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IMT-79: ECONOMIC ENVIRONMENT OF INDIA

PART A Q1. Explain with examples the various aspects of Economic and Social factors influencing Business Environment.

Ans. Understanding the environment within which the business has to operate is very important for running a business unit successfully at any place because, the environmental factors influence almost every aspect of business, be it its nature, its location, the prices of products, the distribution system, or the personnel policies. Thus, it is important to learn about the various components of the business environment, which consists of the economic aspect, the socio-cultural aspects, the political framework, the legal aspects and the technological aspects etc. The primary influences on a business are: political, economic, social and technological. The larger economic environment of a society is a factor that can affect a company's business environment, by which during a recession, consumers spend less on optional items such as cars and appliances. As a result, the business environment suffers. On the other hand, if the economic environment is one of prosperity, consumers are more likely to spend money, not just on necessities, but larger items as well. The main factors that affect the economic environment are: a) Economic Conditions: The economic conditions of a nation refer to a set of economic factors that have great influence on business organizations and their operations. These include gross domestic product, per capita income, markets for goods and services, availability of capital, foreign exchange reserve, growth of foreign trade, strength of capital market etc. All these help in improving the pace of economic growth. b) Economic Policies: All business activities and operations are directly influenced by the economic policies framed by the government from time to time.

c) Economic System: The world economy is primarily governed by three types of economic systems, viz., (i) Capitalist economy; (ii) Socialist economy; and (iii) Mixed economy.

While the social environment of business includes social factors like customs, traditions, values, beliefs, poverty, literacy, life expectancy rate etc. The social structure and the values that a society cherishes have a considerable influence on the functioning of business firms. Social factors that affect the economic environment of a business are the cultural influences of the time, which tends to be more conservative, and will not support styles that appear to be trendy. Q2. Discuss the objective & achievements of the eleventh Five-Year plan.

Ans. The economy of India is based in part on planning through its five-year plans, which are developed, executed and monitored by the Planning Commission, wherein the tenth plan completed its term in March 2007 and the eleventh plan is currently underway. Relatively, the eleventh plan has the following objectives: 1) Income & Poverty Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to double per capita income by 201617; Increase agricultural GDP growth rate to 4% per year to ensure a broader spread of benefits; Create 70 million new work opportunities; Reduce educated unemployment to below 5%; 2) Education Reduce dropout rates of children from elementary school from 52.2% in 200304 to 20% by 201112; Develop minimum standards of educational attainment in elementary school, and by regular testing monitor effectiveness of education to ensure quality; Increase the percentage of each cohort going to higher education from the present 10% to 15% by the end of the plan. 3) Health Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per 1000 live births; Reduce Total Fertility Rate to 2.1; Reduce malnutrition among children of age group 03 to half its present level.

4) Women and Children Raise the sex ratio for age group 06 to 935 by 201112 and to 950 by 201617; Ensure that all children enjoy a safe childhood, without any compulsion to work. 5) Infrastructure Ensure electricity connection to all villages and BPL households by 2009 and round-the-clock power. Ensure all-weather road connection to all habitation with population 1000 and above (500 in hilly and tribal areas) by 2009, and ensure coverage of all significant habitation by 2015; Provide homestead sites to all by 2012 and step up the pace of house construction for rural poor to cover all the poor by 201617. 6) Environment Increase forest and tree cover by 5 percentage points. Attain WHO standards of air quality in all major cities by 201112. Treat all urban waste water by 201112 to clean river waters. Increase energy efficiency by 20 % Q3. Trace the evolution of Industrial Policy in India with special reference to Industrial policy of 1991.

Ans. The Industrial Policy announced on July 24, 1991 heralded the economic reforms in India and sought to drastically alter the industrial scenario in the country. In the subsequent years, India's Industrial Policy evolved through successive Industrial Policy Resolutions and Industrial Policy Statements, by which specific priorities for industrial development were also laid down in the successive Five Year Plans. Building on the so-called "Bombay Plan"1 in the pre-Independence era, the first Industrial Policy Resolution announced in 1948 laid down broad contours of the strategy of industrial development. Thus, at that time the Constitution of India had not taken final shape nor was the Planning Commission constituted. Moreover, the necessary legal framework was also not put in place, and not surprisingly therefore, the Resolution was somewhat broad in its scope and direction, but an important distinction was made among industries to be kept under

the exclusive ownership of Government, i.e., the public sector, those reserved for private sector and the joint sector. Subsequently, the Indian Constitution was adopted in January 1950, the Planning Commission was constituted in March 1950 and the Industrial (Department and Regulation) Act (IDR Act) was enacted in 1951 with the objective of empowering the Government to take necessary steps to regulate the pattern of industrial development through licensing which paved the way for the Industrial Policy Resolution of 1956, which was the first comprehensive statement on the strategy for industrial development in India. The Objectives of the Industrial Policy of the Government are: To maintain a sustained growth in productivity; To enhance employment; To achieve optimal utilization of human resources; To attain international competitiveness Development of indigenous technology through greater investment in R&D and bring in new technology to help Indian manufacturing units Incentive for industrialization of backward areas Ensure running of PSUs on business lines and cut their losses Protect the interests of workers Abolish the monopoly of any sector in any field of manufacture Except on strategic or security grounds to transform India into a major partner and player in the global arena. Q4. Make a balanced assessment of the role played by the PSUs in rapid economic development of India.

Ans. India succeeded in maintaining its economic growth at above 6% largely on account of large doses in shape of government stimulus package, which included a large expenditure program on infrastructure. The Indian government also shielded the consumer's wallet from the vagaries of international market by subsiding fuel, food and fertilizer prices, but none of these policies would have been possible without the resources made available by the large government owned enterprises. Thus, being the largest commercial enterprises in the country, PSUs provide a huge leverage to the government (their controlling shareholder) to intervene in the economy directly or indirectly to achieve the desired socio-economic objectives.

At times, PSUs also play a key role in steering the national economy in the right direction, since government-owned commercial enterprises possess the unique ability to rise above the short-term commercial interest to invest in local assets and resources so as to maximize the long-term economic gains. It does not mean PSUs are important only during the time of crisis. In normal course also it is difficult to think of the Indian economy without public enterprises given India's socio-economic and demographic reality because the sector is deeply entrenched in the domestic economy and their business operations are now enmeshed in the common man's life. The underlying reason for such an extensive presence of PSU in Indian economy lies in the economic policy adopted after independence. Thus, the greater thrust was given on economic development with social perspective, and in order to attain this, the method of central planning was adopted. In many cases, the PSUs have better systems, which minimizes abuse of power by an individual or a group of individuals and, thus, avoid the pitfalls of expensive but unproven bets or ego boosting mergers and acquisitions that may endanger longterm viability of the firm. Q5. Explain the inter-relationship environment with example. between political and economic

Ans. In general, successful utilization of resources depends on having a stable and fairly flexible economic and political system, and a social system compatible with growth, for example, having values and customs which are favorable toward capital development and accumulation. Thus, at the next deeper level, and only some countries developed these kinds of political, economic and social conditions (e.g., stable and flexible systems, values favoring capitalism). Similarly, globalization and democratization eventually lead to the same questions. For example, whether a country is able to participate in the globalization process depends on, or whether a country's political system was able to develop into a democracy. Overall, change is a highly complex process, involving many factors, such as demography, technology, availability of resources, politics, economics, and the interaction of these factors. Also, some aspects of change are seen as systematic and predictable, and others as random or coincidental.

Finally, there are a number of major areas of study of the current world situation: e.g., development, globalization, democratization, demographic changes, and the shift toward the knowledge based society. The process of social, political and economic change is very complex which may involve many different factors, and multiple processes operating concurrently, many coincidental, unique or random factors influence the change process. For example, geography can have an impact on whether a civilization developed one great center versus many smaller independent centers. Thus, social, political and economic change can best be understood by combining systematic with more unique, random or coincidental factors. The inter-relationship is essentially doomed because of th dominating majesty of economic restructuring which is leading to such deep social, economic and political fissures in society that environmental agendas are always likely to be of secondary importance. The political priorities of social and economic gain may be difficult to resist in the context of protecting the quality of life, and the multi-layering of society into different groups and localities (and the contemporary emphasis on place) makes the resolution of that conflict even harder. Finally, the inter-relationship between economic development and the environment is essentially doomed because of the different ways in which individual agencies and sector-based policies are seeking to implement the elusive notion of sustainable development.

PART B Q1. What should be the corporate social responsibility in the modern context.

Ans. In the modern context, Corporate Social responsibility (CSR, also called corporate conscience, corporate citizenship, social performance, or sustainable responsible business/ Responsible Business) is a form of corporate self-regulation integrated into a business model. The CSR policy functions as a built-in, self-regulating mechanism whereby a business monitors and ensures its active compliance with the spirit of the law, ethical standards, and international norms, with the goal to embrace responsibility for the company's actions and encourage a positive impact through its activities on the environment, consumers, employees, communities, stakeholders and all other members of the public sphere who may also be considered as stakeholders. The term "corporate social responsibility" was used to describe corporate owners beyond shareholders which is titled to aid an organization's mission as well as a guide to what the company stands for and will uphold to its consumers. Relatively, a more common approach of CSR is philanthropy which includes monetary donations and aid given to local organizations and impoverished communities in developing countries. Thus, some organizations do not like this approach as it does not help build on the skills of the local people, whereas community-based development generally leads to more sustainable development. Another approach to CSR is to incorporate the CSR strategy directly into the business strategy of an organization, as well as garnering increasing corporate responsibility interest, which is called Creating Shared Value, or CSV, based on the idea that corporate success and social welfare are interdependent. Many approaches to CSR pit businesses against society, emphasizing the costs and limitations of compliance with externally imposed social and environmental standards, which acknowledges trade-offs between short-term profitability and social or environmental goals, but focuses more on the opportunities for competitive advantage from building a social value proposition into corporate strategy. Many companies use the strategy of benchmarking to compete within their respective industries in CSR policy, implementation, and effectiveness that involve reviewing competitor CSR initiatives, as well as measuring and evaluating the

impact that those policies have on society and the environment, and how customers perceive competitor CSR strategy. Q2. What do you understand by Liberalization, Globalization and Privatization? Make a critical assessment of Indias Liberalization experience?

Ans. The economic liberalization in India refers to ongoing economic reforms in India that started on 24 July 1991, and after Independence in 1947, India adhered to socialist policies. While in the 1980s, Prime Minister Rajeev Gandhi initiated some reforms. And in 1991, after India faced a balance of payments crisis, it had to pledge 20 tons of gold to Union Bank of Switzerland and 47 tons to Bank of England as part of a bailout deal with the International Monetary Fund (IMF). In addition, IMF required India to undertake a series of structural economic reforms, and as a result of this requirement, the government of P. V. Narasimha Rao and his finance minister Manmohan Singh (the present Prime Minister of India) started breakthrough reforms, although they did not implement many of the reforms IMF wanted. The new neo-liberal policies included opening for international trade and investment, deregulation, initiation of privatization, tax reforms, and inflationcontrolling measures. The overall direction of liberalization has since remained the same, irrespective of the ruling party, although no party has yet tried to take on powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labor laws and reducing agricultural subsidies. The main objective of the government was to transform the economic system from socialism to capitalism so as to achieve high economic growth and industrialize the nation for the well-being of Indian citizens, and today India is mainly characterized as a market economy. The fruits of liberalization reached their peak when India recorded its highest GDP growth rate of 9%, and with this, India became the second fastest growing major economy in the world, next only to China. Accordingly, the Indian government coalitions have been advised to continue liberalization.

There was a remarkable improvement in the business industry soon after the acceptance and adaptation of liberalization, privatization, and globalization (LPG) in the year 1991 which has geared up in all respects, as well as it being forced to face a lot of healthy competition from many national as well as international private insurance players. Q3. Write a note on the role of the World Bank in developing countries with special reference to India.

Ans. While there are many expectations and definitions of the fundamental role of the World Bank, four different models or perspectives are the most common. The first is the view that the World Bank is a financial intermediary, the Bank-as-abank model. A second perspective or model is the view of the Bank as an evangelical agent in charge of changing the behavior of governments in developing countries. The fourth is the view that the World Bank is a mechanism to transfer financial resources from richer to poorer countries. The World Banks role in India focuses on helping the country to fast-track the development of much-needed infrastructure and to support the seven poorest states achieve higher standards of living for their people which is closely aligned with the Government of Indias own development priorities expressed in the Eleventh Five Year Plan. And this was arrived at after a series of consultations with a broad range of stakeholders including the government and civil society, dialogue, analytical work, engagement with the private sector, and capacity building to help India achieve its goals. The World Bank will continue to assist the central government by providing comprehensive analytical work to underpin policy and institutional reform and to improve the implementation of central government projects on the ground. The World Bank will also support some key multi-year, cross-sectoral studies on important issues confronting policymakers, including poverty and exclusion, skills and job creation, low-carbon growth, the challenges of rapid urbanization, and the management and development of water resources. The World Bank and IFC are also collaborating to bring India cutting-edge expertise to deal with emerging issues in Public-Private Partnerships (PPPs), tailored to Indias needs, and while this work has so far been the strongest in infrastructure power transmission, roads, irrigation and rural infrastructure, urban development it will now be extended to agribusiness, health and education, and renewable

energy. Moreover, the Bank and IFC are also working together on long-term finance: through the proposed India Infrastructure Finance Co. Ltd. Project (IIFCL). Q4. Explain the role of WTO? What are the commitments made by India to WTO?

Ans. The World Trade Organization (WTO) is the only global international organization dealing with the rules of trade between nations. And at its heart are the WTO agreements, negotiated and signed by the bulk of the worlds trading nations and ratified in their parliaments, by which the goal is to help producers of goods and services, exporters, and importers conduct their business. India's economic reforms and trade liberalization policies contributed to a dramatic increase in its economic growth, by which larger flows of inward foreign investment and increased international trade helped India, achieve annual average growth rates of 7 percent. Economic growth slowed, however, and, according to a new WTO Secretariat report on India's trade policies and practices, India should continue liberalizing its trade and investment regime to ensure strong and stable economic growth. The WTO Secretariat report and a policy statement prepared by the Government of India, will provide the basis for a review of India's trade policies and practices, and is on India's policy and trade measures affecting imports, exports and production. The WTO report also notes that India recognizes the need to continue economic reform, with an increased emphasis on improving its industrial infrastructure, where the latter has proved to be a constraint on expanding economic activity and stimulating exports. While other measures under consideration are reductions in tariffs and non-tariff measures, reforming the subsidies structure (estimated to account for 14 per cent of GDP), and restructuring public sector enterprises. The Indian Government initiated a major program of economic reform and liberalization in 1991.

India's financial services are gradually being liberalized while significant headway has already been made in liberalizing telecommunications. Other services, such as shipping, roads, ports and air, are beginning to open up, but, the report states, foreign participation remains relatively low and significant administrative barriers remain.

As a developing country, India has to comply with the TRIPS Agreement but is currently required to provide means for receiving product patent application in certain areas, and on this issue, a decision by a WTO dispute settlement panel and the Appellate Body has stated that India was in violation of its obligation. Q5. How does IMF help Developed and Developing countries?

Ans. The IMFs support for developed and developing countries needed an upgrade as economic conditions improved in these countries, and as they became more open and integrated into the global economy. Many have made great strides toward macroeconomic stability, and the vast majority of low-income countries faced long-standing economic problems that required radical, long-term policy changes often accompanied by debt relief or cancellation. However, many of these economies are becoming more open and integrated into the global economy, and many developing countries are joining international capital markets, entering markets for goods and services, attracting foreign investment, nurturing their own private financial sectors, and benefiting from money sent home by citizens working abroad. With this greater international openness and integration comes greater vulnerability and exposure to the ups and downs of the global economy. To make its financial support more flexible and tailored to the diversity of lowincome countries, the IMF has established a new Poverty Reduction and Growth Trust, which has three new lending windows, all under highly concessional terms. Increased IMF financial support for developing countries has come at a time when these countries needed to respond to the global crisis, by which changes in the design of the agreed policy packages, called programs that accompany IMF loans allowed for countercyclical fiscal policies, including increased fiscal spending. Additional changes to program design include: Strengthening the focus on supporting poverty alleviation and growth; Protecting public spending on social and other priority areas, even as economic downswings cut revenues; Focusing loan conditions on critical areas, such as transparent management of public resources.

The developing and developed countries can benefit by either counting the SDRs as extra assets in their reserves, or selling their SDRs for hard currency to meet balance of payments needs. Moreover, the IMF also established a new Post-Catastrophe Debt Relief Trust (PCDR), which allows the IMF to join international debt relief efforts for very poor countries that are hit by the most catastrophic of natural disasters that allowed the IMF to eliminate Haitis entire outstanding debt to the IMF following the devastating earthquake.

PART C Q1. What do you understand by Public Finance? What is the difference between Public Finance and Corporate Finance?

Ans. Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make these decisions, and its primary goal is to maximize shareholder value. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. Thus, the discipline can be divided into long-term and short-term decisions and techniques. Accordingly, the term corporate finance is associated with investment banking, and the typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs, which may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses. While public finance is the study of the role of the government in the economy, considered to be threefold: governmental effects on: 1) Efficient allocation of resources, 2) Distribution of income, and 3) Macroeconomic stabilization. Collection of sufficient resources from the economy in an appropriate manner along with allocating and use of these resources efficiently and effectively constitute good financial management. Resource generation, resource allocation and expenditure management (resource utilization) are also essential components of a public finance which basically deals with all aspects of resource mobilization and expenditure management in government. Just as managing finances, is a critical function of management in any organization, similarly public finance is an essential part of the governance process that includes resource mobilization, prioritization of programs, the budgetary process, efficient management of resources and exercising control, and rising aspirations of people are placing more demands on financial resources, and at the same time, the

emphasis of the citizenry is on value for money, thus making public finance management increasingly vital. Q2. What is the importance of the Central Budget presented by the Finance Minister? Explain the Budget process?

Ans. The central or the national budget is the main instrument through which governments collect resources from the economy, in a sufficient and appropriate manner; and allocate and use those resources responsively, efficiently and effectively. The central budget preparation process generally follows the same pattern every year, and the time table is described in the constitution, where the law prescribes that the general government draft Budget bill should be introduced, and the Parliament should pass the approved Budget bill or pass a provisional appropriation before the financial year begins. The Ministry of Finance examines central budget preconditions and proposes overall Budget targets, and the breakdown of overall budget targets to ceilings for consumption, income transfers, and investments for each ministry. Central budgets, through revenue and expenditures units, keep their importance in economy increasingly today as in the past, and the increasing significance of budgets in economy has obliged utilizing new techniques in managing it. Particularly, the significance of the budget's expenditure unit has been stressed by both theorists and practitioners through their studies. Since the application of initial central budgets, the achieving of sources, effective and productive usage, source allocation, deficits and gradually increasing public loans have continued to become a problem, and owing to these reasons, studies made heavily depend on state budgets' expenditure direction in the last twenty years in particular. Every country (developed or developing, rich or poor, small or big) needs serious financial resources for its existence, by which all governments have to: collect resources from the economy, in a sufficient and appropriate manner; and allocate and use those resources responsively, efficiently and effectively. The central budget is the main instrument through which these transactions are planned and carried out. However, the growing fiscal burdens as a result of the expansion of the state economy have become a barrier in the development of the economy.

The government expenditures, as in the past, still keep its importance today, especially, despite the fact that it has already been proved in literature that the public expenditures have continually been increasing owing to various reasons, the problems related to essential, effective, productive and on time-using of the increasing public expenditures have gradually been enlarged. Q3. What do you understand by Fiscal Deficit? What is the difference between the Fiscal Policy and Monetary Policy?

Ans. Fiscal deficit is when a government's total expenditures exceed the revenue that it generates (excluding money from borrowings) which differs from debt that is an accumulation of yearly deficits. A fiscal deficit is also regarded by some as a positive economic event that help countries climb out of economic recession. While on the other hand, fiscal conservatives feel that governments should avoid deficits in favor of a balanced budget policy. Subsequently, fiscal deficit is an economic phenomenon, where the Government's total expenditure surpasses the revenue generated which is the difference between the government's total receipts (excluding borrowing) and total expenditure that gives the signal to the government about the total borrowing requirements from all sources. The primary component of fiscal deficit includes: a) Revenue deficit: It is an economic phenomenon, where the net amount received fails to meet the predicted net amount to be received. b) Capital expenditure: It is the fund used by an establishment to produce physical assets like property, equipment or industrial buildings, which is made by the establishment to consistently maintain the operational activities. In India, the fiscal deficit is financed by obtaining funds from Reserve Bank of India, called deficit financing which is also financed by obtaining funds from the money market (primarily from banks). According to the view of renowned economist John Maynard Keynes, fiscal deficits facilitate nations to escape from economic recession. While from another point of view, it is believed that government need to avoid deficits to maintain a balanced budget policy.

In order to relate high fiscal deficit to inflation, some economists believe that the portion of fiscal deficit, which is financed by obtaining funds from the Reserve Bank of India, directs to rise in the money stock and a higher money stock eventually heads towards inflation. Financial advisors recommend that the Government should not promote disinvestment to reduce fiscal deficits which can be reduced by bringing up revenues or by lowering expenditure, and its reduction has an impact over the agricultural sector and social sector. As such, the Government's investments in these sectors will be reduced. Q4. How does the Reserve bank of India control Inflation?

Ans. In a move meant to relieve growing stress in its financial system, Indias central bank sharply reduced the amount of money banks have to hold in reserve, and the action came ahead of a scheduled policy meeting at which the bank was expected to cut the reserve ratio, but less sharply. The Reserve Bank of India, which has struggled to control inflation for the past years by raising interest rates, cut its cash reserve ratio by 0.75 percentage point, to 4.75 percent, by which the move will free up about 480 billion rupees ($9.5 billion) in money that banks can lend, the central bank said, significantly easing the flow of money in the Indian economy. Indian companies and investors have been clamoring for a cut in the reserve ratio for months, saying a cash squeeze had made it difficult for them to do business normally. Thus, combined with high interest rates, the cash squeeze has contributed to the sharp slowing of Indias economy, where short-term rates at which the central bank lends to financial firms stand at 8.5 percent, and most companies have to borrow money at double-digit interest rates. The central bank appears to have decided to move early to ease financial conditions ahead of an important tax payment deadline, when many companies and individuals will be transferring money to the government. Given that, it is signaling that it is quite flexible about providing liquidity in the system, but unlikely to cut rates until prices eased and the Indian government tried to reduce its large fiscal deficit, which is estimated to be nearly 6 percent of the economy. The Reserve Bank of India has been conducting Inflation Expectations Survey of Households (IESH) on a quarterly basis, by which the survey elicits qualitative and

quantitative responses for short and long term indicated by three and twelve month period ahead on expected price changes and inflation. Q5. Explain how does the Political system influence the Business environment and flow of FDI?

Ans. In this era of increasingly globalized world economy, FDI is a particularly significant driving force behind the interdependence of national economies, and even though most of the FDI flows has always concentrated in the developed countries, its importance is undeniable for developing countries as well. While the aggregate wealth of the developing world nearly quadrupled and its total trade volumes rose more than five folds, FDI flows into developing countries grew by over 18 times, and through private direct investments, developing countries are participating more than ever before in the global production network. What these basic facts tell us from political forces; FDI is increasingly tighter global discrepancies in the extent to is that there are more than any other economic aside driving the process of globalization by creating an production network. However, there are great which countries take part in this network.

Not only significant gaps exist between developed and developing countries and among the different regions of the developing world, large and increasing disparities prevail even within the same region which leads us to knowing the roles of FDI in economic development the size and location of FDI flows, as well as the states which reap the benefits of FDI while avoiding its negative impacts in this globalized world. Economic development is an all-encompassing concept that centers on economic and social progress, but also entails many different aspects that are not easily quantified, such as political freedom, social justice, and environmental soundness, and without a doubt, all these matters combine to contribute to an overall high standard of living. However, empirical evidence has amply demonstrated that all these varied elements of economic development correlate with economic growth, which as a general rule, countries with faster economic growth have more rapid improvement in health and education outcomes, progressively freer political system, increasingly more equitable distribution of wealth, and enhanced capacity for environmental management. Therefore, while economic growth does not bring about automatically other aspects of social, institutional and environmental improvements, without economic growth, there is limited prospect for such achievements.

CASE STUDY I The Global Recession Beginning in the United States in December 2007 (and with much greater intensity since September 2008, according to the National Bureau of Economic Research), the industrialized world has been undergoing a Recession, a pronounced deceleration of economic activity. This global recession has been taking place in an economic environment characterized by various imbalances and was sparked by the outbreak of the financial crisis of 2007-2009. Although the late-2000s recession has at times been referred to as "the Great Depression," this same phrase has been used to refer to every recession of the several preceding decades. The financial crisis has been linked to reckless and unsustainable lending practices resulting from the deregulation and securitization of real estate mortgages in the United States. The US mortgage-backed securities, which had risks that were hard to assess, were marketed around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which served to reinforce the risky lending practices. The precarious financial situation was made more difficult by a sharp increase in oil and food prices. The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Leman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established Investment and Commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance. A global recession has resulted in a sharp drop in international trade, rising unemployment and slumping commodity prices. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007. Several economists have predicted that recovery may not appear until 2011 and that the recession will be the worst since the Great Depression of the 1930s. The conditions leading up to the crisis, characterized by an exorbitant rise in asset prices and associated boom in economic demand, are considered a result of the extended period of easily available credit, inadequate regulation and oversight, or increasing inequality. Fiscal and monetary policies have been significantly eased to stem the recession and financial risks. While this has renewed interest in Keynesian economic ideas, the recent policy consensus is for the stimulus to be withdrawn as soon as the economies recover to chart a path to sustainable growth.

Q 1: What do you understand by Global Recession? How was it triggered? Ans. A global recession is a period of global economic slowdown, wherein the International Monetary Fund (IMF) takes many factors into account when defining a global recession, but it states that global economic growth of 3 percent or less is "equivalent to a global recession". Defining a global recession is more difficult because developing nations are expected to have a higher GDP growth than developed nations, and the real GDP growth of the emerging and developing countries is on an uptrend and that of advanced economies is on a downtrend. Downward revisions in GDP growth vary across regions which are one of the factors that triggered global recession, and among the most affected are commodity exporters, and countries with acute external financing and liquidity problems. As such, countries in East Asia (including China) have suffered smaller declines because their financial situations are more robust, and they have benefited from falling commodity prices and they have initiated a shift toward macroeconomic policy easing. The IMF estimates that global recessions seem to occur over a cycle lasting between eight (8) and ten (10) years, and during what the IMF terms the past three global recessions of the last three decades, global per capita output growth was zero or negative. The global recession has slowed development and progress towards achieving the Millennium Development Goals (MDGs), and was estimated that the global economy contracted by 0.6 percent, and the implications of this have been severe for many. The capacity of developing countries to respond to the global recession varied considerably, and countries with a heavy reliance on export revenue and foreign investment were most exposed to the impacts of the downturn. While those with stronger economies and more financial resources were able to implement effective policy responses to support the economy and weathered the global recession relatively well. Others, including many of the Pacific Island countries, had less capacity to respond. Q2: How do you distinguish between Recession, Inflation, Deflation and Stagflation? Ans. In economics, a recession is a business cycle contraction, a general slowdown in economic activity, where the macroeconomic indicators such as GDP,

employment, investment spending, capacity utilization, household income, business profits, and inflation fall, while bankruptcies and the unemployment rate rise. In addition, recessions generally occur when there is a widespread drop in spending, often following an adverse supply shock or the bursting of an economic bubble, with many attributes that can occur simultaneously and includes declines in component measures of economic activity (GDP) such as consumption, investment, government spending, and net export activity. While inflation is a rise in the general level of prices of goods and services in an economy over a period of time, by which when the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects a downfall in the purchasing power of money, a loss of real value in the internal medium of exchange and unit of account in the economy, and its effects can be simultaneously positive and negative. Relatively, deflation is a decrease in the general price level of goods and services which occurs when the inflation rate falls below 0% (a negative inflation rate), but should not be confused with disinflation, a slow-down in the inflation rate (i.e. when inflation declines to lower levels). Lastly, stagflation is a situation in which the inflation rate is high and the economic growth rate slows down and unemployment remains steadily high which raises a dilemma for economic policy since actions designed to lower inflation or reduce unemployment may actually worsen economic growth. Stagflation is also notable because it has generally proven to be difficult and, in human terms as well as budget deficits, very costly to eradicate once it starts. However, in the political arena, one measure of stagflation, termed the Misery Index (derived by the simple addition of the inflation rate to the unemployment rate), was used to swing presidential elections in the United States in 1976 and 1980. Q3: What has been the adverse impact of the present recession on the world economy and the Indian Economy? Ans. Today, India is much more integrated with the world economy through both the current and capital accounts, and the down turn that appears to have begun in the USA in September, 2008 have some negative impact on the world economy, and Indian economy as well.

The most immediate effect of this global financial crisis on India is an out flow of foreign institutional investment (FII) from the equity market, and this withdrawal by the FIIs led to a steep depreciation of the rupee, while the banking and nonbanking financial institutions have been suffering losses. For the developing countries like India, the rise in food prices as well as the knock on effects from the financial instability and uncertainty in the industrialized nations, are having compounding effect, along with the high fuel costs, soaring commodity prices together with fears of global recession are warning many analysts. The crisis has become one of the most radical reshaping of the global banking sector, as governments and the private sector battle to share up the financial system following the collapse of Lehman Brothers which was a symbol of the global financial crisis. The crisis became so severe that after the failure and buyouts of major institutions, market liberalization and privatization in the commodity sector have also not resulted in greater stability of international commodity prices, and there is wide spread dissatisfaction with the outcomes of unregulated financial and commodity markets, which fail to transmit reliable price signals for commodity producers. The fact that the present crisis adversely affected the manufacturing and service sectors imply that occupational diversification is more difficult to achieve, and the financial crisis, therefore threatens to intensify the income deflation that is already feature of the rural economy and simultaneously aggregate the alarming levels of hunger and malnutrition that currently exist in India. Q4: How can Recession be fought? What are the immediate measures and policy changes already undertaken by India and major countries like USA, Japan and Germany? Ans. The contagion from the recession, particularly the global financial crisis required appropriate monetary and fiscal policy responses to ensure enough liquidity in the economy, the orderly functioning of markets, and the financial stability. The impact of the global crisis has been transmitted to the Indian economy through three distinct channels, namely the financial sector, exports and exchange rates, while the other significant channel of impact is the fall in business and consumer confidence leading to decrease in investment and consumer demand.

The government of India and RBI responded to the challenge strongly through its fiscal and monetary policies, and has introduced three fiscal stimulus packages, which are expanded safety-net program for the rural poor, the farm loan waiver package and payout following the Sixth Pay Commission report for stimulating demand in the economy. On the other hand in aftermath of the turmoil caused by bankruptcy, the Reserve Bank has announced a series of measures to facilitate orderly operation of financial markets and to ensure financial stability, which predominantly includes extension of additional liquidity support to banks. Thus, during the financial crisis, India was less affected than others solely on the back of the rural sector and due to the domestic demands, strict banking rules and the mindset of the people, by which the banking system in India is so regulated and it did not blindly follow the USA so we did not face any problems with mortgage issues as USA. Furthermore, in fighting this crisis, India responded through its monetary policy by pumping the liquidity into the system rather than using effective fiscal policy i.e. public expenditure and investment to face the recession. And although India has revived to high growth, this new growth should have to come not from some new speculative bubble but from enlarged government expenditure that directly improves the livelihood of the people.

CASE STUDY II Indias Economic Growth in 2009-10 Displaying unmistakable signs of a surge, the countrys economy grew by a robust 7.9 per cent in the second quarter of the current fiscal (July-September 2009), prompting experts to project a seven per cent growth for the full fiscal as against 6.5 per cent estimated earlier. Planning Commission deputy chairman Mr. Montek Singh Ahluwalia described the happy development as being above expectations. There is also scope to revise the growth projections, Mr. Ahluwalia said, alluding to the prospect of an upward fine-tuning of the Plan panels earlier estimate. The economy had registered a 6.1 per cent growth in the first quarter of this fiscal and took the cumulative expansion for the first half of the current fiscal (AprilSeptember) to seven per cent, the Central Statistical Organization (CSO) said in a statement here. The growth registered last fiscal was 6.7 per cent. The bulk of the recovery was led by a 9.2-per cent growth in manufacturing, while mining and construction activities expanded by 9.5 per cent and 6.5 per cent, respectively. The news also enthused the markets and helped the Sensitive Index (Sensex) of the Bombay Stock Exchange (BSE) gain. The growth rate is the fastest in 18 months, making experts wonder if it was not time to introduce an interest rate rise and cut stimulus spending in the face of mounting inflation. This data could be a green light for the Reserve Bank of India to hike rates, and there are greater chances of this by the end of the calendar year, said Mr. Robert Prior-Wandesforde, senior Asia economist at HSBC in Singapore. Allaying fears about food inflation, Mr. Ahluwalia said: I dont believe there are serious worries on inflation, except food prices. Food prices are a matter of concern, but I dont think conventional monetary policy will take care of that problem. He also reiterated the government stance that stimulus would remain in place. Personally, I dont think the second quarter numbers suggest any change in the (fiscal) policy in the current year, he said. However, RBI Deputy Governor, Mr. Subir Gokarn said he would not be surprised if growth slowed in the December quarter. While it is a recovery and it seems to be gaining strength, we should not ignore the fact that it is still being driven substantially by public spending, he said.

Mr. Rajeev Malik, economist at Macquarie in Singapore, said that the central bank would use liquidity management rather than rate rises in December and January as farming output was likely to fall. I dont think they are going to be swung by what agriculture has done, he said. However, the farm sector grew less than one per cent in the second quarter of this fiscal from 2.7 per cent a year earlier, mainly due to the twin impact of drought and subsequent floods. The growth in agriculture, forestry and fishing is estimated at 0.9 per cent in the July-September quarter, the Central Statistical Organization (CSO) data said. The finance minister, Mr. Pranab Mukherjee, is all smiles at the nation posting a robust growth. Im happy about the figures released by CSO. If you compare it with the earlier two quarters, its a very heartening progress, he told reporters outside Parliament. However, Mr. Mukherjee hastened to caution, even then, I will keep my fingers crossed till the third quarter result comes in. The results that have come out today show that the stimulus package we provided has started paying dividends... The negative trend in exports is coming down. Im happy. We will wait for the next quarter, Mr. Mukherjee said. Q1: What are the projections made above for Indias future growth? Why were the policy-makers optimistic about it? Ans. Demographic change in India is opening up new economic opportunities, and as in many countries, declining infant and child mortality helped to spark lower fertility, effectively resulting in a temporary baby boom. As this cohort moves into working ages, India finds itself with a potentially higher share of workers as compared with dependents, and it has been projected that if working-age people can be productively employed, Indias economic growth stands to accelerate. Theoretical and empirical literature on the effect of demographics on labor supply, savings, and economic growth underpins this effort to understand and forecast economic growth in India, where policy choices can potentiate Indias realization of economic benefits stemming from demographic change. Thus, failure to take advantage of the opportunities inherent in demographic change can lead to economic stagnation. The world experienced dramatic population growth during the twentieth century, with the number of inhabitants doubling from 3 to 6 billion between 1960 and 2000, and India, too, saw very rapid population growth during this period from 448

million to 1.04 billion and to 1.21 billion in 2010 which manifested the effects of past and projected future demographic change on economic growth in the country. Global population grew at roughly 2% per annum from 1960-2000, a level that is unsustainable in the long term, as it translates into population doubling every 35 years. As such, Indias population is currently growing at a rate of 1.4% per year, far surpassing Chinas rate of 0.7%. The differential between India and China will result in India surpassing China with respect to population size in less than 20 years. However, demography is not destiny, and the growth of the working-age share of the population does not automatically lead to an acceleration of economic growth. Thus, policy-makers optimistic about it because demographic change may provide a boost to economic growth, but appropriate policies are needed to allow this to happen because without such policies, a country may instead find itself with large numbers of unemployed or underemployed working-age individuals, and in some instances promoting state fragility and failure, potentially with adverse political, social, economic, and ecological spillovers to other countries. Q2: How is the growth of the economy measured and calculated? Why it is not measured in terms of National Income or Net National Product? Ans. Economic growth is the increase in the amount of the goods and services produced by an economy over time which is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP. Thus, growth is usually calculated in real terms, i.e. inflation-adjusted terms, in order to net out the effect of inflation on the price of the goods and services produced. In economics, "economic growth" or "economic growth theory" typically refers to growth of potential output, i.e., production at "full employment," which is caused by growth in aggregate demand or observed output, and is generally distinguished from development economics. Where the former is primarily the study of how countries can advance their economies, while the latter is the study of the economic aspects of the development process in low-income countries. Economic growth is not measured in terms of National Income or Net National Product, but measured by increases in a country's per capita net national product. Yet economists often do this not because they are convinced of the theoretical and statistical accuracy of these figures as indicators of development, but rather because there is no other superior readily available alternative.

Given that, the per capita income figure indicates nothing about the types of goods and services produced in a country which also fails to measure the amount of welfare which people derive from the use of these goods and services. And often, an increase in per capita national income, involves considerable social cost in the form of environmental pollution, overcrowding in cities or overwork under tremendous stress. National income figures of different countries cannot always be legitimately used for comparing their economic welfare, and difficulties arise in making comparisons of per capita national income of different countries on account of conceptual differences, exchange rate problem and the great differences in domestic relative price structures among countries. Q3: What are the reasons for a very low growth in the Agricultural Sector? What was the future prospect for Indian Agriculture? Ans. In the early 1950s, half of Indias GDP came from the agricultural sector, but despite being one of the largest agricultural-based economies, it remained closed until the early 1990s, by which in 1995, that contribution was halved again to about 25 percent. And as would be expected of virtually all countries in the process of development, Indias agricultural sectors share has declined consistently over time Since then there was growing awareness that the inward-looking import substitution and overvalued exchange rate policy coupled with various domestic policies pursued during the past four decades, limited entrepreneurial decision making in many areas and resulted in a high cost domestic industrial structure that was out of line with world prices. The future prospect for Indian Agriculture was its membership and commitment to the World Trade Organization (WTO) which was a clear sign of Indias intention to take advantage of globalization and face the challenge of accelerating its economic growth. Moreover, in the last five decades, the Indian Governments objectives in agricultural policy and the instruments used to realize the objectives have changed from time to time, depending on both internal and external factors, where the agricultural policies at the sectoral level can be further divided into supply side, which includes those relating to land reform and land use, development and diffusion of new technologies, public investment in irrigation and rural infrastructure and agricultural price supports, while the demand side policies on the other hand, include state interventions in agricultural markets as well as operation of public

distribution systems. Such policies also have macro effects in terms of their impact on government budgets. Macro level policies include policies to strengthen agricultural and non-agricultural sector linkages and industrial policies that affect input supplies to agriculture and the supply of agricultural materials. Productive efficiency would also enhance value added activities in agriculture through agro-processing and export of agricultural and agro-based products which would in turn increase income and employment in the industrial processing sector. Thus, globalizing agriculture has the potential to transform subsistence agriculture to commercialized agriculture and to improve the living conditions of the rural community.