyeconomistsandanalystsbelievewill,soonerorlater,resultinaninternationalfinancialcrisis.Sharing essentials will also mean that developing nations will require less foreign exchange in reserve as they will be purchasing fewer goods from abroad. Balanced trading between nations (using an ICU type mechanism) and the removalofdebtburdenswillalsomeanlesschanceofcountriesexperiencingmajorbalanceofpaymentdeficits.The lack of foreign exchange is a key reason developing countries turn to the IMF for loans, which in turn leads to cripplingdebt.Notonlycansharingresultingreaterfinancialsecurityforadevelopingcountry,itwillalsomeanthat they are less likely to have to implement structural adjustments to their economy to render it acceptable to the countries that follow neoliberal principles.

When there is a need for short term emergency foreign exchange loans, a new UN based Finance Organisation could lend money and provide the necessary expertise in a pro-development manner without crippling interest rates andwithoutcorporateorpoliticalinfluence.ItwouldthenbefeasiblefortheIMFtobegraduallydismantled;itssizeable assets and gold reserves can be applied to the UNCRS and UN development projects. New agencies may be required to undertake the decommissioning of the IFIs. Other measures which are essential if the global economy is to be reformed and subjugated to the needs of the people include cancelling all debt owed by developing countries and regulating the corporate environment.

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SummaryAlthough India has steadily opened up its economy, its tariffs continue to be high when compared with other •countries, and its investment norms are still restrictive.India has recently signed trade agreements with its neighbors and is seeking new ones with the East Asian •countries and the United States.The WTO, IMF and World Bank have been major counterparts in the creation and management of the modern •world economy.Agreement on Tariffs and Trade (GATT). The WTO aims to lower tariffs and non-tariff barriers in order to •increase international trade. The WTO’s trade agreements work alongside the IMF and World Bank measures, ensuring all barriers to trade •and domestic restrictions on how to manage foreign investment are lifted.Both the World Bank and IMF criticise recipient governments for their lack of transparency, widespread •corruption and undemocratic regimes, insisting on the reform of these aspects as a pre-condition to granting loans and debt relief.The WTO is, constitutionally, a democratic organisation with an equal share of votes distributed to all member •nations regardless of their economic power.SAPs have recently been replaced by Poverty Reduction Strategy Papers (PRSPs) as part of an effort to address •the issue of ‘government ownership’ of structural adjustment policy, and to focus on strategies to relieve the debt of Highly Indebted Poor Countries (HIPCs).The General Agreement on Trade in Services (GATS) was agreed at the World Trade Organisation (WTO) in •1994.In recent years the IMF has been vociferously backed by multinational corporate interests when applying for •extra funding for expansion.The IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT - predecessor to the WTO) •were created at the end of the Second World War.Global public ownership and cooperative management of these resources will mean that they are no longer •directlyinvolvedinfinancialmarketsascommercialproducts.Balanced trading between nations (using an ICU type mechanism) and the removal of debt burdens will also •meanlesschanceofcountriesexperiencingmajorbalanceofpaymentdeficits.New agencies may be required to undertake the decommissioning of the IFIs.•

ReferencesMahajan, V. S., 1992. • India’s foreign trade and balance of payments, Deep & Deep Publications.Prasad, P. C., 1977. • Foreign Trade and Commerce in ancient India, Abhinav Publications.Foreign Trade Policy 2009• [Pdf] Available at: <http://pib.nic.in/archieve/foreigntradepolicy/foreigntradepolicy.pdf>[Accessed11July2013].Foreign Trade Policy• [Pdf] Available at: <http://www.ieport.com/foreign_trade_policy_2009-2014/Foreign_Trade_policy_2009-2014.htm‎>[Accessed11July2013].2010. India’s Foreign Policy• [Videoonline]Availableat:<https://www.youtube.com/watch?v=1JrviSFmUZo‎>[Accessed 11 July 2013].2013. Foreign trade policy• [Videoonline]Availableat:<https://www.youtube.com/watch?v=G9EcpZ18Dtg‎>[Accessed 11 July 2013].

Recommended ReadingDr. Mustafa, A., 2010. • Foreign Tarde Finance and Documentation, Laxmi Publications, Ltd.Ghosh, A., 2009. • India’s Foreign Policy, Pearson Education India.Prasad, M., 2011. • India’s Foreign Trade:From Antiquity to Date, Kalpaz Publications.


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Self AssessmentIndia’s trade to GDP ratio has increased from 15 percent to ____ percent of GDP between 1990 and 2005.1.

25a. 35b. 45c. 55d.

Which of the following fosters free trade between nations?2. WTOa. IMFb. IFTc. GATTd.

WTO was established in which year?3. 1991a. 1993b. 1995c. 1997d.

Which of the following was created to maintain global monetary cooperation and stability by making loans 4. to countries with balance of payment problems, stabilising exchange rates and stimulating growth and employment?

WTOa. IMFb. IFTc. GATTd.

The ________ aims to lower tariffs and non-tariff barriers in order to increase international trade. 5. IMFa. WTOb. GATTc. SEBId.

Which of the following was able to create monetary equilibrium between nations and prevent the accumulation 6. of economic and political power to creditor nations?

IMFa. IFTb. ICUc. GATTd.

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In2000,an_______confirmedthisinareportwhichconcludedthatneoliberaltrademeasuresprimarilybenefit7. corporate interests.

ECOSOCa. UNCTADb. UNDPc. UDPd.

What does ICU stands for?8. International Calling Unita. International Clearing Unionb. Internal Call Unitc. Internet Call Unitd.

Which of the following statements is false?9. The Paris Club of creditors, through the IMF, quickly approved the cancellation of 80% of Iraq’s debts, a. approximately $39 billion.The WTO’s Trade Related agreement on International Property Rights (TRIPS), forces developing countries b. to extend property rights to seeds and plant varieties.The IMF, working in conjunction with Wall Street bankers and the US Treasury, has failed to effectively c. forcemanyemergingeconomiestoliberalisetheirfinancialmarkets.Bolivia’s per capita income is less than it was 25 years ago, with 63% of Bolivians living in poverty.d.

In WTO and IMF the maximum number of votes right is allocated to which country?10. Britaina. USAb. Indiac. Japand.


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Chapter VI

Financial System in India: Structure and Evolution

Aim


explainfinancialsystem•

elucidateevolutionoffinancialenvironment•

explicatefinancialintermediation•

Objectives


explainthestructureoffinancialmarkets•

explain the concept of money market•

explicateevolutionoffinancialmarket•

Learning outcome


describe commercial banks•

identify• foreign exchange market

understandotherfinancialinstitutions•

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6.1 IntroductionThefinancialsystemofanycountryiscomprisedofthefinancialinstitutions,financialmarkets,financialinstruments,andfinancialservices.Theseconstituentpartsofthefinancialsystemareinterdependentandworkcomplementarytoeachother.Thefinancialsystemcontributestogrowthanddevelopmentoftheeconomybymobilisingsavingsandallocatingthesetoinvestors.Theinitiationoffinancialreformsintheearly1990swasessentiallytobringaboutatransformationinthestructure,effectivenessandstabilityofthefinancialsystem.Inordertoassessthelimitationsandprospectsofthereforms,weneedanunderstandingoftheorganisationalstructureofthefinancialsystem.ThischapterisdesignedtolookatthestructureandworkingoftheIndianfinancialsystem(IFS),anditsevolutioninthepostindependenceera.Insection2,anattemptismadetolookatthewaythefinancialenvironmentinIndiahasevolved over time. In section 3, the structure of the IFS is discussed in terms of its institutions. Lastly, in section 4, theevolutionofthefinancialmarketsislookedat.Specialemphasisislaidondiscussingthereformswithaviewto seeing whether they facilitate the removal of institutional barriers preventing the effective functioning of the system.

Financialsystemplaysavitalroleintheeconomicdevelopmentofacountry.Thefinancialsystemintermediatestheflowoffundsfromthesaverstotheinvestors.Afinancialsystemisacomplex,well-integratedsetofsub-systemsoffinancialregulators,Institutions,Instruments,MarketsandServiceswhichfacilitatesthetransferandallocationofthefundsefficientlyandeffectively.TheIndianfinancialsystemisbroadlydividedintotwosystems.Theyare:

Formal Financial system (Organised)•Informal Financial system (Unorganised)•

Financial System

Financial Services

Organised

Primary

Primary

CapitalMarkets

MoneyMarkets

Shortterm

Mediumterm

Longterm Banking Non-Banking

Non-Intermediaries

Regulatory Intermediaries OthersUnorganised

Financial Markets

Financial Instruments

Financial Institutions

Secondary

Secondary

Fig. 6.1 Structure of Indian financial system(Source:http://madhanmohan1988.blogspot.in/2010/11/indian-financial-system.html)

6.2 Evolution of the Financial EnvironmentTheenvironmentinwhichtheIndianfinancialsystemhasfunctionedinthepostindependenceeracanbedividedintothreedistinctperiods.ThefirstperiodisbetweenthenationalisationofRBIin1949andthenationalisationof the commercial banks in 1969. The fairly liberal environment in which the banking sector operated marks this period. The second period is from 1969 till 1991 when the structural adjustment cum stabilisation programme was initiated. This period is basically characterised by the active participation of the Reserve Bank in the banking policy formulation and re-orientation. The nationalisation of 14 commercial banks in 1969 was a turning point in theevolutionoffinancialsectorpoliciesinIndia.DuetothemoredirectandactiveroleofRBIindevisingthepolicies so as to meet the social objectives such as the reduction in inequalities of income and the concentration of economicpower,thisperiodisdominatedbythepoliciesoffinancialrepression-interestratecontrols,directed


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credit programmes, etc. The third period starts in 1991, when the attempt is made by the policy-makers to deregulate anddevelopthefinancialmarkets.Inthisperiod,amorecomprehensiveliberalisationofthefinancialsystemwasaimed at, though the initial steps had actually started in the late 1980s.

Soonafterindependence,thebankingsectorwasrecognisedasthemajorsectorofIndianfinancialsystem.TheRBIwas nationalised in January 1949 and has consolidated its position as the supervising and controlling agency of the banks. All scheduled banks were required by the RBI Act to maintain a minimum cash reserve of 5 percent of their demand liabilities and 2 percent of their time liabilities on a daily basis. In addition banks had to maintain liquid assets in cash, gold or government securities amounting to not less than 20 percent of demand and time liabilities. This was referred to as the statutory liquidity ratio (SLR). In 1962 the RBI was empowered to vary the cash reserve requirements (CRR) between 3 percent and 15 percent of total demand and time liabilities while the SLR was raised to an additional 25 percent over and above the CRR. RBI was also empowered to stipulate minimum lending rates and ceiling rates on various types of advances. There was a voluntary agreement among the important banks operating in India regarding the interest payable on deposits prior to 1964. Since 1964, RBI directly regulated the interest rates on various deposits.

Right from the beginning, the RBI was envisaged to play a promotional role in augmenting the advancement of credit to the agricultural sector. However, the allocation of credit from commercial banks was largely to industry and, in particular, to the corporate sector. Between 1951 and 1968 there was an increase in the share of credit to industry from 34 percent in 1951 to 67.5 percent in 1968, whereas the share of bank credit to agriculture was a little over2percent.Thesecondperiodofthedevelopmentoffinancialsystemstartedwiththenationalisationofthe14largest Indian scheduled commercial banks. The broad objective of the nationalisation of banks was to mobilise and disburse resources in accordance with the needs of development. This led to an emphasis on lending to the priority sectors, viz., agriculture and other allied activities. The public sector banks were directed to advance 40 percent of theirtotalcredittotheprioritysectorswithnotlessthan16percentgoingtoagriculture.Otherfinancialinstitutionslike LIC, UTI, IDBI, IFCI, and ICICI etc., had been nationalised in this period with special objectives. UTI was envisagedtopromotethestockmarketandtheIDBItoprovidedirectandindirectlong-termfinancetofirmsinindustrial sector. Term loans were also provided by the IFCI and ICICI.

The rationale for such social controls was diluted subsequently with the government’s increasing need to use the bankingsectorforfinancingitsowndeficits.Itwasatthistimethatthefinancialrepressioncouldbesaidtohaveset in. It was in the 1970s and 1980s that government started using the banking sector as a captive source of funds by raising the SLR and CRR. The SLR requirement, which was 28 percent in 1970-1, was gradually increased to 38.5 percent in 1989-90. The CRR requirement was raised from 7 percent in 1973-4 to 15 percent in 1989-90. At the same time, to keep the cost of borrowing low for itself, the government systematically suppressed the governmentsecuritiesmarketsandmoneymarketsduringthisperiod.Thisfinancialrepressionledtosegmentedandunderdevelopedfinancialmarkets,inefficientuseofcredit,andmostofall,adverselyaffectedthebankprofitability.The nationalisation of banks also meant that the competition in the banking sector was inhibited. It was against thisbackgroundthattheneedforfinancialreformswasfelt.TheimpetusforthiscamewiththesubmissionofthetwoinfluentialcommitteereportstotheRBI-theChakravartycommitteereportin1985andtheVaghulcommitteereportin1987.TheChakravartycommittee,whichwasmeanttosuggestmeasurestoimprovetheefficiencyofmonetary policy recommended to:

develop treasury bills as a monetary instrument to make the open market operation as a dominant instrument •of monetary policyrevise upwards the yield structure of government securities so as to create a demand for public debt; and •adopt monetary targeting as an important monetary policy tool with price stability being the ultimate objective •of monetary policy

The second committee, which was set up to study the money market, recommended for a phased decontrol and development of money markets and the gradual integration of these markets with other key short-term markets such as the treasury bills market.

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The actual reform in thefinancial sector started in themid-eightieswith theRBI implementing someof therecommendations of the two committees. The major steps in this regard are introduction of 182-day treasury bills in1986,commercialpaperandcertificateofdepositsin1989,institutionofDFHIin1988etc.InMay1989,asa further step towards the liberalisation of the money markets, the ceiling on the call money rate was withdrawn. More radical reforms have taken place in 1991, when the government of India adopted the structural adjustment cum stabilisationprogramme.Twoconditionscalledforfinancialsectorreform.Firstly,thegovernment’suseofbankingsectortofinanceitsfiscaldeficithasreduceddrastically.Secondly,thereformsintheindustrialandtradesectorsnecessitatedtheallocationofresourcestobemarket-drivenandthereforerequiredreformsinthefinancialsector.Thefinancialsectorreformgotamajorboostwiththeimplementationofsomeoftherecommendationsof theNarasimhamcommittee set up in 1991 to study theworkingof thefinancial system.These recommendationswere:

lowering the SLR to 25 percent in a phased manner and to use CRR as an instrument of monetary policy•phasing out directed credit programmes and to bring the interest rate on government borrowing in line with •other market-determined interest rates thatbanksandfinancial institutionsachieveaminimum4percentcapitaladequacyratio inrelationtorisk•weighted assets by March 1993thatbanksandfinancialinstitutionsadoptuniformaccountingpracticesinregardtoincomerecognitionand•provisioning for non-performing loansthat freedom be given to issuers of capital to decide on the nature of the instrument, its terms and its pricing in the •capital market (Narasimham committee report, 1991). Most of these recommendations have been implemented by1995-96

Allthisledtosignificantderegulationanddevelopmentofthemoneymarket.Thuswenotethatwhilethefinancialsector had been repressed earlier, several reforms were undertaken from the mid-eighties to deregulate and liberalise it.Alsoawiderangeoffinancialinstitutionshadbeensetup.Thisfacilitatedthecomprehensivereformpackagebrought about in 1991.

6.3 Financial Intermediation: Pattern and InstitutionsThefinancialsectormediatesbetweentheultimatesaversandinvestors,actingasamobiliserofcreditandfinance.Theleveloffinancialdevelopmentisindicatedbytheextentofmobilisationanddispersionoffunds,viz.thefinancialintermediationprocess.Severalindicatorsareusedintheliteraturetoshowtheleveloffinancialdevelopment1(Goldsmith,1969).OvertimetheleveloffinancialdevelopmentinIndiahasshownasteadygrowth,whicheverindicator is used (Sen and Vaidya, 1997). However, the general pattern appears to have been a growth in the banking sector in the 1970s while the capital market grew in the 1980s.

Lookingatthefinancialintermediationprocessintermsoftheflowoffunds,theflowhasbeenfromthehouseholdsector and the rest of the world to the government sector including the public sector enterprises and the private corporate sector. The surpluses of the household and the rest of the world sectors have increased steadily over time andsohavethedeficitsofthegovernmentandprivatecorporatesector(SenandVaidya,1997,pg.26).Governmentsector has been the largest borrower till 1991. After the 1991 reforms, there is an indication of a reversal of this trend with the government sector reducing its dependence on external funds. While government securities are still themostimportantinstrument,thenon-financialsectorhasincreaseditsholdingofcorporateandotherfinancialinstitutions’ securities. The household sector too has been shifting towards holding corporate securities and mutual funds.Aswewouldexpect,thisreflectstherisingdifferentialbetweentherateofreturnonthesesecuritiesandonbank deposits. The private corporate sector’s dependence on external funds has increased steadily till 1985-86, after which it has reduced, with an improvement in the availability

Theindicatorsoffinancialdevelopmentare:Finance ratio•Financial inter-relations ratio •New issue ratio•Intermediation ratio •


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Thedefinitionsof these ratios basically imply the importanceoffinancial institutions relative to non-financialunitsinraisingresourcestofinanceinvestmentofinternalfunds.Otherfinancialinstitutionsasasourceoffundsfor the private sector have increased relative to banks in the 1990s. Also, banks have increased their lending to the government, though a larger share of their funds is held with the RBI or in government securities due to high SLR and CRR.

6.4 Financial InstitutionsNextwelookatthestructureofthefinancialsystemintermsofitsinstitutions.Financialinstitutionsarebusinessorganisationsthatactasmobilisersanddepositoriesofsavings,andaspurveyorsofcreditorfinance.Financialinstitutions are divided into banking and non-banking institutions; the distinction between them is that banks can advance credit by creating claims against themselves while other institutions can lend only out of their resources put at their disposal by savers.

The banking sector consists of the RBI, commercial banks and cooperative banks. Among these, commercial banks formthedominantcomponent.Othernon-bankfinancialinstitutionscanbeclassifiedintothreegroupstermlendinginstitutionsincludingdevelopmentbanks,mutualfundsandtheinsurancesector.Webrieflyreviewdevelopmentsin the banking and non-banking sectors in this section.

6.4.1 Commercial banksSincethenationalisationofthecommercialbanksin1969,therehasbeenasignificantgrowthofbankingsystemsin India both in geographical coverage and amount of resources mobilised. There has been an increase in deposits as a percentage of national income from 15.3 percent in 1969 to 51.8 percent in 1994. Most of this increase in deposits has been in the form of time deposits, which has resulted in a spectacular increase in the M3/GDP ratio since the late sixties.

There are two reasons for mobilisation of such high levels of deposits:Firstly,thegeographicalareacoveredbythecommercialbankshasincreasedsignificantlywithamorethan•seven-fold increase in the number of bank branches since 1969. Most of the new branches have been set up in the rural areas, which led to a sharp decline in the population per bank branch and mobilised savings from the rural sector Secondly, the impressive performance in the mobilisation of deposits is due to the positive real rate of return on •thedeposits,whichMcKinnon(1973)hadarguedisanessentialprerequisiteforfinancialdeepening

Ithasbeenarguedthatthesocialcontrolofbankshadledtoadeclineintheproductivityandefficiencyandreductionoftheprofitabilityofthebankingsector(MinistryofFinance,1991).Thereductionofprofitabilityofbankshasensuedfromfactorsinfluencingbothincomeandexpenditureinthebankingindustry.Ontheincomeside,bankshavenot been able to realise their potential income due to various restrictions on the use of funds. The most important of these have been the directed credit programmes and high levels of SLR and CRR in the late eighties. However, since 1991, there has been a scaling down of the directed credit programmes and a reduction in the SLR and CRR.

Between 1973 and 1993, 84.5 percent of the increase in aggregate bank deposits was in the form of time deposits. In end-March 1993, time deposits constituted 84.3 percent of total deposits. The rigidly enforced branch licensing policyisanimportantcontributingfactorinthepoorprofitabilityperformanceofthecommercialbanks.

6.4.2 Other financial institutionsAsmentionedearlier,theotherfinancialinstitutionscanbeclassifiedintothreegroups,withalmostallthemajorinstitutionsinallthreecategoriesbeinggovernmentowned.ThefirstcategoryconsistsofDevelopmentBanks,which include Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI), Shipping Credit and Investment Company of India (SCICI), Industrial Finance Corporation of India (IFCI),andSmallIndustriesDevelopmentBankofIndia(SIDBI).Thelargestinsizeandinfluenceamongtheseare the IDBI and the ICICI. The IDBI was started in 1964 as a subsidiary of the RBI, but in 1975, the ownership ofIDBIwastransferredtotheGovernmentofIndia.Ithasbeenoperatingastheapexfinancialinstitutionthatis

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responsibleforthecoordinationofallfinancialinstitutionsengagedinfinancingtheindustrialsector.Till1990,the IDBI used to provide loans to the small scale and large-scale industries. In April1990, IDBI set up a subsidiary companycalledSIDBItowhichithandedoveralloperationspertainingtothefinancingofsmall-scaleindustries.The ICICI, a public limited company, was set up in 1955 as a private sector development bank. Its share capital was subscribed to by foreign institutions, banks and insurance companies. The other development banks, likewise, catertothefinancingneedsinspecificareas.

Till1990,theratesofinterestatwhichtheseinstitutionslentcredittofirmswerefixed.ButinAugus1991,thegovernment permitted all term lending institutions to charge interest rates according to the riskiness of the project. This basically freed the interest rates. The interest rates initially rose after this, but subsequently fell between 1993 and 1996. Another major change in their functioning since 1990-91 has been the reduced dependence on the governmentofIndiaandtheRBIforfunds.Someofthem,specificallytheICICIandtheIDBI,havediversifiedtheiroperationsintovariousfieldsofactivitysince1991.Broadlyspeaking,inthepost-liberalisationperiodtheyhaveattemptedtotransformthemselvesintofinancialinstitutionswithareduceddependenceonthegovernmentforsubsidisedandcaptivesourcesoffundsandhavingadiversifiedfieldofactivity.

Among the mutual funds, by far the largest in size is the UTI (though in recent years, several new mutual funds have also arrived on the scene). It was set up in 1964. It is a 50 percent subsidiary of IDBI, the rest of the share capital being held by the LIC, commercial banks, ICICI, and IFCI. UTI was never constrained in any way either by regulation or by policy decisions of the Government of India in the manner in which it invested its resources, and ithasinvestedinbothequityandfixedincomesecurities.Financialliberalisationofthissector,thushasinvolvedaremoval of legal barriers to entry in the mutual funds business in a phased manner, and a strengthening of regulations aimed at ensuring transparency, and the provision of reliable information to investors. Till 1987, UTI had a monopoly positionbutin1987-88commercialbanksandotherpubliclyownedfinancialintermediarieswereallowedintothemutual fund sector. In1993-94, it was opened out to the private sector, and SEBI announced regulations aimed at increasingtransparencyandsafety.TheinvestmentsoftheUTIhaveundergonesignificantchangesoverthetime.After 1990-91, the share of investments in government securities and deposits with banks has declined, while the share of investments in equity shares has dramatically increased.

The major insurance funds are the LIC and the GIC, both of which are government owned. The LIC was established in September 1956 by nationalising all life insurance companies operating in India at that time. Unlike UTI, LIC since its inception had to operate under severe constraints regarding the way it could allocate its investible resources among various instruments. A large part of its investments had to be in government securities, and in socially oriented sectors like public sector, cooperative sector, house building, etc. As of March 1992, the LIC owned about 13.3 percentofalloutstandingcentralandstategovernmentsecurities.TherestrictionsimposedonLIChavesignificantlyreduced the yields on investments. However, the situation has improved in recent years with the yield of government securitiesincreasingsignificantly.In1994,theMalhotracommitteehasrecommendedthattheprivatesectorshouldbe allowed into insurance, and the LIC and GIC should reduce investment in government securities.

Thisbriefoverviewof thefinancial institutionsallowsus tomake the following remarks.Earlier,mostof theinstitutions, even if not completely in government control, had been strictly regulated in terms of rates of interest, source of funds, and the priority areas to which they could advance credit. However, starting mid-eighties, and pickingupmomentuminthenineties,wecansaythatseveralareashavebeenopeneduptoprivatefirmstherehas been a phased deregulation of interest rates; captive and subsidised sources of funds to the development banks has been reduced and they have had to turn to the market for funds; and above all, the pre-emption of funds by the government has been reduced. The whole process however has been gradual, and it is to be noted that mandatory lending requirements of commercial banks to priority sectors is still maintained.

6.5 Structure and Evolution of Financial MarketsWelooknowatthefinancialmarketsinwhichtheseinstitutionsparticipate.Financialmarketsarethecentresorarrangementsthatprovidefacilitiesforbuyingandsellingoffinancialclaimsandservices.Theparticipantsonthedemandandsupplysidesofthesemarketsarefinancialinstitutions,agents,brokersandsavers.Financialmarketsmaybeclassifiedasorganisedandunorganisedmarkets.


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Unorganisedmarketreferstoaplacewherethefinancialtransactionstakeplaceoutsidethewell-establishedexchangesor without systematic and orderly structure or arrangements and largely cater to the rural and unorganised sector. Thefinancialsectorreformsarenaturallycentredonorganisedmarkets,althoughitisexpectedthattheywillhaveanindirecteffectonunorganisedmarketsaswell.Discussioninthissectionisconfinedtotheorganisedfinancialmarkets. Thesemayinturnbeclassifiedintothemoneymarket,capitalmarket,creditmarket,governmentsecuritiesmarket,andforeignexchangemarket,eachofwhichwediscussseparately.Mostofthefinancialmarketswerecharacterisedtilltheearlyninetiesbycontrolsoverthepricingoffinancialassets,restrictionsonflowsortransactions,barrierstoentry, low liquidity and high transaction costs. These characteristics came in the way of developments of the markets andallocativeefficiencyofresourceschannelledthroughthem.Theinitiationoffinancialsectorreformsintheearlyninetieswasessentiallytobringaboutatransformationinthestructure,efficiencyandstabilityoffinancialmarkets,asalsoanintegrationofmarkets.Someoftheimportantstructuralchangesenabledbyfinancialsectorreformsrelatetointroductionoffreepricingoffinancialassetsinalmostallsegments,relaxationofquantitativerestrictions,removalofbarrierstoentry,newmethodsofflotationofsecurities,increaseinthenumberofinstrumentsandenlargedparticipation,improvementintrading,clearingandsettlementpractices,improvementintheinformationalflows,transparency and disclosure practices.

6.5.1 Money MarketThe money market performs the crucial role of providing a conduit for equilibrating short-term demand for and supply of funds thereby facilitating the conduct of monetary policy. The instruments traded in money market are short term in nature. Important among them are:

Call money•Certificateofdeposit•Commercial paper•

The RBI and Securities and Exchange Board of India (SEBI) regulate the participants and use of instruments in the money market.

Call money market is that part of the national money market where the day-to-day transactions in surplus funds of banks are one. Call loans are short term in nature, their maturity varying between one day and a fortnight and are payable on demand. They are given to the bill market, for the purpose of dealing in the bullion markets and stock exchangesandbetweenbanks.Amongtheseuses,interobankusehasbeenthemostsignificantandtheiruseonstock exchanges and other markets has been modest. In the inter-bank call money market, funds are supplied by the member banks that have reserves on a particular day in excess of reserve requirements. Banks borrow from other banks in order to meet a sudden demand for funds, large payments, large remittances, and to maintain liquidity with RBI.

Participants in the call money market are scheduled commercial banks, non-scheduled commercial banks, foreign banks,cooperativebanks,andsomefinancialinstitutionsandmultinationals.Acharacteristicofthecallmoneymarket in India had been that of a few large lenders viz. LIC and UTI and a large number of borrowers. This led to adeficiencyinobtainingshorttermfunds.Butin1988,theRBIsetuptheDFHI,whichparticipatedasbothlenderand borrower. Steps were also taken to widen the market in 1990. At one time, only a few large banks particularly foreign banks operated in the call money market. Over time, however the market has expanded and now small banks andnon-scheduledbanksalsoparticipateinthismarket.Therehasbeenasignificantincreaseinannualturnoversince 1991.

The rate of interest in the call money market was market determined till 1973, but between 1974 and 1989 there were ceilingsfixed.InMay1989,theceilingoninterestratewasremoved.Theremovaloftheceilingonthecallmoneyratelettoanincreaseinfluctuationssince1991,andtherateishighlyvariablefromdaytoday.Asaconsequence,companieshesitatetoissuefloatingratebondsinthecapitalmarket.Anotherfall-outofthefluctuationsinthecallmoney rate is that the rate presents arbitrage opportunities to players in the foreign exchange market. Foreign banks

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now participate in the market, borrowing foreign exchange from their overseas branches and selling in the swap market in India. This has led to an increase in the forward premia on the foreign exchange. To combat this, the RBI introduced ‘Repos’, which were meant to even out liquidity. However, as Rangarajan (1994) pointed out, the RBI has only used repos to drain reserves from banks and not to replenish them. Commercial paper (CP) is quite a new instrumentinthemoneymarket.CPsareshort-termpromissorynoteswithfixedmaturity.In1990RBIintroduceda scheme under which certain borrowers could issue CPs in the Indian money market. This enables highly rated corporate borrowers to diversify their sources of short-term borrowings and to borrow at a lower rate than the bank-lending rate.

CPs are issued at a discount to their face value and the discount rate is freely determined by the company issuing them. The success of CPs and the development of the market depend crucially on the emergence and growth of the secondarymarketforthem.Butsofar,thesecondarymarketforCPshasnotgrownsignificantlyinIndia.Inanattempt to deepen the market some relaxations have been made in the recent past. The maturity period, has been changed from between 91 days to 6 months, to between 15 days to 1 year. The minimum size has been reduced from `. 1 crore to `. 5 lakhs. The issue base has also been widened by allowing Primary Dealers, Satellite Dealers and AIF is to issue them.

The major part of demand for CPs comes from the commercial banks, which in turn is governed by bank liquidity. Though, there is a positive interest rate differential between the bank loan rate and CP rate, commercial banks purchase CPs because bank loans involve a greater transaction cost. As inter-bank Call rates are lower than the CP rate, banks used to borrow in the call money market and invest in CP market to grab the arbitrage opportunity.

Certificateofdeposit(CDs)isashorttermsecuritisedtimedepositissuedbycommercialbanksatthetimeoftightliquidity condition. They are negotiable because they are payable either to the bearer or to the order of the depositor and are traded on the secondary markets. CDs are virtually riskless in terms of default of payment of interest and principal.BanksissueorsellCDseitherdirectlytotheinvestorsorthroughthedealers.CDsarequiteflexibleinrespect of maturity period, which varies between 2 weeks to 5 years; the more common period is 3 months to 1 year.

Since the beginning of the 1980s, the possibility of introducing CDs in India was being seriously assessed. The Tambe Working Group, in 1982, recommended against it because there were no secondary money markets, there wasanadministeredsystemofinterestratesandtherewasthepossibilitythatCDsmightgiverisetofictitioustransactions. The Vaghul committee studied the matter again 5 years later (1987) and was in favour of introducing CDs, provided short-term deposit rates were aligned with other interest rates in the system. Ultimately, following the rationalisation of interest rates on short-term deposits, the RBI formulated and launched, in June 1989, a scheme permitting banks to issue CDs.

Initially, the issuance of the CDs was limited to a certain percentage of fortnightly average of the outstanding aggregate deposits of 1989-90. Over time the limits were raised and subsequently it was abolished on October 16, 1993, enabling the CD to emerge as a market determined instrument. Again, to deepen thanarket for CD, the issuance size has been reduced to `. 5 lakhs and the minimum maturity period has been reduced to 15 days in April 2000.

Reforms in money marketIn1985,theChakravartycommitteefirstunderlinedtheneedtodevelopmoneymarketinstrumentsinIndia,whilein 1987 the Working Group on the Money Market (Chairman: Shri N. Vaghul) laid the blueprint for the institution ofmoneymarkets.TheReserveBankhasgraduallydevelopedmoneymarketsthroughafiveprongedeffort:

Interest rate ceilings on inter-bank call/notice money, inter-bank term money, rediscounting of commercial bills •and inter-bank participation without risk were withdrawn effective May 1, 1989Severalfinancialinnovationsintermsofmoneymarketinstruments,suchas,auctionsoftreasurybills(beginning•withtheintroductionof182-daytreasurybillseffectiveNovember1986),certificatesofdeposit(June1989),commercial paper (January 1990) and RBI repos (December 1992) were introduced


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Barriers to entry were gradually eased by increasing the number of players (beginning with the DFHI in April •1988 followed by primary and satellite dealers and money market mutual funds), relaxing both issuance restrictions and subscription norms and allowing determination of yields based on demand and supply of such paper, and enabling market evaluation of associated risks, by withdrawing regulatory restrictions, such as bank guarantees in respect of CPs The development of markets for short-term funds at market determined interest rates has been fostered by a •gradual switch from a cash credit system to a loan based system, shifting the onus of cash management from banks to borrowers and phasing out the 4.6 per cent 91-day tap treasury bills, which in the past provided an avenue for investing short-term fundsInstitutional development has been carried out to facilitate inter-linkages between the money market and the •foreign exchange market, especially after a market-based exchange rate system was put in place in March 1993

The changes in the money market structure need to be seen in the context of a gradual shift from a regime of administered interest rates to a market-based pricing of assets and liabilities. The development of money markets in India in the last few years has been facilitated by three major factors. Firstly, the limiting of almost automatic funding of the government, largely realised with the replacement of ad hoc treasury bills (which bore a negative real interest rate for most part of the period) by ways and means advances at interest rates linked to the bank rate, and the development of the government securities market, discussed later in the chapter, permitting a gradual de-emphasis on cash reserve ratio as a monetary policy instrument. Secondly, the development and use of indirect instruments for monetary policy such as the bank rate, the strategy of combining auctions, private placements and open market operations in government paper (put in place in 1998-99) and the liquidity adjustment facility (instituted in June 2000). Thirdly, an enabling institutional framework was introduced in the form of primary and satellite dealers and money market mutual funds. The monetary authority uses money markets to adjust primary liquidity in the domestic economy and monetary policy is often, in turn, shaped by developments in the money and the foreign exchange markets.

6.5.2 Credit marketWith a relatively underdeveloped capitalmarket andwith little internal resources, firmsor economic entitiesdependlargelyonfinancialintermediariesfortheirfundrequirements.Creditmarketisthepredominantsourceoffinance.ThemajorinstitutionalpurveyorsofcreditinIndiaarebanksandnon-bankingfinancialinstitutions,i.e.,developmentfinancialinstitutionsandotherfinancialinstitutionsandnon-bankingfinancialcompaniesincludinghousingfinancialcompanies.WhilebanksandNBFCspredominantlycatertoshort-termneeds,FIsprovidemostlymedium and long-term funds.3

Priortothefinancialsystemreforms,thissectorhadbeenhighlyrepressedwithgovernmentrestrictionsonbothpricing and allocation of credit. There were mandatory lending requirements to the priority sectors as well as administeredrates.Thisledtolowproductivityandefficiency,andlowprofitabilityinthebankingsector.Itisinthis background that the recommendations of the Narasimham committee were made in 1991. The consequential financialsectorreformsenvisagedinterestrateflexibilityforbanksandreductioninreserverequirements,besidesa number of structural measures. Interest rates, as a consequence, have emerged as a major signalling device for resource allocation. Credit market reforms included introduction of new instruments of credit, changes in the credit deliverysystemandintegrationoffunctionalrolesofdiverseplayerssuchasbanks,financialinstitutionsandnon-bankingfinancialcompanies.Thegradualintroductionofaloansystemintheplaceofacashcreditsystemhasfacilitatedbanksinplanningtheircashflowsbetter,andinreducingthecostsofuncertainty.Therehasalsobeengreater competition with the introduction of new private sector banks and the permission given to foreign banks to open branches, as also with progressive improvement in the role of the nonbanking sector. Restrictions on project financingbybankshavebeenremoved.

However, there are non-institutional sources of credit as well. These are basically the indigenous bankers and moneylenders.Itisinthefieldofcreditthattheunorganisedsectorismostimportant.Therehasbeenconsiderablederegulation. While lending requirements still remain, there has been rationalisation of the lending rates and a

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scaling down of cash reserve and statutory liquidity requirements. Selective credit controls have been eliminated over time. Credit restrictions have been gradually removed/relaxed for purchases of consumer durables, and loans to individuals against shares and debentures/bonds. As a result, the share of term loans as percentage of total bank loans has increased.

Alargevarietyofnon-bankfinancial institutionssuchasdevelopmentbanks, specialisedfinancial institutions,investmentinstitutions,andrefinanceinstitutionsalsofunctioninthecreditmarket.Asnotedearlier,developmentbanks(IDBI,IFCI,ICICI,SIDBIandIIBI)occupyanimportantpositioninthefinancialsystemasthemainsourceofmediumandlong-termprojectfinancetoindustry.Investmentinstitutionsinthebusinessofmutualfundandinsuranceactivityhavealsoplayedsignificantrolesinthemobilisationofhouseholdsectorsavingsandtheirdeploymentinthe credit and the capital markets. In the agriculture and rural sector and the housing sector, the NABARD (1982) andNHB(1988)respectively,arethechiefrefinancinginstitutions.Besidesprovidingdirectloans(includingrupeeloans,foreigncurrencyloans),financialinstitutionsalsoextendfinancialassistancebywayofunderwritinganddirectsubscriptionandbyissuingguarantees.Recently,somedevelopmentfinancialinstitutions(DFis)havestartedextendingshortterm/workingcapitalfinance,althoughtermlendingcontinuestobetheirprimaryactivity. Historically,theReserveBankandtheCentralGovernmenthaveplayedamajorroleinfinancingtheseinstitutionsby subscribing to the share capital, by allowing them to issue Government guaranteed bonds and by extending long-termloansatconcessionalterms.However,withthefinancialsectorreforms,concessionallendingbytheReserveBankandtheGovernmentwasphasedout,leavingthefinancialinstitutionstorelyfortheirfinancingneedsontheequity capital and the debt markets. Expansion of their equity base through public offers and public issues of long-termbondshasbecomeanimportantelementoftheirmarket-basedfinancing.Inordertoprovideflexibility,theReserve Bank has also allowed Fls to raise resources by way of term deposits, CDs and borrowings from the term money market. A large number of them have also been entering various businesses - venture capital, mutual funds, bankingandfinance.Thisportendswellforagreaterintegrationofthefinancialsystem.

6.5.3 Capital MarketCapitalmarketstructurehasevolvedovertime,withmarketpracticesearlierreflectinggovernmentpoliciesandfive-yearplanpriorities.ThestockmarketinIndiahasbeenfairlywelldeveloped.Itsroleinfinancialmarketshad increased during the 1980s, with household savings in corporate securities increasing between 1985-86 to 1994-95. But an important feature of the pattern of stockholding had been that a large proportion of shares belong togovernmentownedfinancialinstitutionse.g.,UTI.Theimplicationofthisisthatgovernmentwascapableofindirectlyinfluencingthemarket.

Till the reforms in the early 1990s, pricing was not determined by market conditions. Though volume of transaction was high, securities continued to exist in the physical form creating uncertainties for the investor, and increasing transaction cost. Long and uncertain settlement cycles created serious problems for clearing houses. Informational flowstotheparticipantswerealsodeficient.Raisingofcapitalfromthesecuritiesmarketbefore1992wasregulated.UndertheCapitalissues(control)act,1947,firmswererequiredtoobtainapprovalfromtheControllerofCapitalIssues (CCI) for raising resources in the market. New companies were allowed to issue shares only at par. In 1992, the Capital Issues (Control) Act, 1947 was repealed and with this ended all controls relating to raising of resources from the market. SEBI was given statutory powers in 1992 to undertake the tasks of regulation and supervision. The most important fall-out of the reforms was the freeing of pricing and setting up of new guidelines regarding new issues.

Initially,onlyfixedpricemechanismoffloatingnewcapital issueswasfollowed.Analternativemechanismofbookbuildingwasintroducedin1995givingtheissuerthechoicetoraiseresourceseitherthroughthisorthefixedpricemechanism.Although thebookbuildingguidelineswereprescribed in1995,no issuewasfloateddue tocertainrestrictiveguidelines,whichweremodifiedin1999.Thebookbuildingmechanismoffloatingnewcapitalissues has been devised in such a way that small investors are also able to subscribe to securities at a price arrived at through a transparent process. Issuers of capital are required to meet the guidelines of SEBI on disclosure and investor protection.


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In September 1992, foreign institutional investors were allowed unrestricted entry1n terms of volume of investment in both primary and secondary markets. In the secondary market, major reforms were the laying down of capital adequacy ratio for brokers; the banning of inside trading and the introduction of computer based trading system.

Till recently, trading on the Indian stock exchanges took place through open outery system barring NSE and OTCEI, which adopted screen-based trading system from the beginning (i.e., 1994 and 1992, respectively). At present all other stock exchanges have adopted on-line screen-based electronic trading, replacing the open outcry system. Of the two large stock exchanges, the BSE provides a combination of order and quote driven trading system, while NSE has only an order driven system. All stock exchanges operating in India have over 8000 terminals spread wide across the country. While in 1999-00, the SEBI issued guidelines for opening and maintaining the trading terminals abroad, no trading terminal could be opened abroad due to high cost of connectivity. For ensuring greater market transparency, the SEBI has recently banned negotiated and cross deals (where both the seller and the buyer operate through the same broker). In September 1999, all private off-market deals in both shares as well as listed corporate debts were banned. All such deals are now routed only through the trading screens. There are three main advantages ofelectronictradingoverfloor-basedtradingasobservedinIndia,viz.transparency,moreefficientpricediscovery,and reduction in transaction costs. It also reduces the segmentation of markets.

Thus the emphasis has been on disclosure of information, safeguarding of investors’ interests and opening up to foreign investors. The result of this has been a dramatic increase in the number of new issues and amount of capital raised after 1991-92. While traditionally, mainly two instruments, viz., debt and equity, were traded, a large number ofnewandhybridinstrumentswereintroducedinthefirsthalfofthenineties,throughtheincreaseinnewissues.

Markets have widened with an increase in the number of players such as mutual funds and foreign institutional investors.Amajorimplicationofthisisthatfirmsmaybeinapositiontosubstituteonesourceoffundsforanother,dependingonrelativecosts.Also,whiletheamountsraisedonforeignmarketsaremodest,thisalsoenablesfirmsto diversify their source of funds.

6.6 Government Securities MarketGovernment securities consist basically of treasury bills and dated securities, the difference being that the former consists of maturity less than one year, while the latter are longer-term. They are strictly speaking, part of the money and the capital markets respectively. But this market is discussed separately in this section since the characteristics of government securities and therefore the issues concerning them are different.

The market for government securities had been relatively underdeveloped until the mid-eighties, largely because the returns(administeredrates)hadbeenkeptartificiallylow.Thedemandforgovernmentsecuritieswasthereforelargelyrestrictedtoacaptivemarket,consistingofcommercialbanks,cooperativebanks,andsomefinancialinstitutionslike the LIC, UTI etc. and this too through the SLR requirements. Most of the treasury bills were 91-day ad hoes meanttomonetisethebudgetdeficit,andendedupbeingheldbytheRBI.However,followingtheChakravartycommittee report, in 1986 a phased deregulation was carried out. Rates of interest were revised upwards, even within the context of administered rates. The idea here, as mooted by the committee, was to help the transition from direct tools of monetary policy (such as credit controls, CRR), to the use of indirect instruments like open market operations. Thus the 182-day treasury bill was introduced in November 1986 to increase the real rate of interest. This was phased out in April 1992, when 364-day treasury bill to be sold on an auction basis, was introduced. In 1993, an auction system for 91-day treasury bill was also introduced. At present, the sale of government securities is carried out both through auction and through pre-determined coupon issues. Non-competitive bids are, however, acceptedoutsidethenotifiedamount.TheReserveBankalsoparticipatesonanon-competitivebasisintreasurybills and dated securities to primarily take up some part of the issues in case of under-subscription. In the recent years, with a view to moderating the market impact of the large borrowing programme on interest rates, the Reserve Bank has accepted private placement of government stocks and released them to the market when the interest rate expectations turned out to be favourable.

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Thesemeasureshaveledtoasignificantgrowthintheprimarymarketfortreasurybills,withtheamountoutstandingfor 91-day auction based Treasury bills rising from `. 250 crores in January 1993 to `. 3450 crores in August 1994. In August 1994, only sixteen percent was held by the RBI. The amount outstanding for 364-day treasury bills rose from `. 666 crores in April 1992 to `. 7160 crores in August 1994. This is mainly due to the use of open market operations by the RBI. Secondary activity has however not developed. Deregulation has given rise to a tendency fortheratesofinteresttofluctuate;butthe364-dayTreasurybillhasbeenmorestable.

Following the Chakravarty committee recommendations, the rates of interest on dated securities has also been gradually aligned with other rates of interest, and the maximum maturity period has also been reduced from twenty to ten years. The main investors in the Government securities market in India are commercial banks, co operative banks,insurancecompanies,providentfunds,financialinstitutions,mutualfunds,primarydealers,satellitedealers,non-bankfinancecompaniesandcorporateentities.TheReserveBankalsoabsorbsprimaryissuesofgovernmentsecurities, either through private placement or development. Though banks have traditionally been the dominant investors in the government securities due mainly to SLR requirements, they have, in recent years, found it advantageous to invest in the government securities beyond the statutory requirements partly because of the better risk-return characteristic of such securities in the context of adherence to capital adequacy requirements and partly because of relatively sluggish demand for commercial credit. The share of commercial bank holdings continued to rise during the eighties and the nineties.

A large participant base reduces the borrowing cost for the government, reduces market volatility and imparts competition in the market. A market with adequate depth and liquidity for participants with different perceptions and liquidity requirements should emerge. The present structure of the government securities market is pre-dominantly institutional, while the household participation is negligible or nearly absent. Foreign institutional investors are also permitted to invest in the dated government securities and treasury bills, both in the primary and secondary markets, within the overall debt ceilings.

Since the secondary activity/s not very high, to promote the retail market segment and provide greater liquidity to retail investors, the Reserve Bank allowed banks to freely buy and sell government securities at prevailing market prices, removing restrictions on the period between sale and purchase. Furthermore, the interest income on government securities was exempted from the provision of tax deduction at source with effect from June 1997, facilitating quotations at ‘clean prices’ and genuine trading in the secondary market. This has led to some growth as is evident from the fact that secondary market transactions in government securities increased to `. 5,39,255 crores in 1999-00 as against `. 1,27,179 crores in 1995-96 (Bhole, 1999). Thus it can be said that the size of the government securities market is large and is growing.

6.7 Foreign Exchange MarketForeign exchange market includes the market for all deposits, credits and balances payable in any foreign currency, and any instrument payable at the option of the drawee partly in foreign currency. It facilitates the transfer of purchasing power denominated in one currency to another. In the context of globalisation of the Indian economy, theforeignexchangemarketisanimportantelementofthefinancialsystem.

The working of the foreign exchange market depends upon the exchange rate mechanism followed. In India, till 1975, the par value of the Rupee was expressed in terms of gold. Between 1975 and 1992, the rupee was linked to abasketofcurrencies,andtheexchangeratefollowedamanagedfloatsystem.Theregimewascharacterisedbyadaily announcement by the RBI of its buying and selling rate to authorised dealers (ADs) for merchant transactions. Given the various exchange controls that were in position, these were the rates around which the market operated, with the RBI performing a market-clearing role on a day to-day basis. In 1992, the liberalised exchange rate management system involving a dual exchange rate was introduced and the rupee became convertible for all approved external transactions. Under this system, exporters were able to sell sixty percent of their exchange receipts to ADs at market determinedrate.However,itwastheunificationoftheexchangeratesin1993thatusheredinthemarket-determinedexchange rate, based on demand and supply in the foreign exchange market. Full current account convertibility, introduced in August 1994, was a further step in this regard.


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ThestructureoftheforeignexchangemarketinIndiamaybebrieflydescribed.ItoperatesfrommajorcentreslikeMumbai, Delhi, Calcutta, Chennai, Bangalore, Kochi, and Ahmedabad. It is comprised of customers, ADs in foreign exchange and the RBI. It consists of two segments, the customer or merchant segment consisting of transaction of customers to meet transaction needs, and the interbank segment encompassing transaction between banks (ADs). The customer segment includes major public sector units, corporates, and other business entities with foreign exchange exposure. Of late, foreign institutional investors have also been playing a major part. The inter-bank segment is dominated by a few large Indian banks, particularly SBI and a few foreign banks.

Since 1993, several steps have been taken to widen and deepen the foreign exchange market. Firstly, banks have been given the freedom to:

fixnetovernightpositionlimitsandgaplimits•initiate trading position in the overseas markets•determine the interest rates of NRI deposits and maturity period•

Secondly, inter-bank borrowings have been exempted from statutory pre-emptions of SLR and CRR. Thirdly, banks have been permitted the use of derivative products for asset-liability management. Fourthly, in order to facilitate integration of domestic and overseas money markets, ADs have been allowed to borrow abroad. The funds so borrowed are allowed to be used for any purpose, other than lending in foreign currencies. Fifthly, corporates have beenprovidedsignificantfreedominmanagingtheirforeignexchangeexposures.

They are permitted to hedge anticipated exposures, though this facility has been temporarily suspended after the Asian crisis. Other risk management tools like cross currency options on back to-back basis, lower cost option strategies like range forwards and ratio range forwards and hedging of external commercial borrowing (ECB) exposures have been allowed subject to prudential requirements.

At any time in the exchange market there is a spot exchange rate at which current transactions are carried out, and a forward rate for deliveries in the future. Both of these are market determined. In the absence of transaction cost, thedifferencebetweenthetworates(i.e.,theforwardpremium)shouldreflecttheinterestdifferentialbetweenthetwocountries.Thisobviouslyrequirestheexchangemarkettobeintegratedfirstlywiththeotherdomesticfinancialmarkets,andsecondlywithforeignfinancialmarkets.

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SummaryThefinancial systemof any country is comprisedof thefinancial institutions,financialmarkets, financial•instruments,andfinancialservices.Financialsystemplaysavitalroleintheeconomicdevelopmentofacountry.Thefinancialsystemintermediates•theflowoffundsfromthesaverstotheinvestors.TheIndianfinancialsystemisbroadlydividedintotwosystems.•Theenvironment inwhich the Indianfinancial systemhas functioned in thepost independenceeracanbe•divided into three distinct periods.Thenationalisationof14commercialbanksin1969wasaturningpointintheevolutionoffinancialsector•policies in India.The broad objective of the nationalisation of banks was to mobilise and disburse resources in accordance with •the needs of development. This led to an emphasis on lending to the priority sectors, viz., agriculture and other allied activities.The nationalisation of banks also meant that the competition in the banking sector was inhibited.•Thefinancialsectormediatesbetweentheultimatesaversandinvestors,actingasamobiliserofcreditand•finance.Financial institutions are business organisations that act as mobilisers and depositories of savings, and as •purveyorsofcreditorfinance.Financialmarketsare thecentresorarrangements thatprovidefacilitiesforbuyingandsellingoffinancial•claims and services.The money market performs the crucial role of providing a conduit for equilibrating short-term demand for and •supply of funds thereby facilitating the conduct of monetary policy.Creditmarketisthepredominantsourceoffinance.•Capitalmarketstructurehasevolvedovertime,withmarketpracticesearlierreflectinggovernmentpolicies•andfive-yearplanpriorities.

ReferencesKhan, M.Y., 2007. • Indian Financial System, 5th ed., Tata McGraw-Hill Education.Dr. Murthy, D.K., 2006.• Indian Financial System, I.K. International Pvt. Ltd.Financial System in India:Structure and Evolution• [Pdf]Available at: <http://shodhganga.inflibnet.ac.in/bitstream/10603/1732/10/10_chapter%203.pdf>[Accessed11July2013].Current and Structural Developments in the Financial System• [Pdf]Available at: <www.oecd.org/finance/financial-markets/44362303.pdf>[Accessed11July2013].2013. Indian Financial System• [Video online] Available at: <https://www.youtube.com/watch?v=-ShUE6n_4pc ‎>[Accessed11July2013].2013. Indian Financial Services System• [Video online] Available at: <https://www.youtube.com/watch?v= zsanyYtQQ2I‎>[Accessed11July2013].

Recommended ReadingGurusamy, S., 2009.• Indian Financial System, 2nd ed., Tata McGraw-Hill Education.Pathak, B.V., 2011.• The Indian Financial System, 3rd ed., Pearson Education India..Bhole, L. M., 2004.• Financial Institutions and Markets:Structure, Growth and Innovations, 4th ed., Tata McGraw-Hill Education


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Self AssessmentTheenvironmentinwhichtheIndianfinancialsystemhasfunctionedinthepostindependenceeracanbedivided1. into how many distinct periods?

Twoa. Fourb. Sixc. Threed.

ThefirstperiodoftheIndianfinancialsysteminthepost-independenceeraliesfrom_______.2. 1949-1969a. 1969-2000b. 1949-1991c. 1969-1980d.

The nationalisation of RBI was done in _________. 3. 1959a. 1969b. 1949c. 1979d.

WhichofthefollowingwasaturningpointintheevolutionoffinancialsectorpoliciesinIndia?4. Nationalisation of RBI in 1949.a. Nationalisation of 14 Commercial Banks in 1969.b. Increase in foreign trade .c. Decrease in excise duty.d.

In which year RBI started directly regulating the interest rates on various deposits?5. 1949a. 1969b. 1972c. 1964d.

In which year the ownership of IDBI was transferred to the Government of India?6. 1964a. 1975b. 1986c. 1996d.

The ________, a public limited company, was set up in 1955 as a private sector development bank.7. IDBIa. IFCIb. ICICIc. SCICId.

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Which of the following market performs the crucial role of providing a conduit for equilibrating short-term 8. demand for and supply of funds thereby facilitating the conduct of monetary policy?

Capital marketa. Credit marketb. Foreign marketc. Money marketd.

What does SEBI stands for?9. Security Exchange Board of Indiaa. Social Exchange Board of Indiab. Shipping Export Board of Indiac. Shipping Exchange Bay of Indiad.

The LIC was established in _______.10. 1949a. 1969b. 1975c. 1956d.


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Chapter VII

Changing Role of Government

Aim


explain economic growth•

elucidate• structure of investment and capital formation

explicate • structure of national output

Objectives


defineeconomicdevelopment•

elucidate• basic structural changes in the economy

explicate • India’s saving and investment

Learning outcome


define• structure of consumption

identify • growth rate of NNP and NNP per capita

understand • financial-assetstructureofthehouseholdsector

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7.1 Introduction It will be an interesting exercise for you to compare the role played by the governments in two Asian countries – Japan and China. These two countries differ from each other tidally in terms of their political and economic ideologies. The tiny Japanese nation is considered to be a capitalist giant. The populous Chinese nation is one of the very few countries which still, by and large, practice communism.

Of course, both in Japan and China, justice, police and defence are part of the responsibilities of the government. But as regards the economic role of the government, the situations in the two counties are strikingly different. In Japan, there are hardly any government enterprises and the means of production are almost entirely in closely hands. The government at present has a very negligible role in the Japanese economy. In China the situation is almost exactly the opposite. The means of production are almost entire in government hands and the government plays a very prominent economic role even these days.

Actually, if you scan books of economics, you will decipher two diametrically opposite viewpoints about the economic role of government. One is the laissez-faire view as propounded by Adam Smith. According to this, a government that interferes lest with the economy is the best. In such an economy, everyone acts according to his or her own self-interest. But the invisible hand operating through the market mechanism ensures that social interest getspromotedinthisprocess.InstrikingcontractistheviewheldbyKarlMarxandhisgroupofscientificscoliosis.Corroding to the Marxists, centralised planning with public ownership of the means of production leads to an ideal economic and social set up.

Let us not take a brief look at the economic history of the developed nations of today. This is necessary to understand the prevalence of the different viewpoints on the economic role of government. It will also reveal the process of change in these viewpoints over time. In fact there is adequate historical evidence that, basically, economic policies of laissez-faire helped the countries of Western Europe and the United States of America attain high levels of economicdevelopment.Actually,tilltheearlypartsofthetwentiethcentury,scientificsocialismwaslookeduponas something theoretically sound, but impractical and utopian.

YouwillnoticethatthebirthoftheSovietUnionin1917basedonscientificsocialismchangedallthisconsiderably.Further, since the late 1920s the lacunae father laissez-faire economies started looming larger and larger. As a result, government intervention became increasingly popular even in traditional lassie-faire economies. A number of countries turned communist for various reasons particularly after the Second World War. Due to all this a number of Asian and African countries, regarding independence in the 1950s and 1960s, opted for considerable government intervention in their economies.

The pendulum has, however, swung the other way particularly since the 1970s. Many countries of Easter Europe foundcentralplanningof thecommunistvarietydifficult topracticeandhence ineffective.Manyof themlikePoland, Hungary and Yugoslavia started being less rigid forms of Centralised planning. Private ownership omens of production also began to be allowed in some sector soft the economy in these countries. Moreover, both the Soveit Union and China started inducting market forces to supplement Centralised planning. The breakup of the Soviet Union of Yugoslavia and the pulling down of the Berlin Wall are taken as further manifestations of this wind of change. The magic formulae on everybody’s lips these days are liberalisation and globalisation. It looks as if the laissez-faire economic philosophy has been reinstated. Almost all countries of the world, including, India, have been swept off their feet as a result. The changes, particularly, since the 1990s, of the economic role foot he Government in India bear ample testimony to this.

It is, however, being increasingly realised that there are no simple panacea for improving for the levels of living of the people. Most analysis agree that neither laissez-faire nor Centralised planning of the communist verity can deliver the goods. It has, of cause, been admitted for years that even capitalist countries there are certain aspect where government intervention in the economy impose its performance. We are living in an age which is also witnessing attemptstomakescientificsocialismmarketfriendly.Youmighthavecomeacrossthepopularsayingthatwearein the ear of Karl Smith and Adam Marx these days.


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In view of all this, we now embark on a more detailed analysis of the role of government in today’s world.

7.2 Role of Government in Capitalist Economies Youwillfindthatthelaissez-faireeconomicphilosophyunderlyingthecapitalisteconomieshascometoinformstronganalyticaljustification.ThisisdonebypointoutthatsuchpoliceswouldleadtoaPareto-optimalallocationof resources in the economy concerned. A Pareto-optimal situation exists in any economy if one person cannot be made better off without making someone else worse off in their respective options. Under certain assumptions the proponents of laissez-faire have promoted that such a Pareto-optimal situation will emerge in a free market economy with no government intervention. But the assumptions made in deriving the Pareto-optimal solution from laissez-faire economic logic are far from reality. Further, the actual results in countries following laissez-faire economic police revealseriousdrawbacks.Youwillhencefindthatonboththesecounts,evenconfirmedprotagonistoflaissez-fairefavour economic intervention by government. We take up these issues one by one now.

7.2.1 Unrealistic AssumptionsThreebasicassumptionsunderliethejustificationofalaissez-faireeconomicphilosophy.Firstlyitisassumedthatmarkets are characterised by perfect competition. Secondly, it is taken for granted that there are no externalists. Thirdly, not all types of goods can be taken into account in the analysis. The meanings and implications of each of these are discussed below.

Perfect competitionPerfect competition has a number of characteristics. There are a large number of buyers and sellers each buying and selling only a small quantity of the product. The product produced is perfectly homogenous and both buyers and seller are guided solely by economic considerations. There is perfect knowledge and perfect mobility of consumes and of the factors of production. The net result of all this is that there will be only one price for the commodity at one point of time in a market. Further no single buyer or seller can affect the price or the demand or the supply, as the case may be, by his independent action.

You can see by now that the actual situation in most market is a far carry from this. Joan Robinson and E. Chamberlain had pointed this out even in this late 1930s. They build alternative models of market structure, namely imperfect competition and monopolistic competition. Later writers have gone on to build even more realistic models of market structure. These oligopoly models visualise the existence of raw large producers in each industry with some of these working even in collusion.

A Pareto-optimal situation in the allocation of resources even does not emerge with laissez faire polices under any ofthesealternativeandmorerealisticformsofmarketstructure.Hencewefindthatgovernmentinterventiontoprevent non-optima allocation of resources, and higher prices, excessive advertising expenditure, etc., under these forms of market structures, is universally accepted.

Absence of externalities Externalities are defined as incidental benefits and detriments accruing out of nay economic activity. If yourneighbour sets you a motor cycle repair shop, the noise will bother you. The setting up of their repair shop will thus lead to a detrimental externality for the entire neighbourhood. In contrast, assume that one of your neighbours has a beautiful garden. Whenever you pass by the garden, you will feel happy and refreshed. The neighbour cannot charge you for this happiness that he, incidentally, provides you. The setting up of a beautiful garden by someone intheneighbourhoodthusgeneratesthisbeneficialexternality.

You will certainly agree that if society’s interest is to be promoted, these externalities have also to be taken into account in determining economic activities. For this purpose, economic activities have to be based on calculations ofsocialcostandsocialbenefitandnotonmereprivatecostandprivatebenefit.Inlaissez-fairelogic,however,wefindthatcostsandbenefitsareconsideredwithouttakingintoaccounttheseexternalities.Asaresult,theoutputofthosegoodsandserviceswhichcausebeneficialexternalitieswillbetoolittle.Asagainstthistheoutputofthesegoods and services which have detrimental externalities will be too much. Government intervention to correct this anomaly is therefore an accepted practice even in capitalist economics.

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Public goods excluded Youfindthateconomistsmakeadistinctionbetweenprivateandpublicgoods.Accordingtothem,privategoodsposses the attributes of both delectability and excludability. On the contrary, public goods are conspicuous by the fact that they have neither of these attributes. We will not proceed to explain each of these attributes. Assume that an item has the attribute of delectability. If so, the use of threat item an individual will reduce the total available supply for use by others, to that extent, at least temporarily. Goods are excludable if a person not paying for it can be prevented from enjoying it. You notice that the goods that we buy from the market posses both these attributes. In contrast, many things that we collectively consume like street lighting are devoid of both. For private goods, market mechanism determines the price to be charged and the quantity to be produced. But the market mechanism cannot help us on both these counts in the case of public goods. Public goods are hence the responsibility of governments the world over.

7.2.2 Lacunae in Performance You will agree with the statement that the proof of the pudding is in the eating. It is indeed true that some countries following laissez-faire economic policies have attained very high eels of growth in terms of per captain real income. But it has also to be admitted that the laissez-faire economic pudding has actually turned out to be somewhat less tasty than it was supposed to be. In fact, three serious lacunae have been noticed in the economic performance of free market economies. Firstly, these have been experiencing periodic ups and downs in national income, employment and prices. Secondly, there are huge inequalities of income and prevalence of considerable poverty. Thirdly, there is also enough reason to believe that such economics do not make adequate provision for the future at least on two counts, namely in promoting developing and in making development environmentally sustainable. We now take up these three issues one by one.

Cyclic Fluctuations: Periodical upward and downward changes in national income, employment and prices have •characterised free market economies. The laissez-faire economists over refused to accept this reality and went on harping the theme that there is an automatic tendency towards full employment in a free market economy. An extreme downswing- the great depression of the 1930s – made John Maynard Keynes questions the view and propound an alternative theory. According to Keynes, there will be equilibrium at less than full employment inafree-marketeconomy.Hisview,withminormodifications,hascometobeacceptedbyalargenumberofcountries

Hencegovernmentinterventionthroughacombinationofmonetaryandfiscalpoliciesisconsideredessentialfor free market economics. The purpose of such polices it ego ensure stability in national income, employment, and pricesInequalities: Developed free market economies are characterised by considerable interpersonal inequalities •of income and wealth. This causes concern because people in the lowest income groups are often found to be living in poverty. It is also seen that distribution is not equitable between different regions within a nation. Some regions are pockets of poverty. Further, there is usually a gender bias in distribution. The majority of the poor in developed free market economies are often found to be women

A little analysis will convince you that this is not very surprising. It is true that there is a direct relationship between effort and reward in a free market economy. But the effort is judged by the means of production that an individual or a region has. If these are not initially distributed equitably, inequalities arise and are likely to get compounded over time

Hence, we see that measures to lessen extreme inequalities income and wealth are part of the agenda set before the governments of free market economies. And in these measures, particular attention is paid to the removal of poverty in the less developed regions and of the less advantaged groups. The last two aspects of the distributional issue have come into policy focus only in the past few years Inadequateprovisionforthefuture:Generally,wealsofindthatalaissez-faireeconomicpolicydoesnotresult•in adequate economic provision for the future. This is so from two important points of view. Firstly you will agree that most Third World countries cannot attain a high level of economic development without he adoption ofspecificpolicymeasuresinthisregardbytheirgovernment.Secondly,inter-generationalequityintermsofattaining environmentally sustainable development is conspicuous by its absence in almost all countries of the world. These points, we believe, need to be discussed in slightly greater detail


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Developing countries need a lot of investment in area like heavy industries and infrastructure. These arrays need substantial capital and yield returns only in the long run. Further, they are often highly risk and are, often in the formofpubicgoodswithagooddealofbeneficialexternalities.Moreover,thepolitical,socialandeconomicinstitutional structure in these countries is far from congenial for the promotion of economic development. It is therefore accepted that without the government playing a positive role, these institutional constraints cannot be overcome nor can heavy industries or requisite infrastructure come up.

Asregardstheenvironment,wefindthatinprivatecost-benefitcalculationsinfreemarketeconomies,thisaspectnever used to be taken into considerations. This is hardly surprising because leaving a better environment for the succeeding generations has become an economic policy objective only in recent years. Even centrally planned soloist economies have a miserable record on this count. It must however to be admitted that environmental impact assessment is a gray area even today. There are umpteen problems in working out the cost of detrimental externalities on the environment resulting from economic activity. But the environmental aspect is being increasingly recognised the world over. As a result, even in free market economies, governments insist on project getting environmental clearance.

7.3 Pitfalls of Communism We have, by now, discussed what are called cases of market failure in free market economies, justifying government intervention. A question that naturally would arise in your mind is whether we can go to the other extreme and leave all aspects of the economies in government hands. It may appear that ideal solutions from the social point of view would emerge in the economy if this is done. The experience of communist economies suggests that this is simply torture.Economiespraisingcentralplanningunderscientificsocialismhavehadseriousdifficultiesonatleastthreecounts.Firstly,therehavebeenproblemsinfindingouttheconsumer’stastes.Secondly,inanumberofcases,therehavebeendifficultiesinseeingtoitthatadequateinputsaremadeavailabletoproduceplannedoutputs.Lastly,ithas also been noticed that these economies have lagged far being the others in terms of technology. We shall take up these issues in greater detail one by one now.

7.3.1 Good produced not in line with consumer’s preferences In communist countries, the planning authorities decide the basket of commodities to be produced. Price again is fixednotbymarketforces,butbytheseauthorities.Thusthemarketmechanismofthetypethatoperatesinaftermarket economy is conspicuous by its absence in these economies. The result is that there is often a large unsold stock of goods unwanted by consumers in shops. There are also big lines in front of shops of people wanting to buy goods which are much in demand but not produced in adequate quantity by the planners. In fact one of the major reasons for the so-called breakdown of communism is that the strong preference of consumers for VCRs, fast foods, cameras, etc., had not been adequately met by the planners in these countries. Hence, many of the former communist countries are making efforts these days to overcome these lacunae by giving the market mechanism its due place in their economies.

7.3.2 Difficulties in training martial balancing The planners in a communist country have to see that adequate resources are made available at the proper time and place. This is to ensure that the production of outputs takes place according to the plan. Hence such planning for internal consistency takes care of material balancing according to which inputs supplied equal inputs demanded.

Material balancing is sought to be achieved in communist countries by the use o the input-output technique. The input-output table is worked out on the basis of the information regarding the inputs required for producing outputs in the different sectors of the economy. On the basis of such a table, the input requirements needed to produce the targeted output of all sectors together can be mathematically worked out.

The detailed information required for building such a table is seldom available. It has also to be borne inside that if information about input requirements is collected from particular enterprises; there is always a danger of deliberate misinformation. Communist countries are often bedevilled with serious input bottlenecks. More often than not, planners in these countries are consternated to solve these problems by mere trail and error. Other such attempts to minimise input bottlenecks result in scarce inputs being diverted to “priority” sectors like spacecraft to the ultra neglect of sectors producing consumer durables. Due to all this, communist countries also witness the strange phenomenon

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ofsomeenterpriseskeepingunusuallyhighlevelsofstockscarcerawmaterialtofulfiltheirproductionquotasasdetermined by the planning authorities. In the light of all this, communist countries these days are attempting to make socialism market friendly. This is done by gradually introducing private ownership of means of production and using market mechanisms to bring about material balances.

7.3.3 Outdated technologies It is true that countries which took to communism earlier began their process of economic development by borrowing state of art technologies from other countries. You may notice, however, that the communist system was such that there is little incentive for enterprises in these countries to go in for continuous technological up gradation. We can think of at last three important reasons for this lack of incentive. One is the fact that enterprises in communist are static monopolies. Secondly, there is the unpleasant reality that technological up gradation by an enterprise is often notanunmixedblessingforit.Thebenefitsofupgradationmaynotnecessarilyaccruetothatparticularenterprise.Weshallnowbrieflydwellonthereasonsfortheunpleasedconsequences.

No spur of competition: In free market economies, the enterprise competes with each other to capture the •market. This enables customers to look for other producers if the quality of the product of one of the producers is not up to the mark. The producer with poor quality product is forced either to improve his quality or leave the industry In communist countries, scene enterprise are state monopolies, the consume has no such choice. The state decides how much each producer has to produce and there is no continuous rivalry between the producers to improve quality and capture the market. It is found that in a number of these countries, the quality of the products has instead improving gone down over time Technological improvement causes problems: In free market economies, a good deal of technological up •gradationtakesplaceonshopfloors.Suchimprovementscomeinfavouracclaimandoftenresultinlessinputbeing used to produce the same output It is true that in a community se top too such an improvement may result in a part on the back of the concerned enterprise. It may, however, not be an unmixed blessing for it. This is so because it may often imply a much large quote of output to be produced by it. Getting the extra volume of input in time would often cause much greater, ifnotinsurmountable,difficultiestothemanagement.Thismayactasastrongdisincentivetothemanagementtouring about technological improvements As a result of all these factors, countries which took to communism early are facing problems of outdated technology. This is particularly so in their non-priority sectors where government R & D efforts have not been undertaken. More or less the same is the situation in countries which took to communism later on. These coteries, for political reasons, had to adopt outdated technologies prevalent another communist countries

7.4 Indian Experience The Indian economy has also witnessed a bight change in the role of the Government over time. Ever since independence till around the 1980s, as we discussed in the previous units, our objectives was to have planned economic development without adopting extreme forms of capitalism or communism. Heavy industry and infrastructure were left in the hands of the government to develop. Priority sectors were decided upon by the Government. In agriculture, developmentwasencouragedalongcapitalisticlines.Topreventmonopoly,motivatecyclicalfluctuations,lesseninterpersonal inequalities of income and wealth and promote economic development, measures of command and control were frequently resorted to, though some measures operating through the market mechanism were also adopted. Little attention was however paid by the Government to prevent environmental degradation or reduce inter-regional or gender-based inequalities.

The situation in which we found ourselves by the 1980s was not a happy one. Our Government could not provide adequate infrastructural facilities. While we had some success in increasing agricultural production, even now, seems affectedbythevagariesoftheweather,causingcyclicfluctuationsintheeconomy.YouwillfindthattherehavebeenofficialstatementsthatwhiletheIndianeconomyhasgrown,thisgrowthhasnottrickleddownsufficiently.Further,Government-ownedenterprisesinbasicandheavyindustrieswerefunctioningfarfromefficientlyandhavemostlybeen using outdated private sector units of the Indian economy were also more or less in the same boat. There were hence slow rumblings of change in India’s economic policy from the 80s.


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It soon became clear, however, that such gradual changes will simply not work. The unprecedented crisis in the Indian economy in 1990-91 was the last straw on the camel’s back. Our foreign exchange reserves fell to an all-time low level$42.2billion.Inflationratehadalreadycrossedthedouble-digitfigureandwasactuallyat14%.Fiscaldeficithadrisento8.4%oftheGrossDomesticProduct.Thecurrentaccountdeficitonbalanceofpaymentswasashighas $ 9.9 billion. International Credit Rating agencies went on to considerably downgrade India’s creditworthiness.

The Government and many economists agreed that a shock therapy was immediately required to pull the Indian economy out of the woods. The World Bank agreed to bail India out, but imposed certain conditionality for doing so. It wanted two major types of programmes to be carried out. Firstly, there were to be short-term stabilisation measurestocontrolinflationandwipeoutthebalanceofpaymentsdeficit.Thesewereagreedupon.Youareawarethat attempts are being made to rationalist subsidies and cut down wasteful Government expenditure to reduce thefiscaldeficit.Therupeehasbeendevaluedtocorrectthebalanceofpaymentdeficit.Secondly,therehadtobestructural reforms to make the Indian economy competitive and attain a high rate of growth with social justice. These have also been accepted and measures are being taken to liberalise and globalise the Indian economy.

As a result of all this, there was considerable rethinking, reinforced by the conditionality imposed by the World banktohelpIndiaoutofherdifficulties.StepsBegantobeinitiatedinthe1980sandthesegatheredconsiderablemomentum in the 1990s. A sea change has thus come about in the economic role of the Government in India since the 1990s. Many of the sectors reserved for the public sector have now been thrown open to the private sector. More and more physical controls are being replaced by measures to guide the economy through the market mechanism. Restraints in the way of international trade and factor movements are being gradually reduced. The seeming intention istomaketheIndianeconomyfaceinternationalcompetitionandbecomeefficientinperformance.TheGovernmentrole in the provision of public goods is not likely in increase, but as regards the protection of the environment, the Government is likely to play an increasing role.

7.5 Emerging Consensus on the Changed Role of Government You might have noted by now that the vast difference that existed between capitalist and communist countries regarding the role of government in their economies has almost disappeared. A certain consensus seems to be emerging these days on the role the government is supposed to play on the economic front.

Capitalist countries are increasingly accepting the fact that governments have to play an important role in their economies. The governments come into the picture to provide public goods and to ensure that competitive forces are notimpededinplaytheirrole.Thegovernmentspromotetheproductionofcommoditieswithbeneficialexternalitiesand curb the production of commodities with detrimental side effects. Measures to reduce interpersonal inequalities in income and wealth, with particular focus on the removal of poverty, especially among disadvantaged groups, arepartofgovernmentagenda.Sostepstofostereconomicdevelopmentandtopreventwidespreadfluctuationsinnational income, employment and price level.

Communist countries are similarly waking up to the fact that everything about the economy cannot be left to the state. It is, by and large, agreed that the record of these countries in overcoming cases of market failure as regards cyclicfluctuations,povertyremovalandprovisionofpublicgoodshasbeensomewhatgood.Buttherehavebeenglaring cases of state failure in such countries regarding production of commodities wanted by the people, material balances(orstocks)andtechnologicalupgradation.Toovercomethesedifficultiesthegovernmentsofthesecountriesare getting slowly out of the responsibility of running productive enterprises. They are also gradually introducing market forces and adopting more decentralised planning techniques.

It has also to be noted that in both sets of countries, increasing attention is being paid by governments to tackle problems of environmental degradation. As regards the modus operandi of government intervention in this and other areas, the tendency is to adopt measures operating through the market mechanism in preference to command and control measures.

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SummaryThis chapter gave you a brief overview of the change in the role of government in the economies of the world •guided by different politico-economic systems. We studied capitalist economies, the economic role of government had increased over time. This attributed to •market failure on two counts. Threebasicassumptionsunderliethejustificationofalaissez-faireeconomicphilosophy.•Firstly, the assumptions of perfect competition, absence of externalities and non-existence of public goods have •been found to be not based on realities. Secondly,therehavebeenlacunaeintheperformanceoftheseeconomiesintermsofcyclicfluctuationsof•income, employment and prices, existence of inequalities, poverty and inadequate provision for future. Thirdly, not all types of goods can be taken into account in the analysis.•Youwillfindthatthelaissez-faireeconomicphilosophyunderlyingthecapitalisteconomieshascometoinform•stronganalyticaljustification.The Indian economy has also witnessed a bight change in the role of the Government over time.•A certain consensus seems to be emerging these days on the role the government is supposed to play on the •economic front.

ReferencesRamachandran, K. S., 2007. • Economic Environment of India:Lesson from Past and for the Future, Northern Book Centre.Batley, R. & Larbi, G. A., 2004. • The Changing Role of Government, Palgrave Macmillan.The Changing Role of Government• [Pdf]Availableat:<www.cuhk.edu.hk/gpa/wang_files/UNDP.pdf>[Accessed11 July 2013].The changing role of governments in corporate social• [Pdf]Availableat:<www.eurada.org/files/Social%20affairs/CSR%20Business%20Ethics.pdf>[Accessed11July2013].2010. Changing Role of Government in Society• [Video online] Available at: <https://www.youtube.com/watch?v=fnrAZPExSPg‎>[Accessed11July2013].2012. The Role of Government in the Economy• [Video online] Available at: <https://www.youtube.com/watch?v=D23YY11cvzY‎>[Accessed11July2013].

Recommended ReadingShaffer, H.G., 1999. • American Capitalism and the Changing Role of Government, Greenwood Publishing Group.Tanzi, V., 2011. • Government Versus Markets:The Changing Economic Role of the State, Cambridge University Press.Raj, R., 2008.• Economic Environment of Business and Environmental Management, 1st ed., Nirali Prakashan.


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Self AssessmentThe tiny ________ nation is considered to be a capitalist giant.1.

Chinesea. Japaneseb. Indianc. Afghanid.

According to the laissez-faire view as propounded by Adam Smith, “A government that interferes _________ 2. with the economy is the best”.

mosta. leastb. fullyc. partiallyd.

A number of countries turned ________ for various reasons particularly after the Second World War.3. Monarchya. Democraticb. Communistc. Aristocraticd.

Which of the following are defined as incidental benefits and detriments accruing out of nay economic4. activity?

Externalitiesa. Internalitiesb. Variabilityc. Realitiesd.

_____________ free market economies are characterised by considerable interpersonal inequalities of income 5. and wealth.

Advanceda. Developedb. Undevelopedc. Pre-matured.

_________ countries are increasingly accepting the fact that governments have to play an important role in 6. their economies.

Communista. Socialistb. Mixed-Economicc. Capitalistd.

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___________ countries are similarly waking up to the fact that everything about the economy cannot be left to 7. the state after the changing role of government.

Communista. Socialistb. Mixed-Economicc. Capitalistd.

_____________ is sought to be achieved in communist countries by the use of the input-output technique.8. Material balancinga. Capital balancingb. Technology balancingc. Profitbalancingd.

__________ countries need a lot of investment in area like heavy industries and infrastructure.9. Developeda. Developingb. Undevelopedc. Less developedd.

An extreme downswing- the great depression of the _______ made John Maynard Keynes questions the view 10. and propound an alternative theory.

1910sa. 1920sb. 1930sc. 1940sd.


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Chapter VIII

Structural Dimensions of Indian Economy

Aim


explain economic growth•

elucidate structure of investment and capital formation•

explicate structure of national output•

Objectives


defineeconomicdevelopment•

elucidate basic structural changes in the economy•

explicate India’s saving and investment•

Learning outcome


definestructureofconsumption•

identify growth rate of NNP and NNP per capita•

understandfinancial-assetstructureofthehouseholdsector•

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8.1 IntroductionThe socio-economic environment of any country can be explained in terms of an institutional framework and a physical framework, the economic policy statements of the government, economic plan documents, the political constitution,economicregulationsandcontrols,amongotherswhichdefinetheroleandstatusofprivatesector,publicsector, multinationals, corporations, small business, etc. The critical elements constitute the institutional framework of an economic environment. The trends in economic variables such as income, price, output, investment, foreign trade, labour supply and other factor endowments and the structural relation among these variables constitute the physical framework of an economic environment.

Describingandanalysingtheeconomicenvironmentisadifficulttask.Discretionandpersonaljudgementplayanimportantpart.Difficultiesariseinthecontextofbothinstitutionalandphysicalframework.Justasvariousinterpretations of policy statements are possible various conclusions could also be drawn from the economic data.

Thepurposeofgathering(mainlyfromofficialsources)andanalysingdataistoobtainaclearpictureofmajoreconomictrendsandstructuralchangesintheeconomy.Thetrendsandstructuralcoefficientstogetherenableustomakeaquantitativeassessmentoftheeconomicenvironmentofabusiness/firmandtherebytooutlinestrategiesformacroeconomicmanagement.Knowledgeofeconomictrendsandstructuralchangesthushelpsthefirmtoplanout a corporate strategy and policy to cope with short-run and long-run challenges of business environment. This argument is particularly valid for a developing country.

This chapter attempts to present the relevant economic trends, and discuss the structural changes. It then examines the implications of growth and structural changes that have occurred. It also analyses the current economic trends, and discusses the impact of environment on business management. In this chapter, you may have to refer to additional statistical materials time and again. Of course, you are not expected to remember the details of all such data. You should only take note of such trends which are useful to the analysis of the system-environment of your own business.

8.2 Economic Growth and Development“Growth” and “development” are sometimes used synonymously in economic discussion. Though the two terms are used interchangeably, they have different connotations. Economic growth means more output, while economic development implies both more output and changes in the technical and institutional arrangements by which it is produced and distributed.

Growthmaywellinvolvenotonlymoreoutputderivedfromgreateramountsofinputsbutalsogreaterefficiency,that is, an increase in productivity or an increase in output per unit of input. Development goes beyond this to imply changes in the composition of output and in the allocation of inputs by sectors. As with human beings, to stress “growth” involves focussing on height or weight (or national income), while to emphasize development draws attention to changes in functional capacities in physical coordination, for example, or learning capacity (or ability of the economy to adapt).

8.2.1 Economic GrowthEconomicgrowthmaybedefinedasasignificantandsustainedriseinpercapitarealincome.Onemustdistinguishthe “level” from the rate of economic growth, though these two concepts are obviously related. The level of economic growth of a country is measured by the size of national (or per capita) real income. The percentage change in this level over a year is the annual rate of growth. That is, if we denote the levels of real income in two years Y1 and Y2 and g as the rate of growth (expressed in percentage terms), then per capita

real income is supposed to be the least imperfect measure of economic growth of a country. It takes into account changes in national income, population and price level.


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8.2.2 Economic Development‘Economic development’ is a broader concept than ‘economic growth’. As and when the economies grow in terms of national and per capita income levels, certain structural changes accompany the process of growth. Conceptually, the trends in income and the structural changes together constitute economic development.

The structural changes which are quite fundamental in character are inherent in the process of economic growth. The upward trend in per capita real income (i.e., economic growth) implies, given the labour force participation rate, arise in product per worker or labour productivity. An increase in labour productivity cannot result without capitalaccumulationandfundamentalchangesintheproductionfunction(functionalrelationshipbetweenflowsofoutputandcorrespondingflowsofinputs)oftheeconomy.Aprogressiveshiftintheproductionfunctionisthedirect outcome of technological advancement, and science is the base of modern technology.

As science and technology advance, innovations (new products, new production processes and methods, new markets,etc.)takeplace;inventionsresultandgetspread.Suchprocessofgrowth(scientificprogress,inventionandinnovation) cannot be economically sustained for long unless it increases the productivity of labour. The increase in theflowofmaterialgoodsandservicemustalsobeabsorbed;otherwisetheprocessofgrowthgetsobstructedbymarket limitation. In other words, the changes in production structure must be synchronised and balanced with the changes in the consumption structure. The structure of society’s wants and preferences (in short, structure of demand) must change in such a way as to induce or assist changes in production and productivity and thereby to accommodate the changes in science and technology. Similarly, the progressive development through science and technology cannot come about unless the society manages to generate capital formation (through savings and investments) andtofinanceresearchanddevelopmentofscience.(Thepresentdaydevelopingcountriescansupplementtheirscientificresearcheffortswithscienceandtechnologytransferfrommoredevelopedcountries).Thuswefindthatduring the process of economic growth, economy experiences manifold changes in its structure: social, political and economic. For an understanding of the changing economic environment in a developing country, we may examine specificallythenatureofsomeofthestructuralchangeswhichareeconomicincharacter.

Structure of National OutputStudies of economic development of many present day “more developed countries” (a phrase suggested by Everett E. Hagen) like the U.S.A., the United Kingdom, and Japan suggest that a change in the structure of national output is a concomitant feature of economic growth. As an economy grows, on the one hand the level of national income increases while on the other, composition of national income changes. The percentage contribution of agriculture to gross domestic product declines and the contribution of industry and services to gross domestic product increases. Thisreflectspositiveincomeelasticityofdemandfornon-agriculturaloutput.Thismeansthatagivenpercentageincreases in the income will result in higher percentage increase in demand for non-agricultural output. As the ratio of non-agricultural to agricultural output increases during the period of economic growth, labour productivity increases in both agricultural and non-agricultural sectors. The rate of growth of non-agricultural output is observed to be faster than that of non agricultural employment and therefore, the labour productivity (output per worker), in mining, manufacturing and services registers improvement during the process of economic growth.

Structure of EmploymentEconomic growth is also associated with a change in the structure of employment of people. It is generally accepted that one of the structural changes that occur in the course of economic growth is a progressive shift of labour from agriculture and allied activities to secondary and tertiary sectors. Studies based on historical data of the industrialised economies of the West have amply demonstrated the validity of this Fisher-Clark thesis. The shift in occupational pattern runs parallel to the shift in output pattern because the same factor positive income elasticity of demand for non-primary goods and services underlies the process of economic growth.

Structure of Investment and Capital FormationA change in the structure of investment and capital formation is another development during the process of economic growth and development. With industrialisation and consequent urbanisation, the structure of industries changes. Capital and producer goods industries grow in importance and consumer goods industries decline in relative importance. In developing countries (particularly those with planning) in the initial stage of development, resources

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are deliberately shifted from consumption goods to capital goods. Thus the investment structure changes. The investment in human capital (education and health) and in social overhead capital (like irrigation, transport, etc.) increases very rapidly in the early stage of development when the infrastructure of development is laid strongly. Similarly, in the early stage of development, the dependence on foreign capital (aid, loans and grants) and foreign technology may also be very high. This means that the ratio of gross (and net) domestic capital formation to gross (andnet)nationalcapitalformationisaffected.Thepointisthatdifferentcapitalformationproportionsreflectthenature and tempo of economic growth.

While on the subject of capital formation, we may refer to an important determinant of the rate of economic growth. This determinant is the capital output ratio. We distinguish average capital-output ratio from marginal or incremental capital output ratio. Incremental Capital-Output Ratio (ICOR) is the additional capital required to increase output by one more unit. The following is the basic economic growth rate (g) equation.

Rate of investment

ICORg =

In the above equation g is growth rate and ICOR is Incremental Capital-Output Ratio. In macro-economic planning process as well as micro-level management decisions, this ratio proves very useful. Consider, for example, the macroeconomic planning process. If a planning agency wants to achieve an annual growth rate of 5% (growth rate of national income) and if the incremental capital output ratio is 4, then what should be the annual rate of investment? The above equation helps us in answering the question.

Rate of investment

ICORg =

In our above example, g = 5% and ICOR = 4.

Rate of investment

45%

Rearranging terms we getRate of investment = 5% x 4 = 20%Changes in the capital-output ratio are a dimension of economic growth and development process.

Structure of ConsumptionThe upward trend in per capita income (economic growth in short) which initiates and accelerates changes in production, employment, factor proportion, initiates and accelerates changes in production, employment, factor proportion, skill and capital formation directly brings about a change in the structure of consumption. As income changes, the pattern of income distribution (between regions, between sectors and between persons) also changes. This is backed up by changes in relative price structure of the economy, the domestic terms of trade between agriculture and non-agriculture change. It is through the interaction of all these factors that the structure of consumption and thestandardoflivingundergoesafundamentalchangereflectingchangesinsocialvalues,beliefsandconsumerpreferences.

Finally, with changes in the structure of employment production, income distribution and consumption, there comes naturally a change in the structure of foreign trade. In the initial stage of development, an economy may have to import metals and machinery for modernisation and industrialisation. But as the industrialisation proceeds with economic growth, the acceleration in the pattern of exports and imports change.

Structure of foreign trade, in short, changes (a separate block in this course is devoted to the external sector) as economy changes from primary commodity exporting to export of manufactures. In the next section we give an outline of the Indian economic growth experience. The remaining sections deal with major structural dimensions of India’s economic development experience.


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8.3 Indian Economic Growth ExperienceIn this section we present an overview of the Indian growth experience. The interest is to map the broad contours of the Indian growth experience for the period of little over four decades. This is to enable you to get a perspective on country’s economic growth which has at the root of major structural changes in the economy.

During the period 1950-51 and 1999-2000, the Net National Product (NNP) at factor cost at constant (1993-94) prices (real national income) recorded an annual growth rate of 2.4 per cent and 6.2 per cent respectively, while per capita NNP growth rate was only 1.71 per cent. The per capita NNP at constant (1993-94) prices (real per capita income) increased from `. 3687 in1950-51 to `. 10306 in 2000-01. Thus during the 41 years period, the per capita income more than doubled itself approximately.

8.3.1 Growth Rate of NNP and NNP Per CapitaThe growth rates of NNP and NNP per capita during different plan periods give an overview of the Indian growth experience. During the First Five Year Plan period (1951-56) the NNP in real terms grew at an annual compound rate of 3.6 per cent, while per capital income grew at 1.8 per cent. The performance of the economy during the SecondPlanperiodsignificantlyimprovedoverthepreviousPlanperiod.Thegrowthratesofnationalincomeandpercapitaincomewere4.1percentand2.0percentrespectively,higherthanthefirstplangrowthrates.ThegrowthratessignificantlyfellduringtheThirdPlanPeriod(1961-66).WhiletheNNPgrewatanaverageannualrateof2.5per cent, the NNP per capita grew at the rate of 0.2 per cent only.

Duringthethreeannualplans(1966-69),incomeandpercapitaincomegrowthratespickedupsignificantly.Theywere 3.8 per cent and 1.5 per cent respectively. During the Fourth plan (1969-74) the growth rates fell again. While the NNP growth rate was 3.3 per cent, the NNP per capita grew at the rate of 1.0 per cent. The growth rates improved significantlyduringtheFifthPlanperiod(1974-79).TheNNPduringthePlanperiodgrewatanannualcompoundrate of 5.0 per cent, while per capita NNP grew at 2.7 percent. During the annual plan 1979-80 both NNP and per capita NNP recorded negative growth rates. The growth rates were -6.0 per cent and -8.3 respectively. During the SixthPlan(1980-85)periodthegrowthratesweresignificantlyhigh.TheNNPandNNPpercapitagrewatannualaverage rates of 5.4 per cent and 3.2 per cent respectively. Growth rates slightly increased during the subsequent Seventh Plan (1985-90) period. They were 5.8 per cent and 3.6 per cent respectively. In 1990-92 NNP at constant (1993-94) prices grew at 3.0 per cent, per capita income growth rate being 0.9 per cent. During the Eighth and NinthPlanperiodpercentageincomegrowthrateswere6.7and4.6.Thus,growthratessignificantlypickedupandexceeded the average for the 1980s decade.

8.3.2 Income and Per Capita RateTheaboveaccountshowsthatbothincomeandpercapitaincomegrowthratesfluctuatedsignificantly.Severalfactorsexplainfluctuationsinrespectofgrowthexperienceduringthelastfourandhalfdecades.Fluctuationsinweatherconditions(alternatingdroughtsandfloodsandperiodicunfavourablemonsoons)unfavourableincreaseincapital-output ratio (aggregate), balance of payments problems and the consequent foreign exchange crises, wars withChinaandPakistandislocatingthedevelopmentefforts,internationaltransmissionofinflationthroughforeigntrade, exogenous shocks such as oil price hikes during early part of 1970s and later, and the structural imbalances which have developed in the economy as development proceeded were some of the majorfactors to be noted in this connection.

While one can discern several dimensions of economic progress of the Indian economy in the post-independence period, the rate of economic growth has not been adequate enough to take care of the twin problems of unemployment and poverty. Added to this are the problems of growing inequalities in income distribution and in regional development. India’s per capita income is very low relative to per capita income of more developed countries like the USA. Despite lowgrowthrateandlowlevelofpercapitaincome,Indiatodayhasoneofthemostdiversifiedindustrialstructuresin the world. In the remaining sections of this unit we examine the structural changes in the economy.

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8.4 Basic Structural Changes in the EconomyEconomic growth has brought about a structural change (change in sectoral shares of the national income) in the economy.Thisisevidentintheformofashiftinthesectoralcompositionofproduction(income),diversificationof activities and a gradual transformation of a feudal and Colonial economy into modern industrial economy. The composition of gross domestic product has changed steadily during the planning era.

Historical OverviewWhile the share of agriculture and allied activities fell from 58.73 per cent to 27.69 per cent during 1950-52 to 1998-2000, the share of manufacturing increased from 13.29 per cent to 24.71 per cent during the same period. The share of tertiary or service sector increased from 27.98 per cent to 47.60 per cent. Thus a growth has been observed where the relative share of agriculture is declining, industry nearly constant and services rising in the GDP. The expansionofservicesectorhasnotonlybeenconduciveforemploymentgenerationbutalsoforbetterefficiencyofthesystemandbetterqualityoflife.ThussignificantstructuralchangeshavetakenplaceintheIndianeconomyduring the period 1950-2000 when we go by sectoral distribution of national income. Thus by income criterion structuralchangeintheIndianeconomyhasbeenverysignificant.

Now let us consider structural change by employment criterion. It is generally accepted (as we noted before) that one of the structural changes that occur in the course of economic development is a progressive shift of labour from agriculture and allied activities to secondary and tertiary sectors. Studies based on historical data have amply demonstrated the validity of this Fisher-Clark thesis.

Whilethisbroadtrendinsectoralreallocationoflabourasdevelopmentproceededisthusfirmlyestablished,theinteresting fact about these structural shifts in economic activity for our purpose is not so much the ultimate decline in the importance of agriculture (in relative terms) as the rate at which it occurred. To quote Paul Bairoch, “the proportion of active persons in agriculture diminished at a rate of less than 0.4 per cent a year till 1860, about0.9 per cent from 1860 to 1950, but at 4 per cent from 1950 to 1970. The changes in the redistribution of the active population in Western developed countries have thus been more important in the last twenty years.”

Indian ExperienceThe above historical experience tells us that the sectoral redistribution of the active population is a time-taking process. Unlike structural change based on income criterion, structural change based on employment is a slow process. This is demonstrated by the Indian experience also.

The share of primary sector in total employment declined from 12.28 per cent to 8.65 per cent during 1961-63 to 1998-2000.ThatisifwegobyemploymentcriterionstructuralchangeintheIndianeconomyhasnotbeensignificant.The share of secondary sector (mining and quarrying, manufacturing, and construction) declined from 36.7 per cent to 31.7 per cent during the same period. The share of tertiary sector (trade and commerce, transport, storage and communications and allied services) increased from 51.03 per cent to 59.65 percent during 1961-63 to 1998-2000.

Two structural features of the Indian economy emerge clearly from the above account:Agriculture continues to be important in the Indian economy. A little more than 30 per cent of national income •originates in the agricultural sectorThere is only slight structural change in the economy if we go by the employment criterion•

The underdeveloped nature of the Indian economy becomes evident when we compare the employment structure of the Indian economy with that of a more developed country U.S.A. Agriculture in USA in 1986 accounted for only 7 percent of total workforce. The industrial sector and tertiary sector accounted for36 per cent and 57 per cent respectively. In the remaining two sections of this unit we will consider some more structural dimensions of the Indian economy. Structure and changes in foreign trade are separately dealt within the block dealing with “External Sector”.


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8.5 India’s Saving and Investment: Trends and ComponentsGiven the supply of labour force and its annual rate of growth, economic growth is primarily a matter of rate of capital accumulation and resource productivity improvements. Capital accumulation in different sectors of a national economytakesplacethroughinvestmentsinthosesectors.Tofinanceinvestment,savingfromcurrentincomeisnecessary.Furtherawell-developedfinancialsystemisnecessaryformobilisingsavingsfromnetsurplusunitsinordertolendtothenetdeficitunitslargelytofinancetheirinvestmentactivity.Financialintermediationisthecorefunctionofthefinancialsystem.

8.5.1 Savings RateIn our country, the saving rate (net domestic saving as percentage of NNP at current prices) was a mere 6.2 per cent in 1950-51. In the same year, the household sector accounted for `. 441.3 crores of the total net domestic savings of `. 572.2 crores or in percentage terms for 77.1 per cent of the total net domestic saving. Of the total household saving of `. 441.3 crores, about 96 per cent was held in the form of physical assets and about only 4 percent was heldintheformoffinancialassets.Thisisoneaggregativeindicatorofeconomicunderdevelopment,ontheonehand,andfinancialunderdevelopmentontheother,ofthecountryatthattime.

Butduringthelastfourdecadesthecountryhasexperiencedsignificanteconomicandfinancialdevelopment.Thesavingratehasbeenrecordingsignificantimprovements.From6.2percentin1950-51,itroseto9.3percentby1960-61. By 1990-91 it further rose to 14 per cent. By 1993-94 it stood at15.3 per cent.

Households, private corporate sector (including cooperatives) and public sector are three sources of saving. Let us see what has been the trend in respect of the relative contributions to national saving of these sources? In 1980-81, household sector accounted for 75.9 per cent of the total net domestic saving.

Next in importance was the private corporate sector (including cooperatives) which accounted for 8.0 per cent of net domestic saving and public sector accounted for the remaining 16.2 per cent of net domestic saving. By 1990-91thepicturehaschangedsignificantly.Householdsectoraccountedfor84.4percentofthenetdomesticsaving.Thesavingrateofthecorporatesectorfellsignificantlyandwasatthelevelofabout42percent.Publicsectorsavingstood at 0.15 per cent of the net domestic saving. Thus the household sector (which includes apart from individuals, all non-government, non-corporate enterprises) accounts for most of the savings in the economy. The dissaving of public sector was increasing from year to year during the period.

It is seen that household sector saving provides the bulk of national saving. The share of total household saving to total National saving is more than three quarters. It does further suggest that the public sector saving rate declined but the corporate saving rate improved. This declining trend of public sector saving rate is due to negative saving of government administration. A decline in public savings was attributed to poor performance of government on-statutory corporations, mounting government employment.

Household savings take broadly two forms. One is the form of physical assets. Savings in the form of physical assets compriseadditionsto‘construction’,’machines’andequipmentandinventories.Savingsintheformoffinancialassets comprises of currency, deposits with banks with corporate enterprises, provident/pension funds, claims on government,insuranceandcompulsorydeposits.In1999-00financialassetsaccountedfor10.5percentofthegrosssavings of the household sector and 10.3 per cent savings were in the form of physical assets. By 2001-02 the saving intheformoffinancialassetsaccountedfor11.2percent,11.3percentbeingaccountedforbysavingintheformofphysicalassets.Thustheretookplacesignificantfinancialdevelopmentduringthethreedecades.

8.5.2 Financial-Asset Structure of the Household SectorLetusnowlookatchangesinthefinancialassetstructureofthehouseholdsector.Thesignificantchangesinthecompositionofassetsofthehouseholdsectorindicaterapidstridesmadebythefinancialsystemofthecountry.Thecurrency component decreased in relative importance as its share in the total gross saving decreased from 31.8 per cent in 1960-61 to 17.8 per cent in1987-88. The importance of deposits in the portfolios of household sector increased substantially during the period from 2.4 per cent in 1960-61 to 27.9 per cent in 1987-88. The phenomenal growth of

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bankingfacilitiesandotherfinancialintermediationandspreadofbankinghabitamonghouseholdsbecomesevidentfrom this. There is still an untapped potential in respect of government securities, investments in UTI (Unit Trust of India) and life insurance business. Evolving an appropriate structure of interest rates and through LIC rationalising its premium structure which helps in boosting its business, the potential can be realised.

Savingswheninvestedresultsincapitalformation.Theshareofthecommoditysector(agriculture,forestry,fishingetc. and mining and manufacturing, construction, electricity and water supply) in gross domestic capital formation improved from 56 per cent in 1980-81 to about 60 per cent in 1989-90 and that of the non-commodity sector (services) declined from about 44 per cent to 40 per cent during the same period. Within the commodity sector, the shareofminingandmanufacturingsignificantlyroseduringtheperiodfrom37.5percentto48.5percent.Thisisan indicator of the growing importance of mining and manufacturing in gross domestic capital formation

8.5.3 Gross Domestic Capital FormationGrossDomesticCapitalFormation(GDCF)isclassifiedonthebasisoftypeofassetsintotwocomponents:

Gross Fixed Capital Formation (GFCF) and•Changes in stocks or inventories •

The share of the former improved from about 84 per cent in 1950-51 to 92 per cent in 1990-91. This was a healthy trend because it indicated that inventory accumulation was low.

Gross Domestic Capital Formation as a percentage of Gross domestic products increased from about 81 per cent in1960-61toabout23percentin1990-91.Thisshowssignificantimprovementininvestmenteffort.Asforthedivision of GDCF between public sector and private sector, in 1960-61 GDCF in public sector was 38.9 per cent, while that in private sector was 61.1 per cent. By 1990-91 the percentages were 37.5 and 62.5.

The economic growth rate has not been commensurate with the rate of investment. Among many reasons for this (suchasunder-utilisationofproductivecapacity,inefficiencyinresourceuse,etc.),risingcapital-outputratiohasbeen one The ICOR (Incremental Capital- Output Ratio) rose from about 2.95 during 1951-52 to 1955-56 to 4.36 during1985-86 to 1991-92. During Eighth Plan period it declined to 3.43 and again rose to 4.53 during Ninth Plan period.

8.6 India’s Monetary and Price TrendsA serious concern for the Indian economy since the middle of the Second Plan period has been the upward trend in the general price level. The price trends are related to, among others, the trends in money supply and government budgetdeficits.Theimbalancesbetweendemandforandsupplyofwagegoods,particularlyfood,triggeredthepriceriseinearly1960sandseveralotherfactorshavemadeinflationapersistentfeatureoftheIndianeconomy.

8.6.1 Money SupplyMoney supply has increased rapidly and regularly. The money supply with the public (currency plus demand deposits, plus other deposits with RBI, referred to as M1 in RBI publications) during the 21 year period 1970-71 to 1991-92 increased at the annual average rate of 17.7 per cent. In only one year (1977-78) it registered a fall from `. 15609 crores to `. 14388 crores. In all other years, M1 registered positive growth rates. One interesting fact is that while the average annual growth rate of M1 during the 19 year period 1970-71to 1987-88 was 13.12 per cent, during the subsequent four year period from1988-89 to 1991-92 it was 18.5 per cent. Thus, prior to the severe economic crisis in 1991, M1 wasgrowingatasignificantlyhighrate,higherthantheaveragefortheperiod1970-71to1987-88.

M3 isdefinedasM1 plus time deposits. M3 grew at an average annual rate of 20.8 per cent during the period 1970-71 to 1991-92. The high growth rate observable in respect of M3 is largely accounted for by the growth rate in time deposits. During 1995-2001 M1 increased from 192257 crores to 472827 crores, while M3increased from 527596 crores to 1725222 crores during the same period.


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12000.000

10000.000

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2000.000

0.000Ja

n - 5

9Ja

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3

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Components of the Money Supply over Time

M3-M2M2-M1M1

Fig. 8.2 M1, M2, M3 Money Supply Components(Source: http://bigpicture.typepad.com/comments/2005/11/chart_of_the_we_2.html)

8.6.2 Growth Rate: Principal FactorsMoneysupplygrowthratehasbeenanimportantfactorbehindtheIndianinflationexperience.Thethreeprincipalfactors responsible for the expansion of money supply are:

Bank credit to commercial sector•Bank credit to government•Net foreign exchange assets of the banking sector•

InflationratebasedonWholesalePriceIndex(WPI)averaged9percentduringtheperiod1970-71to1991-92.Itreached high levels during the two years 1973-74 (20.2 per cent) and 1974-75 (23.2 per cent).

InflationratebasedonConsumerPriceIndex(CPI)numbers(urbannonmanualemployees)averagedabout9percentreachingthehighestlevelof22.2percentin1974-75.Besidesthegovernmentdeficitsandtheconsequentmoneysupplygrowthrate,severalstructuralandinstitutionalfactorshavebeenattherootofinflationaryriseinprices in India beginning from mid-1950s at a slow rate, accelerating from mid-1960s and recording considerably highratesduringthefirsthalfof1970s.

Thefollowingfactorshavebeenresponsibleforinflation:The very plan strategy adopted for accelerating development and the consequent trends in the composition of •domesticoutputandforeigntradewithadverseinfluenceondomesticoutputandforeigntradewithadverseinfluenceondomesticpricelevelClosely related to the above is the forced pace of structural change with little regard for sectoral balance and •price stabilityRoleofexpectationsemanatingfrominflationarypsychology•Plethoraofcontrolsinspiredbyideologicalfixationwithnofirmeconomicbasisandineffectivenessinoperating•themleadingtothegrowthofparalleleconomymakingmonetaryandfiscalmeasuresalmostineffectiveIneffective institutional measures for redistribution of wealth and income•Inflationarynatureoftheroleofdistributestradepromptedbytheseller’smarketconditions•Exogenous shocks such as wars and oil price hikes•Internationaltransmissionofinflationarypressures•

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The rate of change in wholesale and consumer prices suggest that the overall trend in prices has been on decline since1992.Onestrikingtrendnoticeableisthegrowingdivergencebetweentherateofinflationbasedonwholesaleprices and that for consumer price index since 1993-94. Until 1993-94 the two rates generally converged. Since 1995-96,theconsumerpriceindexbasedrateofinflationhasexceededthebasedonwholesalepricesbyawidemargin. The divergence trend in the wholesale and consumer prices has been explained in terms of the change in the weighting scheme for the two indices.

In the Block dealing with “Economic reforms since 1991”, you will learn about the “New Economic Policy” to tacklewiththeproblemsofIndianeconomy,includingtheproblemofinflation.

8.7 Other Structural DimensionsSome of the other structural dimensions of the Indian economy are:

As for the tax structure, heavy reliance on indirect taxes and declining importance of direct taxes, such as income •tax, have been resulting in adverse consequences so far as the objectives such as price stability and reduction in inequalities in income and wealth distribution are concerned.Growthinnon-developmentalgovernmentexpenditurehasbeenasignificantfactorinseveraleconomicills•facing the economy.Heavy relianceondebtfinancingof government expenditurehas been another feature of the Indianfiscal•system.Rapid population growth largely because of fast decline in death rate and very slow decline in birth rate is •another feature of the country with adverse consequences. Remember, from the standpoint of analysis of business environment, it is important for you to gain mastery over the structural dimensions we have examined in this unit.

8.8 Demographic Trends and StructureThe main problem in India is the high level of birth rates of accompanying falling death rates. The rate of growth of population which was about 1.3 percent per annum during 1941-50 rose to 2.1 per cent during 1981-91. The chief cause of the rapid growth of population was the steep fall in death rate from 49 per thousand during 1911-20 to about 11 per thousand by the end of 1980s.But the birth rate declined from about 49 per thousand during 1911-20 to about31 per thousand by the end of 1980s.

The fast rate of growth of population, given the rate of growth of GNP implies lower per capita GNP growth rate. For example, if GNP growth rate is 5 percent per annum, and population growth rate is 2 per cent, then per capital GNP growth rate is 3 per cent annum. To maintain a rapidly growing population, the requirements of food, clothing, shelter, medical and educational facilities and so on will be rising. Therefore a rapidly rising population imposes greater economic burdens and, consequently, the society has to make greater efforts to accelerate the process of economic growth. Moreover, rapidly rising population implies larger additions to labour force and higher dependency ratio. In 1990, for example, 36.9per cent belonged to 0-14 age group, while 58.7 per cent belonged to age group of 15-64 in India’s population. The rapid growth of labour force creates a higher supply of labour than demand for it leading to the problem of chronic unemployment.

One heartening feature is that over the last three decades there has been declining trend in population growth rates. During 1965-80 the average annual population growth was 2.3 per cent. In subsequent 1980-90 period, it declined to 2.1 per cent. With the government policies for population control and family welfare it is expected that by the end of this century population growth rate will come down. The annual growth rate of population declined to 1.73 by 2002-03.

As for the sex composition of population, the sex ratio (females per 1000males) declined from 972 in 1901 to 933 in 2001. The explanation for a declining sex ratio lies in the poverty of the Indian people. In a country where even after more than 40 years of planned economic development nearly 35 percent (the poverty estimates differ widely) of the population live below the poverty line, high infant mortality, extremely poor or non-existent medical facilities, extremely unhygienic conditions of living and absence of pre-natal and post-natal care, high death rate among women


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are all manifestations of an object low level of living of the people. Preference for male children and attempts to avoid female children is rather a recent phenomenon which contributes to keeping sex ratio at the lower level.

Age structure of population is an important demographic dimension. As noted before, rapid population growth implies high dependency ratio. 0-14, and 60 and above, age groups constitute dependent population. In 1911, 0-14 age group constituted 38.8 per cent of population. In the same year 60 and above age group constituted 1.0 per centofpopulation.Togethertheyconstituted39.8percent.By2001,thefirstagegroupconstituted35.6percentofpopulation and the latter age group constituted 6.3 per cent. Thus the percentage of dependent population increased from39.8percentin1911to41.9percentin2001.Ahighproportionofchildren(0-14agegroup)onlyreflectsalarge proportion of unproductive consumers. To reduce the percentage of non-productive consumers, it is essential to bring down the birth rate.

Rural-urban composition of population is an important demographic dimension, particularly from point of view of economic development. Along with economic development in general and industrialisation in particular the rural-urban composition of population has been changing in India. In 1901, 89 per cent of Indian population was rural, the remaining 11 per cent being the urban population. By 2001 the percentage of rural population declined to 77.2 percent, while that of urban population increased to 22.8 per cent.

The quality of population can be judged from life expectancy, the level of literacy and the level of technical training attainedbythepeopleofacountry.InrespectofallthethreeindicatorsIndiaachievedsignificantprogressalthoughthecountryisstilltogoalongwayinachievingthestandardsofmoreaffluentcountries.Theliteracyratehasgoneup from 18.2 per cent in 1951 to 65.4 percent in 2001. Life expectancy at birth has gone up from 41.2 per cent in 1951to 65.3 per cent in 2001.

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SummaryThe critical elements constitute the institutional framework of an economic environment.•The trends in economic variables such as income, price, output, investment, foreign trade, labour supply and •other factor endowments and the structural relation among these variables constitute the physical framework of an economic environment“Growth” and “development” are sometimes used synonymously in economic discussion•Economicgrowthmaybedefinedasasignificantandsustainedriseinpercapitarealincome.•‘Economic development’ is a broader concept than ‘economic growth’.•Economic growth is also associated with a change in the structure of employment of people. It is generally •accepted that one of the structural changes that occur in the course of economic growth is a progressive shift of labour from agriculture and allied activities to secondary and tertiary sectors.A change in the structure of investment and capital formation is another development during the process of •economic growth and development.The growth rates of NNP and NNP per capita during different plan periods give an overview of the Indian •growth experienceEconomic growth has brought about a structural change (change in sectoral shares of the national income) in •the economy.Given the supply of labour force and its annual rate of growth, economic growth is primarily a matter of rate •of capital accumulation and resource productivity improvements.Thesignificantchangesinthecompositionofassetsofthehouseholdsectorindicaterapidstridesmadebythe•financialsystemofthecountry.GrossDomesticCapitalFormation(GDCF)isclassifiedonthebasisoftypeofassetsintotwocomponents:•Thepricetrendsarerelatedto,amongothers,thetrendsinmoneysupplyandgovernmentbudgetdeficits.•MoneysupplygrowthratehasbeenanimportantfactorbehindtheIndianinflationexperience.•The main problem in India is the high level of birth rates of accompanying falling death rates.•The fast rate of growth of population, given the rate of growth of GNP implies lower per capita GNP growth •rate.

ReferencesJain, T. R, Trehan, M. & Trehan, R., 2010.• Indian Economy, Revised ed., V.K. Publications.Singh, R., 2011. • Indian Economy, 3rd ed., Tata McGraw Hill Education Private Limited.The Structure of the Indian Economy• [Pdf] Available at: <www.iioa.org/pdf/15th%20Conf/dasguptachakraborty.pdf>[Accessed11July2013].Structural Changes in the Indian Economy• [Pdf]Availableat:<isidev.nic.in/pdf/WP1202.pdf‎> [Accessed 11 July 2013].2008. Structural Dimensions of Indian Economy• [Video online] Available at: <https://www.youtube.com/watch?v=7Ibcvolgi2w‎>[Accessed11July2013].2011. Sectors of Indian economy• [Video online] Available at: <https://www.youtube.com/watch?v=lPQUCRb_DYo‎>[Accessed11July2013].

Recommended ReadingGupta, S. P., 1987. • Structural Dimensions of Poverty in India, Mittal Publications.Gupta, K. R. & Gupta, J.R., • Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.Jain, T. R., Trehan, M., Trehan, R. & Uppal, R., 2010. • Indian Economy, V.K.Publications.


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Self Assessment__________________maybedefinedasasignificantandsustainedriseinpercapitarealincome.1.

Capital growtha. Income growthb. Economic growthc. Revenue growthd.

Which of the following is the additional capital required to increase output by one more unit?2. Incremental Capital-Output Ratio (ICOR)a. Gross Domestic Capital Formationb. Gross Development Product c. Investment Capital-Output Ratiod.

WhichofthefollowinghasbeenanimportantfactorbehindtheIndianinflationexperience?3. Money supply growth ratea. Gross Fixed Capital Formation (GFCF)b. Consumer Price Index (CPI)c. Investment Capital-Output Ratiod.

Which of the following is not the principal factor responsible for the expansion of the money supply ?4. Bank credit to commercial sectora. Bank credit to governmentb. Net foreign exchange assets of the banking sectorc. Net custom exchange of goodsd.

______isdefinedas5. M1 plus time deposits.Ma. 2

Mb. 3

Mc. 4

Md. 5

_________ when invested results in the capital formation.6. Savingsa. Commoditiesb. Equitiesc. Assetsd.

The share of total household saving to total National saving is ______ three quarters.7. Less thana. Equal tob. More thanc. Approximatelyd.

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What does CPI stands for?8. Customer Price Indexa. Consumer Price Indexb. Capital Price Indexc. Custom Price Indexd.

The main problem in India is the ____ level of birth rates of accompanying ______ death rates.9. High, higha. Falling, highb. High, fallingc. Falling, fallingd.

The _______ of population can be judged from life expectancy, the level of literacy and the level of technical 10. training attained by the people of a country.

Quantitya. Qualityb. Numberc. Rated.


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Case Study I

Perfect Competition Coke and Pepsi both are trying to gain market share in the beverage market, which is valued at over $30 billion a year. The facts are that, each company is coming up with new products and ideas in order to increase their market share. The creativity and effectiveness of each company’s marketing strategy will ultimately determine the winner withrespecttosales,profits,andcustomerloyalty.NotonlythesetwocompaniesareconstructingnewwaystosellCoke and Pepsi, but they are also thinking of ways to increase market share in other beverage categories. Although the goals of both companies are same, the two companies form different marketing strategies. Pepsi has always taken the lead in developing new products, but Coke also learned their lesson and started to do the same. Coke hired marketing executives with good track records. Coke also implemented cross training of managers so it would bemoredifficulttoformgroupism.Ontheotherhand,Pepsihasalwaystakenrisks,actedrapidlyanddevelopednew marketing ideas.

Both the companies tried to capture the foreign markets. Coke had carried out market research in different regions, and got to know that the customer requirements differ according to their regions. So, Coke has been more successful in foreign markets than Pepsi. However, after 2-3 years, many changes were made by both the companies; some ofthedevelopmenttechniquesfailed,whilesomegainedprofit.Forinstance,thetransformationofCokeintoNewCoke was a major failure. Pepsi’s failure included Pepsi Light, Pepsi Free, Pepsi AM, and Crystal Pepsi.

To overcome failures, the company has to take next step to develop new products to meet customer requirements. If both companies sell the same product, they will never succeed. Gaining market share is possible if the company knows what the customer wants, and takes one step ahead than the competitor to achieve customer satisfaction. To understand the customer requirement, market research is necessary. The companies should collect feedback from customers, next analyse this data, and then develop the new product based on the data. Thus, once the product is developed it should be in the marketplace at the right time. Therefore, if any company follows these factors, it can achieve the market share.

(Source: Coke Vs. Pepsi Case Study, [Online]Availableat:<www.exampleessays.com/viewpaper/84955.html>[Accessed 4 June 2013] ).

QuestionsWhich type of competition is seen in this case study? Give reasons.1. AnswerIn this case study, Perfect Competition is seen. The factors that are present in the perfect competition are as follows:Coke and Pepsi are the two competitors which sell an identical product•The industries are characterised by freedom of entry and exit•Thefirmshaverelativelysmallmarketshare•

What are the different marketing strategies adopted by both the companies?2. AnswerCoke hired marketing executives with good track records. Coke also implemented cross training of managers soitwouldbemoredifficulttoformgroupism.Ontheotherhand,Pepsihasalwaystakenrisks,actedrapidlyand developed new marketing ideas.

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In perfect competition, how can a company achieve complete market share? 3. AnswerGaining market share is possible if the company knows what the customer wants, and takes one step ahead than the competitor to achieve customer satisfaction. To understand the customer requirement market research is necessary. Get the feedback from customers, next analyse this data, and then develop the new product based on the data. Thus, once the product is developed it should be in the marketplace at the right time.

How Coke has been successful in foreign market?4. AnswerCoke had carried out market research in different regions, and got to know that the customer requirements differ according to their regions. So, Coke has been more successful in foreign markets than Pepsi.


116

Case Study II

Gross Domestic Product: JP Morgan Chase

The formation of the Future Generation Initiative was the beginning of a strategic approach to diversity that acknowledgeddiversityasabusinessimperative.JPMorganneededtocreateprocessesreflectingtheimportanceof achieving results that could be measured in numbers, behaviours and attitudes.

The Solution - Diversity effort began in U.S. headquarters with an acknowledgement of retention challenges for women and minorities. An exit survey highlighted the need to create an inclusive work environment. External consultants were hired to design a one-day awareness workshop entitled “Managing Inclusion”. After “Managing Inclusion”, employees expressed desire for follow up programme that told the stories of real employees. Another externaldiversity-consultingfirmwashiredtodesign“LeadingDiversity”.“LeadingDiversity”,aone-dayworkshopusing real case studies as the learning platform was launched in the U.S.

TheLondonofficelaunchedthe“FutureGenerationInitiative”,whichwaslaterrenamedthe“WarforTalentSteeringGroup” (WFT) in recognition of the need to focus on recruitment and retention challenges. Maureen Powell and Pauline Brown and Farrah Qureshi were amongst a team of Leading Diversity consultants who had helped launch theprogrammeintheU.K.workedwithLondonbasedteamtoidentifyissuesuniquetotheLondonofficevia14focusgroup.ThefirstpilotprogrammeforU.K.versionof“LeadingDiversity”successfullylaunchedandtodatealmost 100% of London employees have attended. This group consisted of all nationalities.

The War for Talent Steering Group wrote a diversity strategy to identify commitment, approach, accountability and feedback loops. WFT is business aligned, comprising 16 senior professionals of diverse backgrounds, both part-time and full time. Sub groups focus on implementation of strategic and HR policy-related initiatives. Finally, Employee Networks were formed to provide communications networks for special interest groups such as Women, Gays/Lesbians, Ethnic Minorities, Support staff etc.

Outcomes of this intervention:100% of European employees have attended “Leading Diversity” Workshop•Recruitment efforts have increased for diverse candidates.•Employee Networks are active, well supported and successful•EmployeeClimateSurveyhad63%return rateand results reflectedsignificantareasof improvement90%•agree their manager treats everyone the same regardless of race, gender, religion, sexual orientation or other characteristics unrelated to performance 85% have not experienced unfair treatment 78% agrees that senior management supports policies/practices that ensure a diverse workforce.Feedback from “Leading Diversity” workshops has resulted in task forces forming to tackle issues such as age, •work/life balance, disability etc.

(Source: GDP Case Study : JP Morgan Chase, [Online] Available at: <http://www.globaldiversitypractice.com/?p=415>[Accessed15July2013]).

QuestionsWhat are the outcomes of the intervention?1. How many percentages of employees attended the Leading Diversity Group?2. Employee Climate Survey had how many percentage of return rate?3.

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Case Study III

The Indian Economy Dealing with Inflation in 2006-07Intheearly2007andtheendof2006,theinflationrateinIndiawasaround6-6.8%.Previously,themaincauseofhighinflationinIndiawastheriseinglobaloilprices.However,inearly2007,themainreasonfortheinflationwas the increase in the prices of food articles which was caused by increased demand as well as supply constraints. According to analysts, the increased demand was because of high economic growth and increased money supply, while the stagnant agricultural productivity caused supply constraints.

Causes of InflationGenerally,thetwomainreasonsbehindinflationare:

riseindemandordemandpullinflation•riseincostoffactorproductionorcostpushinflation•The average annual GDP growth in the 2000s was about 6% and during the second quarter (July-September) •offiscal2006-2007,thegrowthratewasashighas9.2%.Thiswasdefinitelygoingtoincreasethedemandforgoods. However, the growth in the supply of goods, especially food articles such as wheat and pulses, was not increasing directly with the growth in demand. As a result, the prices of food articles increased considerably.

Measures Taken to Control InflationIn late 2006 and early 2007, theRBI announced somemeasures to control inflation.Thesemeasureswere asfollows:

increase the repo rates•increase the Cash Reserve Ratio (CRR) •reduce the rate of interest on cash deposited by banks with the RBI •With the increase in the repo rates and bank rates, banks had to pay a higher interest rate for the money they •borrowed from the RBI. Consequently, the banks increased the rate at which they lent to their customers. The increase in the CRR reduced the money supply in the system because banks now had to keep more money as reserve

(Source: TheIndianEconomyDealingwithInflationin2006-07, [Online] Available at: <http://www.scribd.com/doc/25490961/inflation-case-study>[Accessed12July2013]).

QuestionsWhatwerethecausesofinflation?1. InIndia,whytheinflationrateincreasedin2006-07?2. Howinflationratecanbecontrolled?3. Whathappenswhenbanksincreasesthereporatesandbankratestocontrolinflation?4.


118

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Recommended ReadingAcocella, N., • Economic Policy in the Age of Globalisation, Cambridge University Press.Bhole, L.M., 2004.• Financial Institutions and Markets:Structure, Growth and Innovations, 4rth ed., Tata McGraw-Hill Education.Bianchi, P. & Laboy, S., 2011. • Industrial Policy after the Crisis:Seizing the Future., Edward Elgar Publishing Limited.Bianchi, P., 2006. • International Handbook on Industrial Policy, Edward Elgar Publishing Limited.Dr. Mustafa, A., 2010. • Foreign Tarde Finance and Documentation, Laxmi Publications, Ltd.Ghosh, A., 2009. • India’s Foreign Policy, Pearson Education India.Gupta, K.R. & Gupta, J.R., • Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.Gupta, S.P., 1987. • Structural Dimensions of Poverty in India, Mittal Publications.Gurusamy, S., 2009.• Indian Financial System, 2nd ed., Tata McGraw-Hill Education.Jain, T.R., Trehan, M., Trehan, R. & Uppal, R., 2010. • Indian Economy, V.K.Publications.


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Kapila, R. & Kapila U., 2004. • Indian Economy, Academic Foundation.Krueger, A.O., • Economic Policy Reforms and the Indian Economy, The University of Chicago Press, Chicago.Pailwar, V. K., 2008. • Economic Environment of Business, PHI Learning Private Limited.Pathak, B., 2007. • Industrial Policy of India: Changing Facets, Deep and Deep Publications Pvt. Ltd.Pathak, B.V., 2011.• The Indian Financial System, 3rd ed., Pearson Education India.Prasad, M., 2011. • India’s Foreign Trade:From Antiquity to Date, Kalpaz Publications.Raj, R., 2008.• Economic Environment of Business and Environmental Management, 1st ed., Nirali Prakashan.Shaffer, H.G., 1999. • American Capitalism and the Changing Role of Government, Greenwood Publishing Group.Smith, A., Richards, M., Heale, G. & Meer, N. V., 2008. • Economic Environment Level 3, Pearson Education South Africa (Pvt.Ltd).Sterner, T., 1996. • Economic Policies for Sustainable Development, Kluwer Academic Publishers.Tanzi, V., 2011. • Government Versus Markets:The Changing Economic Role of the State, Cambridge University Press.

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Self Assessment Answers

Chapter Ib1. a2. d3. a4. d5. b6. c7. d8. a9. b10.

Chapter IIc1. a2. d3. a4. b5. d6. c7. b8. a9. c10.

Chapter IIIa1. b2. a3. b4. a5. c6. a7. b8. a9. b10.

Chapter IVc1. a2. b3. d4. c5. a6. d7. c8. a9. c10.


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Chapter Vb1. a2. c3. b4. c5. c6. b7. b8. c9. b10.

Chapter VId1. a2. c3. b4. d5. b6. c7. d8. a9. d10.

Chapter VIIb1. b2. c3. a4. b5. d6. a7. a8. b9. c10.

Chapter VIIIc1. a2. a3. d4. b5. a6. c7. b8. c9. b10.

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