Module – 1 Business Environment Reference: Economic Environment Misra & Puri Pg no:5-60 Characteristics / Nature of Modern Business • Large size • Oligopolistic

character • Diversification • Global reach • Technology orientation • Change • Government control Environment of Business Environment by definition is something external to an individual or an organization. Business environment refers to all external factors which have direct or indirect bearing on the activities of business. The business environment is divided into • Internal environment • External environment a. Micro environment b. Macro environment Diagrammatic Representation of Business Environment

Internal Environment


Micro/ macro External Environment

Internal Environment • Value system, • goals and objectives, • management structures, • relationship among the various constituents, • physical assets, • technological capabilities and human,


financial and marketing resources make the internal environment of business.

External Environment External environment of business consists of institutions, organizations and forces operating outside the company. External environment can be classified into • Micro Environment • Macro Environment (1) Micro environment The micro environment refers to such players whose decisions and actions have a direct bearing on the company. Since modern business broadly has two aspects, viz., Production and selling of goods, the micro environment of business can be divided accordingly. The most prominent performers in the micro environment are: • Suppliers of inputs • Workers and their unions • Customers market intermediaries • Competitors • Publics (2) Macro environment Macro environment comprises large societal and physical forces which affect the company and also the players in the company’s micro-environment. Macro environment of a company refers to all those economic and non- economic factors which exercise their influence on the business activity in general and thus determine opportunities that a company may have to promote its business. Macro environment can be classified into • Economic environment • Non-economic environment Diagrammatic representation
Dia r m a ic r p e e t t n ga m t e r s n a io

Na tiona l
l itica pol l o ci ra So ltu cu

Globa l

Na tu a r l e ch no lo De og phic m ra g ic a l


Economic Environment Since business is basically an economic activity, economic environment of business – both national and global – is of strategic importance. In the economic environment of the country, • country’s economic system, • macroeconomic scenario , • phase of business cycle through which the company is passing, • organization of the financial system and • economic policies of the government are the most important elements. 1.Economic System a. Capitalism b. Socialism 2. Macro-economic Scenario a. High rates of growth b. Inflation c. High rates of savings and investment d. Fiscal imbalance e. Balances of payments f. Deficits Phases of business cycle a. Prosperity b. Recession c. Depression d. Stagflation Financial System Economic Policies a. Industrial policy b. Trade policy c. Monetary policy d. Fiscal policy Non-Economic Environment The non- economic environment of business can be classified as: • Political environment • Legal environment • Socio-cultural environment • Demographic environment • Technological environment • Natural environment


(a) Political Environment

(b) Legal Environment The governments sets the legal framework within which business operate. Legislations defining property and business organizations, laws of contracts and bankruptcy, mutual obligations of labour and management and a multitude of laws and regulations constraining the way business activities are carried out constitute legal environment of business. Economic legislations, as these, are often called, have a direct bearing on the business. Economic legislations can be classified into two categories: Legislations which have a facilitatory role. Ex: The Contract Act provides the rules for systematic exchange transactions. Legislations which are restrictive in nature. Ex: MRTP Act and FERA. (c) Socio-cultural Environment The Social environment is made up of the attitudes, desires, expectations, degrees, of intelligence and education, beliefs and customs of people in a group or a society. Culture is the heart of a particular group or society – what is distinctive about the way members interact with one another and with outsiders – and how they achieve what they do. Socio-cultural environment is made up of attitudes, desires, expectations, beliefs, faiths, customs of people besides their set of material practices through which people produce goods and services that they need for satisfying their wants. Globalization of culture Multiculturalism a. Caste b. Race c. Ethnic issues Demographic Environment Demographic factors like the Size and Growth rate of population, Life Expectancy, Age and sex composition of population, Work participation rate, Employment status, Ruralurban distribution, Educational levels, Religion, Caste, Ethnicity and Language are all relevant to business. Some of the issues are: • Size and growth of population


• • •

Age structure of population Urban-rural population Burden of population on environment Module – 3 Economics Of Development

Meaning of Economy (or) Economic System An economy or economic system refers to the manner in which the various economic activities relating to production, distribution, exchange and consumption of goods and services are organised in a country, and the way in which the people of a country earn their living. It comprises the farms ,factories, mines, shops, offices, banks, schools and colleges, transport systems, hospitals, defence, etc The economy of a country is divided into three sectors: 1. Primary Sector – agriculture, mining, forestry, fishing, etc. 2. Secondary Sector – large scale and small scale industries. 3. Tertiary Sector – services like transport, banking, insurance, trade, public administration, defence, etc. Classification of Countries (economy) The World Bank in its World Development Report (2005) has classified various countries of the world on the basis of their per capita Gross National Income (GNI) or (GNP). They are 1.Low income countries – with per capita GNP of $765 and below. Ex : Myanmar, India, Ghana, Sudan, Nepal, Uganda. 2.Middle income countries – with per capita GNP between $766 and $9,385. Ex : China, Fiji, Brazil, Cuba, Egypt, Iran, Iraq, etc. 3. High income countries – with per capita GNP higher than $9,386. Ex : Australia, USA, UK, UAE, Canada, Spain, Germany, France, etc. Types of Economies An economy or economic systems can be classified into two types on the basis of the level of economic development attained by them. They are 1. Developed economy (advanced) 2. Under-developed economy (backward) Developed economy The United Nations Experts in 1971have classified countries with per capita real national income of $1000 and $4000 a year as developed countries. A developed economy is one which is economically advanced and whose economy is 5

characterized by large industrial and service sectors and high levels of income per head. Under-developed / developing economy An economy where the per capita real income is less than $1000 a year is considered an under-developed economy. A under-developed economy is characterised by • Low per capita income • Chronic mass poverty • Predominance of agriculture • Obsolete methods of production and social organisation • Under-utilization of manpower and natural resources India as a Developing Economy Reference - B.S.Raman: pg 19-21 HRK: pg 11-14 Meaning of a Developing Economy Developing economy, no doubt, refers to an under-developed economy. But this term is mostly used to refer to that under-developed economy which is not stagnant, but has started developing by making use of its natural and human resources. The following changes in the Indian Economy over the last five decades clearly prove that India is a developing economy. Increase in national income 1950-51 – Rs. 9,142 crores 2001-02 – Rs. 18,64,292 crores Increase in per capita income 1950-51 – Rs. 255 2001-02 – Rs. 17,978 Increase in investment 1950-51 – Rs. 1,960 crores 2001-02 – Rs.15,25,639 crores Increase in agricultural production (food grains) 1950-51 – 50.8 mn. tonnes 2001-02 – 212 mn. tonnes Increase in industrial Production Increase in social over-heads Structural changes Progress in Science and Technology Progress in Banking and Financial sector Reduction in inequalities in income and wealth Improvement in living standards Desirable changes in society Determinants of Economic Development ( Reference – Ruddar Dutt and 6

Sundaram: pg12-14 ) Economic development implies the process of securing levels of productivity in all sectors of economy and this in turn, is a function of the level of technology. Economic development thus depends upon two sets of factors: 1. Non-Economic Factors 2. Economic Factors Non-Economic Factors Non-economic Factors includes social attitudes, political conditions, human endowments and efficient governance. • Religious beliefs • Political Instability • Family System • Development of Education • Nature of People Economic Factors • Capital Formation • Capital-output Ratio • Growth of Population • Building Human Capital • Availability of Natural Resources • Climatic Conditions • Level of Technology Major Issues of Developments (Reference – Ruddar Dutt and Sundaram: pg 10-12) • Low per capita income and low rate of economic growth • High proportion of people below the poverty line • Low level of productive efficiency due to inadequate nutrition and malnutrition • Imbalance between population size, resources and capital • Problem of employment • Instability of output of agriculture and related sectors • Imbalance between heavy industry and wage goods • Imbalance in distribution and growing inequalities Business Cycles The business cycle is an alternate expansion and contraction in overall business activity, as evidenced by fluctuations in aggregate economic activity such as GNP, industrial production, employment and income. According to J.M.Keynes “ A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, alternating with 7

periods of bad trade characterized by fall in prices and high unemployment percentages.” Phases of a Business Cycle A business cycle will have 5 different phases or stages. They are 1. Depression 2. Recovery 3. Prosperity or full employment 4. Boom or overfull employment 5. Recession (1) Depression During this period business activity in the country will be much below normal level. It is characterized by a short fall in production, mass unemployment, fall in prices, low wages, contraction of credit, a high rate of business failures and an atmosphere of all round pessimism. The USA experienced 2 longest depressions in the history i.e during 1873-1879 and 1929-1932. (2) Recovery During this period business activity increases. The industrial production and volume of employment steadily increases. The prices and wages increases. The recovery may take place due to the following reasons: • New government expenditure • Exploitation of new sources of energy • Innovations • Investment in new areas • Changes in the techniques of production (3) Prosperity This stage is characterized by high capital investment in basic industries, expansion of bank credit, high prices , high profits, high rate of formation of new business enterprises and the full employment. The longest sustained period of prosperity occurred in the USA between 1923 and 1929. (4) Boom It is the stage of rapid expansion in business activity resulting in high stocks and commodity prices, high profits and over-full employment. A situation develops in which the no. of jobs exceeds the no. of workers in the market. Such a situation is known as over-full employment. Profits will further increase. This will lead to more investment and in turn further raise in price level and inflation. (5) Recession In this stage more business enterprises fail, prices collapse and confidence is shaken. Building construction slows down and unemployment increases. There is fall in income, 8

expenditure, demand, prices, and profits. The recession will have cumulative effect on the working of the economy. USA experienced recession in 1957-1958. Diagrammatic Representation

Characteristics of Business Cycles Business cycle is a wave like movement. • The cyclical fluctuations are recurrent in nature. • The upward or downward swing of the business cycle is self reinforcing. • Business cycle contains self generating forces. • They are all pervasive in their effects. • The peak and the trough of a business cycles are not symmetrical. • In cyclical fluctuations the prices and the production generally rise or fall together. • The cyclical upward and downward swings move parallel with production and monetary demand. • The cyclical fluctuations are felt more in capital goods industries than in consumer goods industries. • They are not periodical in nature. • Prices of manufactured goods are comparatively rigid while that of agricultural goods are normally flexible. • The cyclical fluctuation tend to be not only national but also international in character. Importance of Agriculture to Indian Economy 1.Provides largest employment 60 % of working population 2. Greater share in national income 23 % of national income 3. Supply of food to people 212.22 mn tonnes of food grains in 2003-04 4. Industrial development


5. Contribution to foreign trade Share of agricultural exports in total exports is 10% 6. Source of revenue to government 7. Source of capital formation 8. Market for industrial products 9. Good national defence 10. Price Stability Agricultural commodities account for 80% of total consumption expenditure 11. Development of tertiary sector 12. Influence on government budgets 13. Supply of fodder 14. Influences general price level 15. Involves low capital 16. Supplier of raw materials 17. Main role in consumption basket 60% of household consumption and 85% of household commodity consumption is of agricultural products. 18. Source of revenue and also exports 19. Political and social significance Importance of Industrialisation in India 1. Employment generation 2. Larger production 3. Increase in national income and per capita income 4. Promotion of agriculture 5. Development of agriculture 6. Increase in productive capacity 7. Use of potential resources 8. Contribution of export trade 9. National defence 10. Balanced development 11. More revenue to government 12. Changes in the outlook of people 13. Expansion of markets 14. Economic stability and self sufficiency 15. Proper balance between industry, agriculture and tertiary sector 16. Urbanisation 17. Stable growth of the economy The Importance of Transport in the Economic Development of India • Development of market • Large scale of production • Facilitates territorial division of labour • Price stability • Mobility of labour and capital 10

• • • • • • • • • • • • • • • •

Growth of towns and cities Employment generation Facilities agricultural development Helps industrial development Social benefits National defence Efficient administration Unity Meeting emergencies Place and time utility Breaking the isolation Development of trade and commerce Solution to population problem Revenue to government Efficient use of resources Facilitates balanced regional development

Importance of Foreign Trade in the Economic Development of India • helps India to import plant and machinery, raw materials and technical know-how. • helps to import goods like petroleum, metals, etc. • helps India to export goods which are in surplus. • widens the market for our products. • contributes to expansion of domestic industries. • contributes to growth of national income. • contributes to improvement in the civilisation of our people. International Trade is an index of civilisation. • contributes to economic co-operation between India and other countries. • Gives employment to a large number of people. • Gives encouragement to the exploitation of unexploited resources of the country. The Role of Communication System in the Economic Development • Supply of necessary information • Motivation • Development of industries, commerce and trade • Development of transport • Bringing buyers and sellers together • Accelerating the growth rate • Easy contact • Improving global competitiveness • Attracting foreign direct investment Module – 4 National Income Accounting 11

Reference : Ahuja – Pg 15-35 National Income  According to J.R Hicks, “National income consists of a collection of goods and services reduced to a common basis by being measured in terms of money”.  According to the National Income Committee of India-1951, “A national income estimate measures the volume of commodities and services turned out during a given period, counted without duplication”. Important Points • National income refers to the income of a country, Ex: India • Its measurement refers to a specified period of time, say 1year • National income includes all goods and services which have exchange value, counting each one of them only one. Different Concepts of National Income 1. Gross Domestic Product (GDP) 2. Net Domestic Product (NDP) 3. Gross National Product (GNP) 4. Net National Product (NNP) 5. National Income at Factor Cost (NI) 6. Personal Income (PI) 7. Disposable Personal income (DPI) Gross Domestic Product • GDP is the aggregate money value of all final goods and services produced by normal residents as well as non-residents in the domestic territory of a country during a year. • It is a geographical or territorial concept. • GDP = GNP – net factor income from abroad Net Domestic product • NDP refers to the market value of all final goods and services produced during a period of one year after making allowance for depreciation changes. • NDP = GDP – Depreciation Gross National Product • GNP is defined as the total market value of all final goods and services produced during a year in a country. • GNP is a monetary measure. • GNP includes the market value of only final goods and services. • It is a flow measure of output of goods and services during a year / currently produced goods. • GNP refers to the value of goods and services currently produced by normal residents of a country.


• The depreciation or replacement value of the fixed assets is not deducted Net National Product • This refers to the net production of goods and services in a country during a year. • NNP = GNP – the value of capital depreciated during the year. • NNP is a highly useful concept in the study of growth economics. National Income at Factor Cost • It refers to the total of all income payments earned by the factors of production in the form of rent, wages, interest, and profit during a given year. • NI = NNP – Indirect Taxes + subsidy Personal Income • It is that income which is actually received by the individuals and households in a country during a year from all sources. • PI = NI – Corporate income tax -- social security contributions -- undistributed corporate profits + transfer payments This concept is useful in estimating the potential purchasing power of the individuals in an economy. Disposable personal Income • It is that part of personal income which is left behind after the payment of personal direct taxes is called disposable personal income. • DPI = PI – Personal direct taxes • DPI = Consumption + Saving Uses / Practical Importance of National Income Estimates • Economic Position • Contribution of Different Sectors • Distribution of National Income among the Factors of Production • Economic Planning • International Comparison • International Payments • Help to Backward Countries • Role of Public and Private Sectors • Grant-in Aids to States • Anti-Inflationary and Deflationary Measures • Reveals the Cyclical behavior of an economy Difficulties in the Measurement of National income • Treatment of Non-monetary Transactions • Treatment of Government activities in national income accounts • Treatment of income generated by foreign firms • Illiteracy 13

• • • • • •

Non- availability of statistical data Existence of barter transactions Difficulty in calculating depreciation Lack of professional competency Problem of consideration of goods and services Commodities of self-consumption

Difficulties of Measuring National Income in Developing countries • Prevalence of non-monetized transactions • Illiteracy • Incomplete Occupational specialisation • Agricultural and industrial production is unorganized • Lack of adequate statistical data Trends in National Income Growth and Structure I. Trends in net national product and per capita income II. Annual growth rates during the plans III. Trends in distribution of national income by industrial origin IV. Trends in the share of the public sector V. Urban and rural income break-up VI. Share of organised and unorganised sector in NDP National Income Estimates in India According to the National Income Committee, “ A national income estimate measures the volume of commodities and services turned out during a given period, counted without duplication”.  Pre-independence period estimates  Post-independence period estimates  National income committee and C.S.O estimates Circular Flow of Income  Two Sector Model Without Savings Households and Firms  Two Sector Model With Savings S=Y–C Where Y = income S = savings C = consumption  Case 1 : S > I  Case 2 : S = I  Case 3 : S < I  Three Sector Model (Government) T = T1 + T2


 Four Sector Model Firm + Household + Government income and Expenditure + Exports and Imports S+T+M=I+G+X Module: 5(a) Capital Structure Meaning of Capital Structure Capital Structure refers to the various sources from which the long-term funds are raised. The Capital Structure refers to the proportion of equity capital, preference capital, reserves, debentures and other long-term debts to the total Capitalization. Characteristics of a sound Capital Structure • Simplicity • Profitability • Flexibility • Intensive use of funds • Conservation • Provision for meeting future contingencies • Control over the company • Economy in cost of maintaining different securities Forms/Patterns of Capital Structure • Equities only • Equities and preference shares • Equity shares and debentures • Equities, preference shares and debentures Factors determining capital structure Two types • Internal factors or controllable factors • External factors or uncontrollable factors Internal factors • Financial leverage • Growth & stability • Cost of capital • Asset structure • Retaining control • Purpose of finance External factors 15

• • • • • • •

Size of the company Nature of company Cost of floatation Interest rates Taxation policy Fluctuation in stock market Availability of funds

Pecking order theory Internal Debt Issue of Debt Equity Shares Business risk Uncertainty about – demand, sales, price, Leverage:- Meaning and Definition costs, etc.

The Dictionary meaning:

“An increased means for accomplishing some purpose”.

In financial analysis: Leverage is ability of using fixed costs to enhance the potential returns to a firm. There are 2 types of fixed costs: 1) Fixed operating costs(rent, depreciation, etc.) 2) Fixed financial costs(interest, cost of debt, etc.) Is also called ‘GEARING’ in USA James Horne has defined “Leverage as the employment of an asset or funds for which the firm pays a fixed cost or fixed return”. Christy and Roder defined 16

“Leverage as the tendency for profits to change at a faster rate than sales”. Types of leverage Financial leverage The use of long term fixed interest and dividend Bearing securities like debentures and preference shares along with equity is called financial leverage or trade on equity. FL = EBIT EBT DFL = Percentage change in EPS Percentage change in EBIT Operating leverage The operating leverage occurs when a firm has fixed cost which must be recovered irrespective of sales volume. The fixed cost remaining the same the percentage change in operating revenue will be more than the percentage more than the sales OL = contribution EBIT DOL=Percentage change in EBIT Percentage change SALES Combined leverage Combined leverage shows the relationship between the change in sales and corresponding variation in taxable income. Combined leverage = operating leverage X financial leverage Contribution = EBIT X EBIT EBIT/operating profit EBT = contribution earnings before tax DCL = Percentage change in EPS Percentage change in SALES FINANCIAL LEVERAGE Q 1. A Ltd. Company has equity share capital of Rs. 5,00,000 dividend into share of Rs. 100 each. It wish to raise further Rs. 3,00,000 for expansion cum modernization plans. The company plans the following financing schemes.


(a) all common stock . (b) Rs. One lakhs in common stock and Rs. 2 lakh in 10% debentures. (c) All through debentures at 10 % interest pa. (d) All debt in common stock and Rs. 2 lakh in preference capital with the rate of dividend at 8% The Company’s existing earnings before interest and tax (EBIT) is Rs.1,50,000. The corporate rate of tax is 50%. You are required to determine the earnings per share (EPS) in each plan and comment on Financial Leverage. SOLUTION earnings before interest and tax Less : Interest 1,50,000 1,30,000 Less : tax @ 50% 75,000 1,20,000 PLAN 1 1,50,000 _ 1,50,000 75,000 _______ ______ Earnings after tax Less : preference dividend at 8% 16,000 Earnings available for common stockholders No. of common shares Earnings per share (EPS) Financial leverage = EBIT EBT 75,000 __ _______ 75,000 8,000 Rs. 9.375 1 PLAN 2 PLAN 3 PLAN 4 1,50,000 __

1,50,000 1,50,000 20,000 30,000 65,000 _______ 65,000 __ _______ 65,000 6,000 Rs. 10.83 1.15 60,000

_______ 60,000 __ _______ 60,000 5,000 75,000 ______ 59,000 6,000 Rs. 9.83 1

Rs. 12 1.25

COMMENTS Since EPS as well as degree of financial leverage is highest in financial plan 3 it should be accepted. The company should raise Rs. 3 lakh only through debt. Problems on Leverages: A simplified income statement of Zenith Ltd. is given below. Calculate the Operating leverage, Financial leverage, & combined leverage. Sales 10,50,000/-


Variable cost Fixed cost Interest Tax Soln :Sales (-)Variable cost Contribution (-)Fixed cost EBIT (-)Interest EBT (-)TAX(30%) NET Income 10,50,000 7,67,000 2,83,000 75,000 2,08,000 1,10,000 98,000 29,400 68,000


Operating leverage = contribution EBIT = 2,83,000 2,08,000 = 1.36 Financial leverage = EBIT EBT = 2,08,000 98,000 = 2.12 Combined leverage = Operating Leverage X Financial Leverage =1.36 X 2.12 =2.88 Module – 5 Structure Of Industries ( References: Dutt & Sundaram Misra & Puri B S Raman HRK) Structure / Classification of Industries (HRK – 204-209) Large Scale Industries : Large Scale Industries are those industries which invest huge amounts of capital, reaping the benefits of division of labour and producing goods on a large scale involving fixed capital investment of more than Rs.10 Cr but less than Rs.100 Cr.


Medium Scale Industries : Medium Scale Industries are those industries which are organised on a medium scale, and produce goods on a medium scale by using machines, hired labour and power involving fixed capital investment of more than Rs.1 Cr but less than Rs.10 Cr. Small Scale Industries: Small-scale industries are those industries which are organised on a small-scale, and produce goods on a small scale by using machines, hired labour, and power. Ex: Ready garments, paper, electrical goods, etc. Agro-industries and Ancillary Industries: Industries which produce goods by using agricultural raw-materials are called agroindustries. Ex: jute, oil, sugar, cotton textiles, etc Industries which produce spare parts, components, etc required by the large industries are called ancillary industries. Cottage Industries: A cottage industry is one which is carried on mainly in a house with the help of the members of the family and with the help of simple and hand-operated tools. Ex: pottery, toy-making, weaving, carpet-making, wood work, agarbhatti, etc. Manufacturing Industries: Any industry which is engaged in the conversion of raw materials into finished goods fit for consumption with the help of men and machines is generally known as manufacturing industry. Ex: conversion of iron ore into iron and steel, wood pulp into paper, etc Industrial Development Under Five Year Plans ( B S Raman – 258-267 Dutt & Sundaram – 636-640)   o o o o o India implemented five year plans and industrial development became an integral part of India’s development planning. High priority was given to programmes of Industrialization on account of following reasons: The country was industrially backward and the establishment of new industries of industries on a big scale and development of the traditional industries was an imperative necessity. Productivity of labour is the highest in manufacturing Industries. Development of the industrial sector is a pre-condition for agricultural development. Industrialization induces development of other sectors. Development of transport, communications and energy is still more dependant on industrial growth. Despite the secondary importance given to industry, the annual rate of growth of


o o o o o

industrial output was about 6%. The overall production of industrial goods increased by 39%. Capital goods industries like iron and steel were expanded. A number of public sector industries like HMT, penicillin factory, etc were established. A number of industries like petroleum-refining, cement, penicillin, etc were set up. Infrastructural facilities like power, transport and communication were expanded considerably.

Second Five-year plan (1956-61) • This plan was based on the Industrial Policy Resolution of 1956 which envisaged a big expansion of Public sector. • It was really an industrial plan. • Total investment in industries was Rs. 1,180 crores (27% of total plan). • The annual rate of growth was 7.25%. • Industrial production increased by 46%. • • • • • • • Three major public sector steel plants were set up at Rourkela in Orissa, Bhilai in MP and Durgapur at WB. This plan witnessed a major diversification of the industrial spectrum. Most of the investments were in Heavy and Basic Industries. Tractors, motor cycles, scooters, etc were produced for first time in India. Good progress was also recorded in modernization and re-equipment of jute, cotton textiles and sugar industries. Good progress was made in the production of consumer goods like fans,radio,etc. About 60 industrial estates comprising 1000 small factories were set up.

Third Five-year plan (1961-66) • Rs.1726 crores(20% of total plan) was allotted for the development of industries and mining. • The annual rate of growth was 7.9%. • UTI and IDBI were set up in 1964. • A no. of industries like aluminium, automobiles, textiles, etc achieved rapid growth. • Mining and extractive industries also showed progress. • Despite the over-all under-achievement of targets this plan reflected the first stage of intensive development leading to a self –reliant and self-generating economy. • Mining and extractive industries also showed progress. • Despite the over-all under-achievement of targets this plan reflected the first stage of intensive development leading to a self –reliant and self-generating economy. Fourth Five-year plan (1969-74) 21

• • • • •

This plan was based on the industrial policy of 1977. Rs 5298 crores (23%) was allotted. The actual growth rate was 5% as against 8%. This plan aimed to enlarge capacities in export promotion and import substitution industries. Public sector enterprises had started earning profits. Fifth Five-year plan (1974-78) • This plan was formulated to achieve the twin objectives of self-reliance and growth with social justice. • Rs.16,660 cr (26%) was allocated. • Actual growth rate was 6% as against 8% • This plan took many bold steps such as • Removing the restriction on the private sector • Monopolistic undertakings • Foreign investments in India

Sixth Five-year plan (1980-85) • This plan was a very ambitious plan. • It was based on the industrial policy of1980. • Rs.22,200 cr (22.8%) was provided. • Actual growth rate was only 3.7% as against 7%. • There was a shortfall in the production of many industrial goods like cement, iron and steel, etc. • Industrial progress during this period was most disappointing. Seventh Five-year plan ( 1985-90) • This plan laid emphasis on the development of infrastructural facilities, modernisation, upgradation of technology, reduction in cost, accelerated growth in selected industries. • This plan was a success as annual growth rate was 8%. • Total outlay for industries was Rs. 22,460 cr. • The govt had liberalised industrial licensing policy to provide incentives to industries. • Encouragement of ‘Sunrise’ industries such as telecom, bio-tech, computers, etc. • Industries were encouraged to adopt technologies like laser, robotics, fibre-optic, etc for enhancing productivity. • About 30% of industries had installed Pollution Control systems. Eighth Five-year Plan (1992-97) • This plan was formulated under Economic Liberalisation and was based on the industrial policy of 1991. • During this period, the private sector has developed considerable managerial, technological, financial and marketing strengths. 22

• • • • • •

The outlay was Rs. 40,670 cr (19% of total plan). Over all 9.5% growth rate has been achieved. The factors for the slow growth fo industrial sector: Could not face foreign competition as a reduction of import duties. Under utilisation of domestic capacity Dumping by foreigners

Ninth five-year plan (1997-2002 • This plan was a failure as the actual growth rate was only 5% as against 8% of target. • This plan allocated Rs. 69,972 cr for industry. • The internal and external factors are responsible for slowdown. • The failure can be attributed to the fall in public sector investment . • Lack of external demand resulting from slowdown in world economy decelerated the growth of industrial sector. Changes in Industrial Structure During the Planning Period (Misra & Puri – 479-481) • Increase in the Share of industrial Sector in GDP: • The share of industry in GDP at factor cost increased from 13.3% in 1950-51 to 24.6% in 2003-04. • Building up of Heavy and Capital Goods Industries: • Growth of Infrastructure Industries: Infrastructure industries include: i. Electricity ii. Coal iii. Steel iv. Crude petroleum v. Petroleum refinery vi. Cement  A Well Diversified Industrial Structure: o Machinery: 1950-59--- 1.2% 1990-99 --- 12.7% o Chemicals: 1950-59 --- 5.7% 1990-99 --- 12.4% o Non metallic Mineral products: 1.6% to 4.6% o Transport Equipment: 3.4% to 6.5% o Rapid Growth of Consumer Durables: o The rate of growth of this industry in 1980-85 was 14.4% and in 2003-04 was 11.6%. o Emphasis on Chemicals, Petrochemicals and Allied Industries in 1980s: o Emergence of Public Sector: 1950 – 5 PSUs with Capital of Rs.29 Crore


2003 – 227 PSUs with Capital of Rs. 4,18758 Crore Change in Industrial Structure in 1990s • Shifts in favour of consumer goods and intermediate goods • Structural changes within basic industries and capital goods industries • Changes within the consumer goods sector • Changes within the intermediate goods sector • Declining role of public sector Public Sector Enterprises Reference: Dutt and Sundaram – 188-204 B S Raman -- 213-221,HRK • The Industrial Policy Resolution of 1956 gave the public sector a strategic role in the Indian economy. • Public enterprises or public sector refers to that sector which is owned and managed by the central government or the state government or a body set up by the government to direct the undertaking in the public interest. • Forms or Types of Public Enterprises: i. Departmental undertakings : Railways, Defence, etc ii. Statutory Corporations : LIC, the Indian Airlines Corporations, etc iii. Government Companies : Heavy Electricals Ltd, HMT Ltd, etc iv. Holding Company : Steel Authority of India Ltd. Objectives of Public Sector a. To promote rapid economic development through creation and expansion of infrastructure b. To generate financial resources for development c. To create employment opportunities d. To promote redistribution of wealth and income e. To promote balanced regional growth f. To promote exports and import substitution g. To encourage SSIs Role of Public Sector in Indian Economy • Capital Formation • Development of Infrastructure • Development of Defence Industries • Development of Basic and Key industries: • Iron and steel, cement, etc • Development of Power projects • Development of Banking and Insurance • Balanced Regional development • Balanced Economic Growth • Strong Industrial Base


• • • • • • • • •

Economies Of Scale Removal of Regional Disparities Import Substitution Export Promotion Expansion of Employment Opportunities Source of Revenue to the Government Saving in Foreign Exchange Better Allocation and Utilisation of Resources Diversity of Projects

Problems and Shortcomings of the Public Sector o Mounting Losses o Price Policy of Public Enterprises o Delay in Completion of the Projects o Increase in Costs of Construction o Poitical factors influence decision about Location o Over-Capitalization o Under-Utilization of Capacity o Unfavourable Input-output Ratio o Use of Manpower Resources in excess of actual requirements o Faulty Planning and Controls o Inefficient Management o Bureaucratic Procedures and Red-tapism o Labour Problem resulting in Strikes and Lockouts o Higher Capital Intensity -- Low Employment Generation o Shortage of Raw materials and Power Remedies / Measures to be taken for the Performance of Public Sector o Reduction in Unproductive Expenditure o Utilisation of Installed Capacity o Better Utilisation of manpower and materials o Proper Planning and Control o Improvement of Efficiency of Management o Suitable Price Policy o Making them Autonomous o Improvement of Industrial Relations o Motivation of Staff and Workers Joint Sector Reference: D&S-222-226,B S Raman- 224-225 • • Joint Sector Enterprises refer to economic enterprises or industries which are owned and managed jointly by the Government and the Private sector. Ex: Madras Fertilizers, the Cochin Refineries, etc.


Rationale behind Joint Sector Enterprises: To combine the financial resources of the Government with the managerial skill of the private entrepreneurs for the successful running of the economic enterprises. Types of Joint Sector Enterprises 1. Existing Private Enterprises : through the conversion of bonds or debentures into equity shares. 2. Existing Public Sector : through the sale of equity shares of such enterprises to private entrepreneurs. 3. New enterprises set up by the Government jointly with the Private entrepreneurs. Role / Benefits of Joint Sector Enterprises in India a. Social Control over Industries b. Better Industrial Growth c. Broad-basing of Industrial Entrepreneurship d. Prevent monopolies and concentration of Economic power e. Mobilisation of Financial Resources f. Mobilisation of Techno-managerial Resources g. State-sponsored Industrialisation h. Extension of Public Control i. Failure of Public and Private Sectors j. Acceleration of Economic Growth k. Run on Efficient lines and earn sufficient Profits l. Effective instrument for ensuring Balanced Regional Growth Private Sector Dutt & Sundaram – 217-221 B S Raman – 222-224 • • • Private Sector or Private Enterprises refers to that sector which is owned and managed by private individuals. A private enterprise is controlled either by an individual investor or a joint stock company or a group of individuals or public or private limited companies. Private sector is purely profit motive.

Role of Private Sector in India 1. Help third world countries in their economic development 2. Agriculture : this sector which is completely managed by the private enterprises contributes 25% of GNP an 60% of employment in 2001. 3. Dominates the Trading Sector 4. Dominant in forestry, fishing, railways, construction, etc. 5. Contribution to national income of country 6. Development of large no. of small scale and cottage industries 7. Production of a variety of goods 8. Efficient management Limitations Of Private Sector 26


Emphasis on Non-priority Industries Emergence of monopoly power and concentration Industrial disputes Industrial sickness Small Scale Industries (SSI) Misra & Puri – 571-585  Small-scale industries are industries which are organised on a small-scale and produce goods with the help of small machines, hired labour and power.  The investment limit for a SSI is Rs 1 crore  SSIs plays a pivotal role in India in terms of employment and growth has recorded a high rate of growth.

Significance of SSIs in the Economic Development of India 1. Expansion of SSI sector and its share in Industrial Output :  No of SSI units rose from 79.6 lakhs in 1994-95 to 114.0 lakhs in 2003-04.  The rate of growth of output exceeded 10% from 1994 to 1997. 2. Employment Generation: 1994-95 – 191.4 lakh people 2003-04 – 271.4 lakh people 3. Efficiency of Small-Scale Industries: At the all-India level, the SSI is more efficient than the large scale sector. 4. Equitable distribution of National Income 5. Mobilisation of capital and Entrepreneurial Skills 6. Regional dispersal of Industries 7. Contribution to Exports 8. Sustains Agricultural Development 9. Less Industrial Disputes 10. Decentralisation of Industries 11. Contribution to National Income 12. Foreign Exchange Earnings Problems of SSIs Misra & Puri – 582-585 i. ii. iii. iv. v. vi. vii. viii. ix. x. Finance and Credit Inverted tariff structure and raw material availability Machines and other equipment Problems of marketing Infrastructural constraints Delayed payments Problem of sickness Poor database Adverse effects of economic reforms and globalisation Inefficient management


xi. xii.

Competition from large scale industries Burden of local taxes

Measures to Reduce Sickness among SSI  Credit and Finance  Marketing Assistance  Allocation of Raw materials, Imported Component and Equipment  Technical Assistance  Industrial Estates Small-scale Industrial Policy,1991 Misra & Puri-579 The main features of policy were: 1. Investment for Tiny Enterprises was raised from Rs.2 lakh to Rs.5 lakh. 2. Proposed a separate package for the promotion of SSIs. 3. Provided Equity Participation by other industrial units in the SSIs not exceeding 24% of the total shareholdings. 4. Introduction of new Legal form of organisation of business, namely restricted or limited partnership. 5. Proposed to meet the entire credit demand of SSIs. 6. Scope of National Equity Fund and Single Window Scheme was enlarged. 7. Provided priority to SSIs in the Government Purchase Programme. 8. Accorded in allocation of indigenous raw materials. 9. Envisaged market promotion of SSI products to be undertaken by Cooperatives, PSUs and other agencies. 10. Proposed a scheme of Integrated Infrastructure Development for SSI to facilitate location of industries and to promote co-ordination b/w Industry and agriculture. Multinational Corporations Ishwar C Dingra – 552-560  An MNC is one which undertakes FDI, i.e., it owns or controls income generation assets in more than one country, and in doing so produces goods or services outside its country of origin ,i.e, engages in international production.

Characteristics of MNCs The MNCs are multi-process, multi-product and multi-national composite enterprises. 1. Giant size 2. International Operations 3. Oligopolistic Character 4. Spontaneous Evolution 5. Collective Transfer of Resources Significance Of MNCs Impact area 1. Capital Potential benefits 1. Provision of scarce capital 28

2. Technology 3. Exports and balance of payments 4. Diversification

resources. 2. Provision of sophisticated technology not available in host country 3. Access to superior distribution and marketing systems 4. MNCs command technology and skill required for diversification of industrial base and for the creation of backward and forward linkages 1. Insignificant net flow Large dividend remittances Large technical payments 2. Costly ‘over-import’ Problems with advanced technology Problems with technical support 3. Higher import propensity than domestic companies Negative BOP effects 4. Increased foreign influence in key sectors

Actual impact of MNCs 1. Capital 2. Technology 3. Exports and balance of payments 4. Diversification

Module – 7 - Money and Banking Commercial Banking Structure In India • Indian commercial banks are called Joint Stock Banks as they are organized in the form of joint stock companies. • Under the Reserve bank Of India Act,1934, the commercial banks in India are classified into: i. Scheduled Commercial banks ii. Non-scheduled Commercial Banks Scheduled Commercial Banks • Scheduled commercial banks are those banks which are included in the second schedule of the Reserve Bank of India, having a paid-up capital and reserve together Rs.5 lakh and above. • As on March 2004, there were 286 schedule commercial banks in the country Non-scheduled Commercial Banks • Non-scheduled banks are those whose total paid-up capital and reserve fund is less than Rs.5 lakh and whose name is not included in the second schedule of RBI 29

Act,1934. At present, there are only two non-scheduled banks in the country.

Diagrammatic Representation

Diagrammatic Representation
Scheduled Commercial Banks
Public sector banks Nationalised banks SBI and its associates Private sector banks Indian private sector banks New private sector banks Foreign banks

Old private sector banks

Nationalisation Of banks • Nationalisation of banks is nothing but the government taking control of those banks which were owned by private people. • This was the milestone in the history of Indian Banking. • There are 20 nationalised banks which carry out 90% of banking business in the country. Nationalisation on 19 July 1969 1. Central Bank of India 2. Bank of India 3. Punjab National bank 4. Bank of Baroda 5. United Commercial Bank 6. Canara Bank 7. United Bank of India 8. Dena Bank 9. Syndicate Bank 10. Union Bank Of India 11. Allahabad Bank 12. Indian Bank 13. Bank of Maharashtra 14. Indian Overseas Bank Nationalisation on 15 April 1980


1) 2) 3) 4) 5) 6)

New Bank of India Vijaya Bank Andhra Bank Corporation Bank Punjab and Sidh bank Oriental Bank of Commerce

Causes of Nationalisation a. Concentration of Economic Power b. Neglect of Agricultural Sector c. Misuse of Power by Directors d. Credit to Anti-social Elements e. Neglect of Small Units f. Plan Objectives Ignored g. Insufficient Mobilisation of Resources h. Unbalanced Growth Objectives of Nationalization  To prevent concentration of wealth and economic power in the hands of few people.  To prevent control and administration of banks by few people  To prevent misuse of funds  To provide required finance to priority sectors  To provide banking facilities to unbanked and rural areas  To provide deposit security to deposit holders  To mobilise resources of the country  To make the banks respond to plan objectives  To bring banks under the control of RBI  To prevent the flow of bank credit to anti-social elements  To provide atmosphere for balanced growth of banking in the country. Arguments Against Nationalisation a. Results in the political interference in the functioning of banks. b. Leads to bureaucratic dictatorship. c. Results in inefficiency d. Banks suffer losses e. Results in corruption f. Leads to flow of funds to unworthy sectors g. Results in the disclosure of banking secrets Achievements Of Nationalisation  Branch Expansion In 1969 – 8,260 bank branches In 2002 – 67,284 bank branches  Deposit Mobilisation


 

   

In 1969 – 4,665 crores In 2002 – 16,22,579 crores Developmental Functions Finance to Priority Sectors In 1969 – 505 crores (2% of total bank credit) In 2002 – 3,41,291 crores (43.7%) Increase in Total Transactions In 1969 – 4,664 crores of Deposits In 2002 – 12,59,128 crores of Deposits Differential Rate of Interest Profit Making During 1999-2000 – Rs.13,064 crores of profits. Safety Finance to Public Sectors

Functions of the Reserve Bank of India • Bank of Issue • Banker to Government • Bankers’ Bank and lender of the last resort • Controller of Credit a. Quantitative Methods 1. Bank rate 2. Variable cash reserve ratio (CRR) 3. Statutory liquidity ratio (SLR) 4. Open market operations (OMO) b. Qualitative Credit controls/selective credit control 1. Minimum margin for lending 2. Ceiling on amount of credit 3. Discriminatory rate of interest • Custodian of Foreign Exchange Reserves • Supervisory Functions • Promotional Functions Recommendations of the Narasimhan Committee, 1991 Reference: Dutt and Sundaram Pg:853 • Aimed At : 1. Ensuring a degree of operational feasibility 2. Internal autonomy for the public sector banks in their decision making process 3. Greater degree of professionalism in banking operations

Important Recommendations : 1. Directed Investment a. Statutory Liquidity Requirements: The committee recommended that the government should reduce SLR from 32

38.5% to 25%. b. Cash Reserve Ratio CRR should be reduced from 15% to 3-5%. 2. Directed Credit Programmes 3. The Structure Of Interest rates 4. Structural Reorganization of the Banking Structure 5. Nationalisation of banks 6. Setting up of New banks Foreign Banks 8. Bad and Doubtful Debts 9. Removal of Dual Control 10. Autonomy to Banks 11. Disinvestment 12. Rural Banking Subsidiaries 13. Recruitment of Staff 14. Computerization Reform Of the Banking Sector Dutt and Sundaram Pg:855 1. Statutory Liquidity Ratio (SLR) SLR on incremental net demand and time liabilities (DTL) has been reduced from 38.5% to 25% in 1997. 2. Cash Reserve Ratio (CRR) RBI reduced CRR from 15% to 5.5% in 2001. the purpose was to release funds locked up with RBI for lending to the industrial sectors . 3.Deregulation of Interest Rates Interest rates slabs were gradually reduced from 20 to 2 by 1995. 4. Prudential Norms The purpose was that commercial banks should reflect their financial positions more accurately and in accordance with international accounting practices. 5. Capital Adequacy Norms: were fixed at 8% by RBI in 1992. 6. Access to Capital Market: SBI was the first to raise through public issue over Rs. 1,400 crores as equity and Rs. 1,000 crores as bonds. 7. Freedom of Operation 8. New Private Sector Banks 9. Local Area Banks: LABs help to mobilise rural savings and to channelise them into investment in local areas. 10. Supervision of Commercial Banks RBI has set up a Board of Financial Supervision with an Advisory Council under the chairmanship of the Governor to strengthen the Supervisory and Surveillance system of


banks and FIs 11. Recovery of Debts: The Government of India passed “Recovery of Debts due to banks and FIs Act, 1993”. Six Special Recovery Tribunal have been set up. 12. Phasing out of Directed Credit 13. Competition Measures of Money Supply Reference : Ahuja – 301--303 From April 1977, the Reserve Bank of India has adopted four concepts of money supply in its analysis of the quantum of and variations in money supply. The four concepts of money supply are: 1. Money Supply M1 or Narrow Money 2. Money Supply M2 3. Money Supply M3 or Broad Money 4. Money Supply M4 Money Supply Chart

• •

Money Supply Chart
Money Supply and its determinants

M1 = Currency + Demand Deposits + Other deposits of RBI

M2 = M1 + Savings deposits with Post-office Savings Banks

M3 = M1 + Time Deposits with the Banks

M4 = M3 + Total Deposits of Post Office Savings Organisation (excluding NSC)

Money Supply M1 or Narrow Money • Liquid measure of money supply • M1 = C + DD + OD • C = Currency with the public • DD = Demand deposits with the public in the commercial and Co-operative Banks • OD = Other deposits held by the public with the Reserve Bank of India • C (Currency with the Public) consists of the following: 1. Notes in Circulation 2. Circulation of rupee coins asa well as small coins 3. Cash Reserves on hand with all banks


Money Supply M2 • M2 = M1 + Savings Deposits with the post office savings bank • M2 is a broader concept of money supply Money Supply M3 or Broad Money • M3 = M1 + Time deposits with the banks • Time deposits serve as store of value and represent savings of the people • Time deposits are very liquid. • M3 has become a popular measure of one supply. • M3 is used for monetary planning of the economy and setting target of growth of money supply. • M3 also called as Aggregate Monetary Resources (AMR). Money Supply M4 M4 = M3 + Total deposits with Post Office Savings Organization. Sources of Broad Money (M3) or Factors affecting Money Supply In India (Dutt & Sundaram-823) • There are Five Factors / sources which contribute to the Aggregate Monetary Resources in the country: 1. Net Bank Credit to Government (A+B) A. RBIs net credit to Government i. Claims on Government ii. Govt deposits with RBI B. Other Bank’s credit to Government 2. Bank Credit to Commercial Sector ( A+B) A. RBIs credit to commercial sector B. Other bank’s credit to commercial sector 3. Net Foreign Exchange Assets of Banking Sector (A+B) A. RBIs net foreign exchange assets B. Other bank’s net foreign exchange assets 4. Government’s Currency Liabilities to the Public 5. Net Non-monetary Liabilities of the Banking Sector (A+B) A. Net Non- monetary liabilities of RBI B. Net Non- monetary liabilities of banks. Thus, M1 = 1+2+3+4+5 Monetary Policy Of the RBI / Measures of Control Imposed by RBI to Regulate Monetary Systems in India (Dutt and Sundaram – 902) Controlled expansion ( 1951-72) RBIs Anti- Inflationary Monetary Policy since 1972. Entry of RBI into Foreign Exchange Market Major weapons of Monetary Policy / Control Measures 35

• • •

• Credit Control: 1. General Credit Controls a. Bank rate b. Cash reserve ratio c. Statutory Liquidity Requirements d. Open market Operations Of RBI 2. Selective and Direct Credit Controls • Credit Authorization Scheme (CAS) • Credit Monitoring Arrangement (CMA)

Module 8 CURRENT ECONOMIC ISSUES TOPICS • PUBLIC ACCOUNTS COMMITTEE • COMPTROLLER AND AUDITOR GENERAL PUBLIC ACCOUNTS COMMITTE Composition  The Public Accounts Committee consists of fifteen Members elected by Lok Sabha every year


 Seven members of Rajya Sabha elected by that House in like manner are associated with the Committee Appointment of Chairman The Chairman of the Committee is appointed by the Speaker from amongst the members of Lok Sabha elected to the Committee. As a convention, starting from the Public Accounts Committee of 1967-68, a member of the Committee belonging to the main opposition party/group in the House is appointed as the Chairman of the Committee A Minister is not eligible to be elected as a member of the Committee and if a member, after his election to the Committee, is appointed as a Minister, he ceases to be a member of the Committee from the date of such appointment The term of office of the members of the Committee is one year FUNCTIONS  The Public Accounts Committee examines the accounts showing the appropriation of the sums granted by Parliament to meet the expenditure of the Government of India  Committee also examines the various Audit Reports of the Comptroller and Auditor General on, expenditure by various Ministries/ Departments of Government and accounts of autonomous bodies.  To ascertain that money granted by Parliament has been spent by Government "within the scope of the demand".  The Committee examines various aspects of Government’s tax administration.  The Committee identifies loopholes in the taxation laws and procedures and make recommendations in order to check leakage of revenue. COMPTROLLER AND AUDITOR GENERAL  The Comptroller and Auditor General of India is the head of the Indian Audit and Accounts Department  CAG is an office which directs, monitors and controls all activities concerned with audit, accounts and functions of the Department  Offices of the Accountants General (Audit) are responsible for audit of all receipts and expenditure of the State governments and audit of State Government companies, corporations and autonomous bodies  Offices of the Principal Directors of Audit are responsible for audit of the activities of the Union Government including Defence, Railways ,Postal, Telecommunications etc.. The present Comptroller and Audit General of India is Mr. Vijayendra.N.Kaul FUNCTIONS 37

1. He can engage consultants and/or obtain professional services in conducting audit 2. He can make rules for maintenance of accounts 3. Make regulations for carrying out the provisions relating to the scope and extent of audit 4. To supervise and regulate external auditors' work under the Indian Companies Act 5. Appointment of external auditors. 6. Access the computer systems of the auditees and suggest changes if any. 7. CAG assists the Public Accounts Committee in examination of Accounts and Audit reports. COMMITTEE ON PUBLIC ACCOUNTS 8. 15 members elected from lok sabha by every year 9. 7 are elected from rajya sabha to associate with the committee Process of electing  Appointment of chairman  Minister not to be Member of Committee Term of the office Functions      Showing the appropriate of sums Examines the audit reports Usage of money Identifies loopholes in taxation laws Recommends in order to check leakage of revenue

Functions • Showing the appropriate of sums • Examines the audit reports • Usage of money • Identifies loopholes in taxation laws • Recommends in order to check leakage of revenue • Assistance by comptroller • Sub-committees • Evidence of officials • Ministers are not called before committee  Reports  Action taken on reports Public Disinvestment Board


Privatisation v/s disinvestment • The words privatisation and disinvestment are often used interchangeably. • Disinvestment leads to privatisation when the Government held equity is reduced to a level when the company no longer remains a Government company Privatisation has different nomenclature in different countries • Disinvestment. • Peopalisation. • Popular capitalism . • Denationalisation. • Prioritisation. • Industrial transition. • Economic democratisation. • Partners in development. • Transformation and restructuring. Objectives of Ministry of Disinvestment • Releasing the large amount of public resources locked up in the non-strategic PSEs for re-deployment in areas of high social priority. • To reduce the public debt. • Transferring the commercial risk to the private sector wherever it is willing to. • Releasing other tangible & intangible resources such as man power etc. Emergence of disinvestment policy • Industrial policy 1991. • Rangarajan Committee 1993. • Disinvestment commission recommendations 1999. • Budget speech: 1998-99. • Budget speech: 2000-01. Strategic and non-strategic classification • Arms and ammunitions. • Atomic energy. • Railway transport. • All other public sector enterprises to be considered as non-strategic. The Department of Disinvestment • The Department of Disinvestment was formed on the10th December 1999. • With a view to establish a systematic policy approach to disinvestment and privatisation. • To give a fresh impetus to the Government’s disinvestment programme. TARGETED AND ACTUAL DISINVESTMENT YEAR TARGET ACTUAL RECEIPTS RECEIPTS 39

1991-92 1993-94 1994-95 1995-96 1996-97 1997-98 1999-00 2000-01 2002-03 2003-04

2500 3500 4000 7000 5000 4800 10000 10000 12000 14500

3038 NIL 4853 362 380 902 1829 1870 3348 15547

Economic Survey (2004-05 Changing profile of PSUs PSUs Net profit 01-02 ONGC IOC SAIL GAIL SCI BSNL 6198 2885 -304 1186 242 5740 Net profit 02-03 10529 6115 1498 1739 275 1444

All through the years now  The Government’s approach to PSUs has a three-fold objective: • revival of potentially viable enterprises • closing down of those PSUs that cannot be revived and • bringing down Government equity in non-strategic PSUs to 26 percent or lower Government’s promise Government would continue to ensure that disinvestment does not result in alienation of national assets, which, through the process of disinvestment, remain where they are. It will also ensure that disinvestment does not result in private monopolies. Criticisms • Privatisation of profit making public enterprises. Mr. George Fernandes in NDA Govt. • Basic criticism – that the funds raised by selling family silver were used to pay the butler. To set up disinvestment proceeds fund. • Methodology for disinvestment. 40

Open auction sale during 94-95 to allow NRIs to participate in the offer. • Creation of private monopoly in place of public monopoly. Public sector monopoly is accountable for the parliament but private need not be…… • Valuation of PSUs slated for disinvestment. Eg: PAC quantified the loss to be of the order of Rs.3000 crores in 91-92 out of Rs.4950 crores raised. Disinvestment policy and the future of PSUs The recent changes in the culture of the PSUs as mentioned above also reinforces the fact that by disinvesting highly profitable PSUs, the government is trying to kill the goose which lays golden eggs. OPERATING LEVERAGE • % change in operating revenue will be more than the % change in sales (FC remains the same) • Any increase in sales, FC remaining the same, will magnify the operating revenue formulas…… contribution = sales- VC operating profit (EBIT) = sale - VC – FC or OP = contribution – FC

Example Following is the cost information of a firm: FC = 50,000 VC = 70% of sales Sales = 2,00,000 in previous year 2,50,000 in current year Find out % change in sales and operating profits when: i) FC are not there (no leverage)


ii) FC are there ( with leverage) Solution: (i) Sales Less: VC(70% of sales) Profit from operations (ii) Sales Less ; VC(70% of Sales) Contribution Less : FC Profit from operations Previous year (Rs) 2,00,000 1,40,000 60,000 Previous year (Rs) 2,00,000 1,40,000 60,000 50,000 10,000 Current year (Rs) 2,50,000 1,75,000 75,000 Current year (Rs) 2,50,000 1,75,000 75,000 50,000 25,000 % change (Rs) 25 % 25 % 25 % % change (Rs) 25 % 25 % 25 % 150 %

Comments: • In case (i) %change in sales & %change in OP is the same i.e. 25% • In case (ii) % change in profit (150%) is much more than the %change in sales (25%). • The FC element has helped in increasing profits. COMPOSITE LEVERAGE • Operating leverage affects the income which is the result of production • Financial leverage is the result of financial decisions • Composite leverage focuses attention on the entire income of the concern Composite Leverage = operating leverage * financial leverage. EX: The following figures relate to two companies P LTD Q LTD Sales 500 1000 Variable costs 200 300 Contribution 300 700 Fixed costs 150 400 150 300 Interest 50 100 Profit before tax 100 200 i) Calculate the OL, FL, CL. ii) Comment on the relative risk position of them.


Calculation of Leverages P.Ltd O.P = contribution EBIT F.L = EBIT EBT C.L = OL*FL 300 150 =2 150 100 = 1.5 300 100 =3 700 300 =2.333 300 200 = 1.5 700 200 = 3.5 Q.Ltd

a) OL : As the OL for Q Ltd is higher than that of P Ltd ; Q ltd has a higher degree of operating risk. The tendency of profit to vary disproportionately with sales is higher for Q Ltd as compared to P Ltd. b) F.L : Since FL for the two companies is the same both the companies have the same degree of financial risk, i.e. the tendency of net disproportionately is the same for P Ltd and Q Ltd. C) C.L : As the combined leverage for Q Ltd is higher than P Ltd has overall higher risk as compared to P Ltd.


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