ECONOMIC ENVIRONMENT OF BUSINESS

MACROECONOMICS

Scope & Importance of Macroeconomics

To Understand the Working of the Economy: The study of macro-economic variables is

indispensable for understanding the working of the economy. Our main economic problems
are related to the behavior of total income, output, employment and the general price level in
the economy. These variables are statistically measurable, thereby facilitating the possibilities
of analyzing the effects on the functioning of the economy.

Framing Economic Policies: Macroeconomics is extremely useful from the point of view of
economic policy. Modern governments, especially of the underdeveloped economies are
confronted with many national problems. There are problems of overpopulation, inflation,
balance of payments, general underproduction, etc. The responsibility of the governments
rests in the regulation and control of overpopulation, general prices, general volume of trade,
general outputs, etc. Working with macroeconomic concepts is necessary to solve the existing
problems.

To Study Problem of Unemployment: According to the Keynesian theory of employment,

level of employment in an economy depends upon effective demand. Unemployment is
caused by deficiency of effective demand. To eliminate it, effective demand should be raised
by increasing total investment, total output, total income and total consumption. Macroecono-
mics has special significance in studying (he causes, effects and remedies of general
unemployment.

To Study National Income: The study of macroeconomics is very important for evaluating
the overall performance of the economy in terms of national income. With the advent of the
Great Depression of the 1930s, it became necessary to analyze the causes of general over-
production and general unemployment. This led to the construction of the data on national
income. National income data help in forecasting the level of economic activity and to
understand the distribution of income among different groups of people in the economy.

Study of Economic Growth: The economics of growth is also a study in Macroeconomics.

It is on the basis of macroeconomics that the resources and capabilities of an economy are
evaluated. Plans for the overall increase in national income, output and employment are
framed and implemented so as to raise the level of economic development of the economy as
a whole.

Understanding Monetary Problems: It is in terms of macroeconomics that monetary

problems can be analyzed and understood properly. Frequent changes in the value of money
—inflation or deflation—affect the economy adversely. They can be counteracted 'by
adopting monetary, fiscal and direct control measures for the economy as a whole.
Understanding Business Cycles: Further macroeconomics as an approach to economic
problems started after the Great Depression. Thus its importance lies in analyzing the causes
of economic fluctuations and in providing remedies.

FINANCIAL MARKETS

Financial Markets: Financial markets are a mechanism enabling participants to deal in financial
claims. The markets also provide a facility in which their demands and requirements interact to set a
price for such claims. The main organized financial markets in India are the money market and capital
market.

a. Money Market Money market is a market for dealing in monetary assets of short-term nature,
generally less than one year. It refers to that segment of the financial market which enables the
raising up of short-term funds for meeting temporary shortages of cash and obligations and the
temporary deployment of excess funds for earning returns. The major participants are the RBI and
commercial banks. Money market organization/structure consists of a number of interrelated sub-
markets, that is. Call market, Treasury-bills market. Commercial bills market, Commercial papers
(CPs) market, Certificate of deposits (CDs) market, Money market mutual funds (MMMFs) and
Repo (repurchase) market and so on.

b. Capital Market A capital market is a market for long-term securities (equity and debt). Its focus
is on financing of fixed investment in contrast to money market which is the institutional source of
working capital finance. A capital market can be further classified into primary and secondary
markets. The primary market is meant for new issues and the secondary market is a market where
outstanding issues are traded. In other words, the primary market creates long-term instruments
for borrowings, whereas the secondary market provides liquidity through the marketability of
these instruments. The secondary market is also known as the stock market, The main par-
ticipants in the capital market are mutual funds, insurance organizations, foreign institutional inves-
tors, corporate and individuals.

MONEY MARKET

The money market is a market for financial assets that are close substitutes for money. It is a
market for overnight to short-term funds and instruments having a maturity period of one or less
than one year. It is not a place (like the Stock Market), but an activity conducted by telephone.

The characteristics of the money market are:

1. It is not a single market but a collection of markets for several instruments

2. It is a wholesale market of short-term debt instruments
3. Creditworthiness of the participants is important

The main players are: Reserve Bank of India (RBI), Discount and Finance House of India (DFHI),
mutual funds, banks, corporate investors, non-banking finance companies (NBFCs), state
governments, provident funds, primary dealers, Securities Trading Corporation of India (STCI),
public sector undertakings (PSUs), non-resident Indians and overseas corporate bodies.
 1. It is a need-based market which depends on demand and supply of money.
2. It is dichotomous in nature consisting of organized and unorganized sector
3. Unorganized Sector consisting of Money Lenders, Nidhis, Chit funds etc.
4. RBI occupies a strategic position in Indian Money market- acts as a regulator
Role of the Reserve Bank of India in the Money Market

The central bank is an important constituent of the money market due to its role as a lender of
last resort to banks which form a sizable segment of the money market. By regulating the
cost and quantum of lendable resources of banks, central banks transmit monetary policy
signals to the economy through the money market. Hitherto, Cash Reserve Ratio (CRR) and
Open Market Operations (OMO) have been used by the RBI as important instruments for
monetary management. The Reserve Bank of India is the most important constituent of the
money market. The market comes within the direct purview of the Reserve Bank regulations.

The aims of the Reserve Bank's operations in the money market are:

1. to ensure that liquidity and short-term interest rates are maintained at levels consistent with
the monetary policy objectives of maintaining price stability;
2. to ensure an adequate flow of credit to the productive sectors of the economy;
3. To bring about order in the foreign exchange market.

The Reserve Bank influences liquidity and interest rates through a number of operating instruments
— cash reserve requirement (CRR) of banks, conduct of open market operations (OMOs), repos,
change in bank rates and, at times, foreign exchange swap operations.

Money Market Instruments

Call Money Market

It is by far the most visible market as the day-to-day surplus funds, mostly of banks, are traded there.
The call money market accounts for the major part of the total turnover of the money market. It is a
key segment of the" Indian money market. Since its inception in 1955-56, the call money market
has registered a tremendous growth in volume of activity.

The call money market is a market for very short-term funds repayable on demand and with a
maturity period varying between one day to a fortnight. When money is borrowed or lent for a day, it
is known as call "(overnight) money. When money is borrowed or lent for more than a day and up
to 14 days, it is known as notice money. No collateral security is required to cover these transactions.
The call money market is a highly liquid market, highly risky and extremely volatile as well. It is
basically an over the counter (OTC) market without the intermediation of brokers.

Call money is required mostly by banks. Banks mainly borrow in this market for the following
purposes:

1. To fill the gaps or temporary mismatches in funds

2. To meet the CRR & SLR mandatory requirements as stipulated by the Central bank
3. To meet sudden demand for funds arising out of large outflows.
Repo

Repo is a money market instrument enabling the smooth adjustment of short term liquidity
among varied market participants such as banks and financial institutions . Repo refers to a
transaction in which a participant acquires immediate funds by selling securities and simultaneously
agrees to the repurchase of the same or similar securities after a specified time at a specified price. It
enables collateralised short-term borrowing and lending through sale/purchase operations in debt
instruments. It is a temporary sale of debt involving full transfer of ownership of the securities.
Repo is also referred to as a ready forward transaction as it is a means of funding by selling a security
held on a spot basis and repurchasing the same on a forward basis.

Reverse repo is exactly the opposite of repo—a party buys a security from another party with a
commitment to sell it back to the latter at a specified time and price. In other words while for one
party the transaction is repo (seller), for another party it is reverse repo (buyer). Reverse repo is
undertaken to earn additional income on idle cash.

The difference between the price at which the securities are bought and sold is the lender's profit
or interest earned for lending the money. It signifies lending on a collateral basis. It is also a good
hedge tool because the repurchase price is locked in at the time of the sale itself.

The factors which affect the repo rate are the credit worthiness of the borrower, liquidity of
the collateral and comparable sales of other money market instruments.

Importance of Repos:

 Repos are safer than pure call/notice/term money and inter-corporate deposit markets which
are non-collateralized. Thus, the counter party risks are minimum.

 They can be utilized by central banks as an indirect instrument of monetary control for
absorbing or injecting short-term liquidity. Repos help maintain an equilibrium between
demand and supply of short-term funds. Monetary authorities can transmit policy signals
through repos to the money market which has a significant influence on the government
securities market and foreign exchange market.

Uses of Repo

 It helps banks to invest surplus cash

 It helps investor achieve money market returns with sovereign risk.
 It helps borrower to raise funds at better rates
 An SLR surplus and CRR deficit bank can use the Repo deals as a convenient way of
adjusting SLR/CRR positions simultaneously.
 RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the
system.
Treasury Bills

Treasury Bills are short-term instruments issued by the Reserve Bank on behalf of the government
to tide over short-term liquidity shortfalls. This instrument is used by the government to raise short-
term funds to bridge seasonal or temporary gaps between its receipts (revenue and capital) and
expenditure. Since April 1997 adhoc treasury bills have been replaced a system of Ways and Means
Advances from to accommodate temporary mismatches in the government of India receipts and
payments.

T-hills are repaid at par on maturity. The difference between the amount paid by the tenderer at the
time of purchase (which is less than the face value) and the amount received on maturity
represents the interest amount on T-bills and is known as the discount. Tax deducted at source
(TDS) is not applicable on T-bills. Being a risk free instrument their yields at various maturities
serve as a benchmark and help in pricing instruments in market T-Bill market. It is RBI’s most
preferred tool for intervention to influence liquidity and short term interest rates. Its development
is a pre-requisite for effective OMOs

Banks, Primary Dealers, State Governments, Provident Funds, Financial Institutions, Insurance
Companies, NBFCs, FIIs (as per prescribed norms), NRIs & OCBs can invest in T-Bills.

Commercial Paper

A commercial paper is an unsecured short-term promissory note, negotiable and transferable

by endorsement and delivery with a fixed maturity period. It is generally issued at a discount by
the leading creditworthy and highly rated corporates. Depending upon the issuing company, a
commercial paper is also known as Finance paper, industrial paper, or corporate paper.

Initially only leading, highly rated corporate could issue a commercial paper. The issuer base has
now been widened to broad-base the market. Commercial papers can now be issued by primary
dealers, satellite dealers, and all-India financial institutions, apart from corporate, to access short-
term funds.

A commercial paper can be issued to individuals, banks, companies, and other registered Indian
corporate bodies and unincorporated bodies. Non-resident Indians can be issued a commercial
paper only on a non-transferable and non-repatriable basis. Banks are not allowed to underwrite
or co-accept the issue of a commercial paper. It is usually privately placed with investors, either
through merchant bankers or banks. A specified credit rating of P2 is to be obtained from credit
rating agencies.

It is issued as an unsecured promissory note or in a dematerialized form at a discount. The discount is

freely determined by market forces. The paper is usually priced between the lending rate of
scheduled commercial banks and a representative money market rate.

Corporate are allowed to issue CPs upto 100 per cent of their fund-based working capital limits.
The paper attracts stamp duty. No prior approval of the Reserve Bank is needed to issue a CP and
underwriting the issue is not mandatory.
Commercial Bills

The working capital requirement of business firms is provided by banks through cash-
credits/overdraft and purchase/discounting of commercial bills.

Commercial bill is a short-term, negotiable, and self liquidating instrument with low risk. It enhances
the liability to make payment on a fixed date when goods are bought on credit. Bills of exchange are
negotiable instruments drawn by the seller (drawer) on the buyer (drawee) for the value of the goods
delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks,
they are called commercial bills. The bank discounts this bill by keeping a certain margin and credits
the proceeds. Banks, when in need of money, can also get such bills rediscounted by financial
institutions such as LIC, UTI, GIC, ICICI, and 1RBI. The maturity period of the bills varies from 30
days, 60 days, or 90 days, depending on the credit extended in the industry.

Commercial bill is an important tool to finance credit sales. It may be a demand bill or a usance
bill. A demand bill is payable on demand, that is, immediately at sight or on presentation to the
drawee. A usance bill is payable after a specified time.

Commercial bills can be inland bills or foreign bills. Inland bills must (a) be drawn or made in India
and must be payable in India; or (b) drawn upon any person resident in India. Foreign bills, on the
other hand, are (a) drawn outside India and may be payable in and by a party outside India, or may
be payable in India or drawn on a party in India: or (b) it may be drawn in India and made payable
outside India. A related classification of bills is export bills and import bills. While export bills are
drawn by exporters in any country outside India, import bills are drawn on importers in India by
exporters abroad.

Commercial bills can be traded by, offering the bills for rediscounting. Banks provide credit to their
customers by discounting commercial bills. This credit is repayable on maturity of the bill. In case
of need for funds, activity in the bills rediscounting market remained subdued and came down from
Rs 4,612 crore in 1991-92 to Rs 906 crore at the end of March 2002. This depicts the small size and
volume of the bills rediscounting market. Though the number of participants has been increased by the
Reserve Bank, the volume of activity is quite low.

Certificates of Deposit

Certificates of deposit are unsecured, negotiable, short-term instruments in bearer form, issued by
commercial banks and development financial institutions.

"Certificates of deposit were introduced in June 1989. Only scheduled commercial banks were allowed
to issue them initially. Financial institutions were permitted to issue certificates of deposit in 1992.
The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of
issue.

An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with
other instruments, viz., term money, term deposits, commercial papers and inter-corporate deposits
should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.
Certificates of deposit are time deposits of specific maturity similar to fixed deposits (FDs). The
biggest difference between the two is that CDs, being in bearer form, are transferable and tradable
while fixed deposits are not. Like other time deposits, certificates of deposit are subject to SLR and
CRR requirements. There is no ceiling on the amount to be raised by banks. The deposits attract
stamp duty as applicable to negotiable instruments. They can be issued to individuals, corporations,
companies, trusts, funds, associates, and others. NRls can subscribe to the deposits on non-repatriable
basis.

Money Market Mutual Funds

Money Market Mutual Funds (MMMFs) were introduced in April 1991 to provide an additional
short-term avenue for investment and bring money market investment within the reach of
individuals. These mutual funds would invest exclusively in money market instruments.

MMMFs bridge the gap between small individual investors and the money market. MMMF
mobilizes savings from small investors and invests them in short-term debt instruments or money
market instruments.

The Reserve Bank has been making several modifications to the scheme since 1995-96 to make it
more flexible and attractive to a larger investor base such as banks, financial institutions, and
corporate besides individuals. Modifications such as the removal of ceiling for raising resources,
allowing the private sector to set up MMMFs, permission to MMMFs to invest in rated corporate
bonds and debentures, reduction in the minimum lock-in period to 15 days, and so on are steps
towards making the MMMFs scheme attractive.

The growth in Mammas has been less than expected. Though, in principle, approvals were granted to
10 entities, only three MMMFs have been set up—one in the private sector—Kothari Pioneer Mutual
Fund, and the other two by IDBI and UTI. The total size of these funds is not very large.

The MMMFs, earlier under the purview of the Reserve Bank, come under the purview of the
SEBI regulation since March 7, 2000. MMMFs can grow only when the money market grows in
volume and acquires depth.

CAPITAL MARKET

Capital Market It is a market for long-term funds. Its focus is on financing of fixed investment
in contrast to money market which is the institutional source of working capital finance. The
main participants in the capital market are mutual funds, insurance organizations, foreign
institutional investors, corporate and individuals. The capital/securities market has two
segments:

(i) Primary/new issue market and

(ii) Secondary market/stock exchange(s)/market(s)
New Issue Market (NIM)/Primary Market

The NIM deals in new securities, that is, securities which were not previously available and
are offered to the investors for the first time. Capital formation occurs in the NIM as it
supplies additional funds to the corporate directly. It does not have any organizational set up
located in any particular place and is recognized only by the specialist institutional services
that it tenders to the lenders/borrowers (buyers/sellers) of capital funds at the time of any
particular operation. It performs triple-service function, namely; (i) origination, that is,
investigation and analysis and processing of new issue proposals; (ii) underwriting in terms of
guarantee that the issue would be sold irrespective of public response and (iii) distribution of
securities to the investors.

Secondary Market / Stock Exchange (SE)

The SE is a market for old/existing securities, that is, those already issued and granted SE
quotation/listing. It plays only an indirect role in industrial financing by providing liquidity to
investments already made. It has a physical existence and is located in a particular
geographical area. The SE discharges three vital functions in the orderly growth of capital
formation: (i) Nexus between savings and investments; (ii) Liquidity to investors by offering
a place of transaction in securities and (iii) Continuous price formation.

BUDGET

The word 'Budget’ means 'plans of government finances submitted for the approval of the
legislature'. The budget reflects what the government intends to do. The budget has become
the powerful instrument for fulfilling the basic objectives of the government. The budget
covers all the transactions of the central government.

Budget is a time bound financial program systematically worked out and ready for execution
in the ensuing fiscal year. It is a comprehensive plan of action which brings together in one
consolidated statement all financial requirements of the government. A rational decision to
allocate resources to satisfy different social needs require considerable thinking and planning.

Public Expenditure is most important component of Budget. The term 'public expenditure' is
used to designate the expenditure of government—central, state and local bodies. It differs
from private expenditure in that governments need not pay for themselves or yield a
pecuniary profit. Public expenditure plays the dual role of administration and economic
achievement of a nation.

The size and composition of government spending and the way in which it is financed
(including the types and levels of the various taxes) can have a significant impact on
important macro-economic variables such as aggregate production, income, employment,
price level and distribution of income.

The government budget has four major functions. Prof. Musgrave assigned the following
important functions to budget policy:
 i. Proper allocation of resources or the provision of social goods
ii. Equitable distribution of income and wealth
iii. Securing economic stability or full employment
iv. long-term economic growth

It implies that the objective of budget policy is to take corrective measures or to adopt
regulatory policies to remove imperfections or inefficiencies of market mechanism. Besides,
the objective of the budget policy is to make provision of social goods or the process by
which total resources are divided between private and social goods. It means that the
objective of budget policy is to ensure equitable distribution of income and wealth. This may
be termed as distribution functions. Third objective of budget policy is to maintain a high
level of employment, reasonable degree of price stability and an appropriate rate of economic
growth.

Public Revenue - Sources

The public revenue is the means for public expenditure. Various sources of public revenue
are: Tax revenue, Non-tax revenue, Capital receipts-internal debt and External loans

Increasing activities of the Government are the cause of increasing public expenditure.
Methods of public revenue and their volumes have significant impact on production and
distribution of wealth and income in the country. It has effects on the nature and volume of
economic activities and on employment. Broad classification of various government receipts
are shown below:

1. Tax Revenue
Direct Taxes : Income Tax, Corporate Tax
Indirect Taxes : Customs, Excise
2. Non-Tax Revenue Interest, Dividend, Profits of PSUs, External Grant.
3. Capital Receipts Recovery of Loan, Market Borrowing, External Assistance,
Disinvestment of PSUs
4. External Loans/Debts
BALANCE OF PAYMENT

Balance of Payment of a country is one of the important indicators for International trade,
which significantly affect the economic policies of a government. As every country strives to
a have a favorable balance of payments, the trends in, and the position of, the balance of
payments will significantly influence the nature and types of regulation of export and import
business in particular.

Balance of Payments is a systematic and summary record of a country’s economic and

financial transactions with the rest of the world over a period of time.

Structure of Balance of Payment :The structure of balance of payments is usually

composed of two accounts, viz. Current Account and Capital Account
1. The Current Account

The current Account gets splits up into two main sub accounts. Viz.

1. The Trade Account

2. The Service Account

The Trade Account: is also called as Merchandise Account; it is also called as visible
Account. The merchants trade with goods and hence it gets referred to as merchandise
account. Since goods are visible it gets referred to as visible account.

The Service Account: Along with goods services are also traded which is entered separately
in a separate account called service account. The services belong to the tertiary sector of an
economy hence it gets referred to as tertiary account. The services are invisible and hence it
also getting referred to as invisible account.

The services are of two types, via

1. Individual professional services rendered by the individual professionals like doctors,

teachers, singers, musicians, etc.
2. Services rendered by institutions like banking, fire, transportation, communication
etc.

Besides the two main sub accounts the Current Account also includes within its fold
unilateral transfer. These are the receipts which the residents of the country receive free of
change without having to make any payment in return either at present or in future. Receipt
from abroad are entered as positive item with the sign plus (+) while payments made to the
resident of the foreign country are entered as negative item with the sign minus (-). The
unilateral transfers include gifts, grouts, charities etc. The net value of balance of visible
accounts, invisible accounts and unilateral transfer points out balance on Current Account.

2. The Capital Account

The Capital Accounts records that international transaction which-involve residents of a

country concerned changing their assets or liabilities with the resident of the foreign country.
Very often a distinction is made between various forms of capital account transactions via
Direct Investment and Portfolio and direct investment.

Direct investment entails an act of purchasing an asset and acquiring a control over it.
Acquiring a house property in a firm of one country into another country having a full control
over it is a glaring example of private direct investment. Role of multinational corporations
can be cited in this regard, Portfolio investment on the other hand refers to acquisition of
assets like shares or bonds of a company in foreign country

Balance of Payments Disequilibrium

The balance of payments of a country is said to be in equilibrium when the demand for
foreign exchange is exactly equivalent to the supply of it. The balance of payments is in
disequilibrium when there is either a surplus or a deficit in the balance of payments. When
the debit exceeds the credit due to the excess of imports over export of current account items
a partial disequilibrium gets created. When there is a deficit in the balance of payments, the
demand for foreign exchange exceeds the demand for it.

Then a country brings about adjustment in the capital account transactions such that the
deficit in the current account transactions gets checkmated by the surplus in the capital
account.

The equilibrium in the balance of payments gets represented by an equation as follows:-

B = RI – PF = 0

RI stands for receipts accrue due to exports. PF stands for payments made to foreign
countries due to imports. The term 'Disequilibrium' in the balance of payments means
imbalance in the balance of payments. The disequilibrium in the balance of payments can
either be favorable or unfavorable ie surplus or deficit.

When Rf > Pf then it will lead to favorable disequilibrium in the balance of payments.
Conversely when Pf > Rf then it will lead to unfavorable disequilibrium in the balance of
payments. Unfavorable disequilibrium in the balance of payments presents a very sorry or
disturbing state of affair for the country concerned.

a) Correction of Disequilibrium
A country may not be bothered about a surplus in the balance of payments; but every
country strives to remove, or at least to reduce, a balance of payments deficit. A number
of measures are available for correcting the balance of payments disequilibrium.

b) Automatic Corrections- Exchange Depreciation

The balance of payment disequilibrium may be automatically corrected if the market
forces of demand and supply are allowed to have free play. For example, assume that
there is a deficit in the balance of payments. When there is a deficit, the demand for
foreign exchange exceeds its supply, and this result in an increase in the exchange rate
and a fall in the external value of the domestic currency. This makes the exports of the
country cheaper and its imports dearer than before. Consequently, the increase in exports
and the fall in imports will restore the balance of payments equilibrium.

The various deliberate measures may be broadly grouped into;

a. Monetary measures
b. Trade measures; and
c. Miscellaneous.

a) Monetary Measures

The important monetary measures are outlined below:

Monetary contraction- the level of aggregate domestic demand, the domestic price level
and the demand for imports and exports may be influenced by a contraction or expansion
in money supply and correct the balance of payments disequilibrium. The measure
 required is a contraction in money supply. A contraction in money supply is likely to
reduce the purchasing power and thereby the aggregate demand. It is also likely to bring
about a fall domestic prices. The fall in the domestic aggregate demand reduces demand
for imports. The fall in domestic prices is likely to increase exports. Thus, the fall in
imports and the rise in exports would help correct the disequilibrium.

Devaluation- Devaluation means a reduction in the official rate which one currency is
exchanged for another currency. Devaluation makes foreign goods costlier in terms of the
domestic currency, and this would discourage imports. On the hand, devaluation makes
exports (from the country that has devalued the currency) cheaper in the foreign markets.
A country with a fundamental disequilibrium in the balance of payments may devalue its
currency in order to stimulate its exports and discourage imports to correct the
disequilibrium. The success of devaluation, however, depends on a number of factors,
such as the price elasticity of demand for exports and imports.

Exchange Control - Exchange control is a popular method employed to influence the

balance of payments position of a country. Under exchange control, the government or
central bank assumes complete control of the foreign exchange reserves and earnings of
the country. The recipients of foreign exchange such as exporters are required to
surrender foreign exchange to the government/central bank in exchange for domestic
currency. By the virtue of its control over the use of foreign exchange, the government
can control the imports.

b) Trade Measures

Tariffs

Tariffs are the protective devices. Tariffs can be defined broadly as the schedule of
custom duties which include import duties, export duties and transit duties. In the narrow
sense tariffs mean import duties. Tariffs act as protective umbrella to protect home infant
industries against foreign competition. When import duties are imposed imports of
foreign goods become costlier leading to curtailment in imports which saves our scarce
foreign exchange. However it leads to contraction of the volume of foreign trade.

Import Quota

It is the most direct method of correcting disequilibrium in the balance of payments.

Under this method the Government fixes the quota of imports ie Govt. fixes the limit to
the maximum amount of goods to be imported from foreign countries during a specified
time period. Thereby it controls our imports because of which we can correct the deficit
in the balance of payments.

Export Promotion

Exports may be encouraged by reducing or abolishing export duties, providing an export

subsidy, and encouraging export production and export marketing by offering monetary,
fiscal, physical and institutional incentives and facilities.
 Import Control: Imports may be controlled by imposing or enhancing import duties,
restricting imports through import quotas and licensing, and even by prohibiting
altogether the import of certain inessential items.

Miscellaneous Measures

Apart from the measures mentioned above, there are a number of other measures that can
help make the Balance of Payments position more favorable, such as obtaining foreign
loans, encouraging foreign investment in the home country, development of tourism to
attract foreign tourists, providing incentives to enhance inward remittances, developing
import substituting industries, etc.

ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT

Economic growth of a nation is a sustained increase in the production and supply of diverse
economic goods and services to its population over a period of time. It is an important
measure of the macroeconomic performance of a country.
The major determinants of economic growth are availability of natural resources, rate of
capital formation, capital output ratio, technological progress, rate of growth of population,
dynamic entrepreneurship, and availability of social overheads and infrastructure facilities.
Economic growth can be measured as a rise in real national income or a rise in per capita real
income.
Economic development implies production and supply of more output along with changes in
the technical and institutional arrangements by which it is produced. It is economic growth
with structural changes. It includes important social goals such as reduction in poverty,
improvement in quality of life, cleaner environment, enhanced opportunities for better health
and education, freedom of human choices, enjoyment of human rights, provision of basic
needs like housing, sanitation, safe drinking water and adequate nutrition.
Human Development Index (HDI) prepared by UNDP is considered as a better indicator of
economic development. The concept of economic development is given more importance by
the United Nations, World Bank and Nobel laureate Amartya Sen.
SECTORAL CONTRIBUTION TO NATIONAL INCOME OF INDIA
National income includes the value of production of all sectors of the economy. The
following are the sectors:
 Primary sector: agriculture, forestry, fishing, mining, quarrying.
 Secondary sector: manufacturing, gas, electricity, contracts, water supply.
 Tertiary / service sector: transport, communication, banking, insurance, health,
hospitality, education.

Economic growth results in structural changes of an economy. It leads to changes in the

composition of sectoral shares of national income. It can be explained with the help of the
following data showing the percentage contribution of each sector to national income of India
over the years.
 Year Primary sector Secondary sector Tertiary sector

1950-51 59 13 28

1970-71 48 20 32

1980-81 42 22 36

1990-91 35 25 40

2006-07 19 27 55

BUSINESS CYCLES
Economic activities move in a wave-line manner with ups and downs in business activities.
The period of high employment, output and income is known as the period of expansion,
upswing, prosperity or boom. The boom period is the peak level of economic activities during
which there will be high values for the economic variables such as investment, employment,
production, income, demand, price and profit. These variables will be low during depression.
The period of low employment, output and income is known as the period of contraction,
downswing, recession or depression. Business cycles or trade cycles refer to the alternate
occurrence of booms and depression, peak and trough, expansion and contraction, and
optimism and pessimism in business or economic activities.
If an economy produces more amounts of commodities and if the demand is not sufficient to
buy them, there will be overproduction or lack of effective demand. This will lead to low
investment and low level of economic activities. If it continues for long period, the economy
reaches the stage of depression.
After some time, when the unsold commodities are demanded, the producers will be get
incentive for investment and produce more commodities. The economy gets recovery or
revival of economic activities.
Due to increase in demand, there will be increase in prices. Since supply can be increased till
the stage of full employment due to the availability of unemployed factors of production,
increase in price level due to increase in demand will be partial. This is known as semi-
inflation or reflation.
If it continues after the stage of full employment, price level will increase fully due to
increase in demand. The increase in price level after the full employment stage which is not
accompanied by the increase in supply of commodities is called true inflation.
With further increase in price level, the economic activities reach the highest level known as
boom period. Due to anti-inflationary fiscal and monetary policies taken by the government
and the central bank respectively, the price level will begin to decrease. The economic
activities will begin to decrease. The decrease in price level at this stage will be without
creating unemployment. This is called as disinflation.
As a result of decrease in price level and profit, the producers will not have incentive to make
investment leading to low level of economic activities involving unemployment. The
decrease in price level with the economy operating below full employment is known as
deflation.
When the price level continues to decrease, the economic activities will decrease further and
reach the stage of depression.
The phases of business cycles can be generalised as follows:

 Expansion (Boom, Upswing or Prosperity)

 Peak (Upper turning point)
 Contraction (Downswing, Recession or Depression)
 Trough (Lower turning point)

LIBERALISATION

Liberalisation means the opening up of markets within and between countries to promote free
trade by reducing barriers to trade such as tariffs (import and export duties) and other forms
of regulation. It is a movement towards a free market system in which the market forces will
become more important in determining major decisions in economic matters. In the domestic
economy it is accomplished by allowing prices and quantities to be determined by market
forces. The role of government in production is reduced as privatisation and competition are
encouraged.
The New Industrial Policy, 1991 was initiated to lead industries away from excess direct
controls and regulations to a free market- oriented economic system. In the global context,
liberalisation means eliminating or reducing the impact of tariff and non-tariff barriers. The
WTO encourages liberalisation by organising worldwide negotiations to reduce import
controls. Thus, liberalisation refers to fewer government regulations and restrictions in the
economy in exchange for greater participation of private entities. The principle of economic
liberalisation is aimed at greater efficiency that would translate into better benefits for
everybody.
PRIVATISATION

Privatisation is the process of transferring ownership of business and property from the public
sector or government to the private sector. It involves the decision to sell companies owned
by the government to private individuals and companies. In a broader sense, it refers to the
transfer of any governmental function to the private sector. The disinvestment of public
sector enterprises will ensure that they will be governed by professional managers and market
mechanism rather than by bureaucrats. This will also yield significant amount of resources
for the government.
Due to competition with other enterprises, it can result in benefits such as reduction of
financial and administrative burden of the public sector, promotion of private sector
involvement, faster growth, innovative solutions, time bound results, cost reduction,
improved quality, better efficiency, increased productivity, improved product quality and
customer service, efficient and better services. hard work and excellence. But there can also
be negative effects such as increase in unemployment, exploitation of workers and
consumers. closure of less efficient units, more restrictions, lack of ethical values.
GLOBALISATION
Globalisation is the process of transformation of local or regional phenomena into global
ones. It is a process by which the people of the world are unified into a single society and
function together. It involves a combination of economic, technological, socio-cultural and
political forces.[ Globalisation is often used to refer to economic globalisation, that is,
integration of national economies into the international economy through trade, foreign direct
investment, capital flows, migration, and the spread of technology. It leads to greater
movement of people, goods, capital and ideas due to increased economic integration which in
turn is propelled by increased trade and investment. It is like moving towards living in a
borderless world.

Globalisation provides opportunities and challenges. The advantages of globalisation include

availability of a wide range of quality products and services to the consumers at competitive
prices Bigger markets can lead to bigger profits which results in greater wealth for investing
in development and reducing poverty in many countries. The disadvantages of globalisation
include losing jobs when companies move abroad or fail to compete due to domestic
comparative cost disadvantage and possibility of risk due to international capital flows and
crisis. Weak domestic policies, institutions, infrastructure and trade barriers can restrict a
country's ability to take advantage of the changes. Each country should adopt policies to
maximise the benefits and minimise the challenges presented by globalisation.

ROLE OF COMMERCIAL BANKS

1. Branch expansion to provide services throughout the country
2. Mobilisation of savings and its utilisation for investment
3. Mobilisation of savings for capital formation
4. Implementing monetary policy
5. Promotion of agricultural development
6. Promotion of industrial development
7. Promotion of exports
8. Expansion of money supply
9. Creation of savings habit
10. Provision of various types of loans