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BUSINESS ENVIRONMENT
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REFERENCES : Mohinder Kumar Shartna - Business Environment in India
Adhikary M, Economic environment of business
Amarchand, D. Government and Business Francis
Cheunilam : Business and Government Maheswari & Gupta
: Government, Business and Society Kuchal, S.C :
Industrial economy of India Fredrick Davis : Business and
society.

CHAPTER I
Business environment - Dynamic factors of environment - Importance of scanning
the environment - Fundamental issues - Economic environment of business - Socio
- cultural environment - Political / Legal environment -Cultural environment

This chapter focuses on the following aspects of Business environment:
Definition of business, meaning of business environment, the classification of
business environment, need to study environment in business decisions, the
methods of scanning the business environment, issues that are to be addressed
while scanning the environment, various types of factors that influence
business environment, non-economic environment and its impact on business
decisions.

To highlight the importance of the Business environment, three case studies
have been appended at the end of this lesson.

Definition of business
The term business is understood and explained in different ways by different
people. For some, business is an activity, for some it is a method of transacting,
for sonic others, it is a method of money making and some people argue that
business is an organized activity to achieve certain pre-determined goals or
objectives. Dictionary meaning of business is: the act of buying and selling of
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goods and services, commerce and trade. Based on all these meanings of
justness, we may define business as: gainful activity through which various
elements of society conduct exchanges of the desirable things.

In the olden days, the people engaged in different activities in a society were
classified into four groups : Brahmnas, Shatriyas, Vysyas and Sudras, Of these
our fold classification of social activities, the activities of vysyas included
basically, facilitating exchange. Hence, business as an exchange activity
remained since the days of exchange started. It could also be recalled that
business as a social activity became popular only when the wants of different
people in a society were to be met with the available resources. In other words,
whenever there was a scope for producing something, which is wanted, then
business activity automatically emerged.

But now a days, business is viewed more as a profession or occupation. From
the days of family owned business, we have reached a stage of professionals
and experts starting and running business. It could also be noted that business
administration and business management have emerged as the most
prospective field of study and occupation. Persons with educational background
in business, enter business or join business organizations to make them
successfully function. Unlike the olden days, a number of interests are involved
in business today, viz. owners, investors in business, suppliers, customers,
employees, government, stake holders, administrators, managers, strategists,
executives, and so many others. Hence, every business activity has to meet the
goals or aims or objectives of these various groups of people. That in fact, has
made business a most complicated activity.

Modern business has a number of features. Understanding of these would help
to appreciate and organize business activities in a highly professional way.
1. Business is an economic activity :

Business involves organizing activities to satisfy human plants. These activities
may result in the manufacture or production of a commodity or extension of a
service. When a good or service is produced, resources are involved. Resources
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like human resources, physical resources and financial resources are all
required to realize output to meet human needs. These resources are limited in
supply, and so business involves identification of resources, evaluation of
resource qualities, buying these resources and utilizing these resources. These
resources being scarce in relation to their demand, the resources carry some
value [i.e., price]. They cannot be procured at any cost to produce anything to
meet human wants. So automatically selection among various resources come
up which is made on the basis of requirement and cost. Once they are
procured, then they are used in a very judicious manner so that there is no
waste. That is optimal utilization-of resources is to be achieved. In this context,
several decisions like resource selection, resource procurement, resource mix,
resource utilization, etc. are all involved. As in all these stages, choice among
alternatives is involved, every business activity is to be treated as economic in
nature. Depending upon the business activity, the approach to selection among
alternatives would differ. For example, in a manufacturing business, the choice
is about input selection to supply quality output, in a service organization the
choice is about-inputs and delivery process, in a government organization it is
about production and equitable distribution of output, in an institution like
bank, provision of various investment opportunities of short term and long term
to the public, etc.
2. A business organization is an economic unit

Every business organization is engaged in transforming inputs into output to
meet the requirements of the people. The selection of input and size of
procurement will depend upon, the size of the organization. This would also
depend upon the nature or product or service extended/by the business unit.
All these are attended with the objective of making profit or surplus. Only when
there is surplus achieved, can the business units grow. Hence creation of
surplus in a business becomes the focal point and this is best achieved through
optimal utilization of resources. That way, all business units have to achieve the
maximum output with minimum inputs which in other words is the effort to
achieve economic efficiency. Only economic efficiency can enable firms to be
efficient in every other sense. Therefore, business organizations are only
economic units in nature.
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3. Business decisions making is essentially an economic process

All business decisions involve selection from alternatives. In other words, the
rational choice of inputs is implied in every business decision. Hence, to be
rational, a business unit goes through the process of : determining objectives,
identifying opportunities, generating alternatives, classifying these alternatives
as feasible and infeasible alternatives, then rank the feasible alternatives on
some criteria and then select those alternatives fulfilling the constraints. For
example, if the objective of a business unit is to maximize profits, then this
would call for minimizing cost and maximizing revenue. On the cost side, the
business unit have to identify, procure and utilize resources in the optimal way
and on the revenue side, the business unit should determine the price which
would facilitate maximization of revenue. Price determination again would
depend on various factors like demand, supply, competitive scenario,
government interference, statutory compulsions, conflicting interests of the
stake holders of the business, etc. Therefore, every decision made in a business
would automatically depend on the economic process.

Changing concept of business
It has been stated already that the concept of business has undergone a vast
change. From a producer driven stage business has become consumer centered
and driven stage. While the earliest concept was * sell what is produced' the
modern concept is 'produce what is wanted' So every business depends on
consumers and their ever changing needs. Any business unit which has
successfully understood its customers and offer the product or service meeting
their requirements alone is successful. But in this process, business units have
to manage pressures from its owners and other stake holders. It should take
into account the requirements of the workers and the trade unions. It should
abide by the rules and regulations of a number of government agencies and
institutions. It should meet the challenges and threats from competitors. Most
important, it has to fulfill its social obligations. To survive every business unit
has to also consider: the revolutionary changes in technology, market
expansion, information explosion, competitor strategies. These are days when
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the consumers are better informed and so no business unit can afford to ignore
consumer awareness and preferences. Technological development has brought
with it the compulsion to use modern methods and techniques. Social
obligations have made business units to meet pollution norms, etc. Trade union
pressures have made them to design satisfactory service conditions for the work
force. Then there is compulsion to provide for development of human resources
in the organization to achieve organizational development. All these have made
modern business tight rope walking.


BUSINESS ENVIRONMENT
Business involves activities, which links an organization with outside world.
Within an organization, a business is governed by the behaviour of its
employees, management or decision makers. But externally a business is
influenced by a score of factors, which range from customers to competitors and
government. Therefore, a business cannot be independent of (he influence of
these external factors. It should also be noted that a business has absolute
control over all the internal factors, it has no control over the external factors.
So often it becomes necessary for business houses to modify their internal
decisions and policies, on the basis of the pressure from external factors This
highlights the need to be ever- cognizant of changes and influences of external
factors so as to conduct business on healthy lines. It is in this context that
business environment assumes all significance. Business environment therefore
refers to the influences and pressures exerted by external factors on the
business. The following Figure would help to understand the various factors
which constitute the business environment.

From the Figure: 1, it would be clear that business organizations function in an
environment subject to the influence of various constituents. Earh one of the
constituents have in turn a number of factors influencing them. For example,
economic environment has micro and macro environmental factors affecting it.
To develop a right perspective about business environment, let us discuss
briefly about each one of the external environment constituents.

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1. Demographic environment : This refers to the size and behaviour of
population in a country. Suppose a country has a huge size of
population, then, the country would provide extensive business or
marketing opportunities for all types of business organizations. On the
other hand, a country with low size of population would force the
business organizations to seek external market for their products or
services. Similarly, if the population in a country is well - tuned to 'use
and throw concept [like most of the Western countries] then there would
be limited scope for repair shops and employment scope in that segment
would be almost nil. But alternatively this would give wide marketing
opportunities for manufacturing organizations. On the other hand, if the
population is averse to 'use and throw' concept, then the business
opportunities would be limited for manufacturing organizations but the
repair shops, self-employed technical persons and spares manufacturers,
would have roaring business. Hence, the size and quality of population
emerges as a vital factor influencing business environment.

2. Economic environment: Economic environment refers to the overall
economic factors like economic philosophy of the country, economic
structure, planning, economic policies, controls and regulations, etc. All
these have a serious impact on the functioning of business organizations
in a country. For example, in a Capitalistic economic system, business
organizations would be subjected to limited government regulations and
controls. They would be more governed by market forces [demand and
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supply] rather than by other factors. On the other hand, in a Socialist
system, the government would determine everything on behalf of the
country. In a Communist set up, the government has absolute control
over every aspect over production that private enterprises may not exist
at all. In a Mixed economic system, government would be selective in
allowing die presence of private enterprises in certain activities, reserving
some spheres completely for governmental operations. Hence, the
economic philosophy of the country directly determines the scope and
functions of business organizations in that country.

3. Geographical and ecological environment: Geographical environment
refers to climatic conditions and natural resources, which determines flu
manufacturing scope and the nature of the products that could be
marketed. For example, a country like Kenya has to manufacture more of
products based on forest resources, while the Gulf countries can produce
only crude, Japan can have business in fish, fruits, etc., Countries in the
tropical region would have organizations specializing in products from
geographical resources available in abundant in that region, while
organizations in Mediterranean countries have a Different business
scope, Scandinavian countries have scope for dairy product
manufacturing, etc. Similarly ecological imbalance is taking place at an
alarming rate in the world today, that deforestation and hunting of rare
species of animals for food are all prohibited now. Hence, while
identifying the business opportunities, business organizations have to
be conscious of the limitations posed by the geographical and ecological
considerations.

4. Legal environment: It is well known that every country has a number of
legal regulations to ensure that the interests of business organizations do
not run counter to national interests. Right from the stage of
incorporation of organizations, their listing in stock exchange, reprisal of
customer complaints, payment of tax to government, manufacturing
practices, human resources development to pricing of products and
services, a number of legal regulations have to be fulfilled. For example,
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in USA and several western countries, consumer protection is very active,
that even a medical practitioner is subjected to huge liabilities in limes of
deficiency in services. In India and other countries, very rigorous legal
provisions arc in place to prevent hunting of rare species, that any
organization, which manufactures products based on such species, have
lo get legal sanctions. In case of failure to honor cheques
issued, organizations are now a days made to pay hefty compensations.
Hence, the deterrence in terms of legal provisions has become the order
of the day. All organizations have to first of all address these provisions
become coming in to steam.

5. Technological environment: This is a very significant external factor
determining the destiny of business organizations. Supported
by computerize operations, modem business organizations have
succeeded in analyzing customers, minimizing the defects in products,
ensuring service at the right time and place, etc. While communications
use to take unduly long time in those days, business communications
are instantaneous these days, thanks to modem satellite technology.
Modern organizations have recognized that research and development
alone can ensure organizational growth and stability. They have become
more and more pro-active and remain as change agents of the economy.
Governments have also become more technology conscious that right
from police controls to registration of title deeds, computerizations has
been adopted. Customer servicing through call centers is the latest
necessity of organizations. Manufacturing activities have become more
and more technically sophisticated. Therefore business environment
has become highly dynamic.

6. Social environment: Social environment today has brought compulsions
on business organizations to adhere to certain business ethics and
morals. Social responsibility of business is an important force that
modern business organizations cannot wriggle out of their duties and
responsibilities towards the society. For example, every leather
manufacturing or process unit is made to install pollution prevention
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system. Similarly, the expectations of various interests in the society
have undergone a sea of change. The shareholders, promoters and
owners expect a reasonable return on their investments. The workers
expect security of service, terminal benefits, accident relief and various
other compensations from the organizations. Government expects the
business units to pay tax regularly and participate in social
improvement. The distributors and agents expect the organizations to
ensure smooth delivery process and demand more commission and
compensation. Suppliers expect the organizations to give them
continuous business and prompt payment of bills. Therefore each social
group has a specific interest, the combination of all these, exerts
enormous pressure on the business unit. A business unit which
succeeds in meeting the interests of all these groups remains successful
and grows.

7. Educational and cultural environment: Educational environment in a
country determines the quality of population. A country with very high
illiterate population would always experience political and economic
instability. Similarly, lack of education may also give scope for the
existence of superstitious beliefs, fatalistic attitude, etc. People's choice of
goods and services would be more governed, by their religious faiths and
beliefs. For instance, in the colonial days, the Indian population was a
victim of the Britisher's divide and rule tactics. The economic
development of a country completely depends on the literacy level which
alone can pave the way for improvement in science and technology,
modernization, industrialization, etc. In such a country, the business
opportunities are plenty.

Cultural environment refers to the values, norms, customs, ethics, goals
and other accepted behaviour pattern of people in a country. In olden
days, religion was the basis of all activities in a society. The religious
leaders and institutions determined what business should do and what
people must consume. In India, the existence of caste system has done
more damage than any good. Caste based politics has become the order
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of the day. Under the pretext of working for backward and downtrodden
people, several persons have amassed fortune. This is worsened by
political support and policies. A modern organization does not have the
liberty to recruit people on merit but it has to follow strictly die
reservation policy of the government. Another serious aspect of the
cultural environment is the attitude and behaviour of the people in
urban and rural areas. The urban - rural divide has created enormous
problems for administrators and specifically business organizations
prefer urban educated person to persons from rural areas.

8. Political environment: Political stability is one important factor winch
determines the business growth or downfall. A country with relative
political stability would witness inflow of foreign capital and
collaboration. By political stability we mean that the policies of
government remaining consistent. As the business decisions arc based
on government policies, frequent changes in these policies would force
business organizations to change their policies too which, makes
functioning very difficult. Sometimes, when the policies determined by a
party in power are reversed by the succeeding party forming the
government, there would be far reaching changes in business
environment For example, India was following a policy of protectionism
till late" 1908's. Hence, the industrial development and economic
development could not take place at a rapid rate. In the absence of
competition, the business organizations, made people to accept inferior
quality goods and services. Once, the liberalization policy is adopted, the
scene has completely changed. Today, no business can survive unless it
provides quality goods or services on par with the multinational
corporations. Another aspect of political environment is the political
ideology with which a party is wedded to, would make the government
tow the lines of countries with similar ideologies. Until the disintegration
of USSR, India was simply following USSR's lines, but after the
disintegration, India has to literally fend for itself. With the pressures
mounted by the Western countries, India had to accept various trade and
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monetary policies. This has brought about a complete change in
business environment.

NEED TO SCAN ENVIRONMENT
Having discussed very briefly the features of each one of the constituents of
business environment, let us discuss why the environment should be analyzed
by the business organizations.

It is well known that business enterprises cannot remain independent of the
society and the institutions. So whatever decision they take as to be in tune
with the requirements of society and the dictums of the institutions. A business
organization has to continuously monitor the environment so as to identify the
business opportunities and threats. By exploring its strengths and minimizing
its weaknesses, if the organizations can capitalize these opportunities and
effectively thwart the threats, then it would be able to grow. Let us elaborate
this with an example.

Suppose an organization wants to introduce a new consumer durable product
in the market. Then it would study whether there would be demand for this
product and the product would be accepted by the society. At the outset, the
organization would examine whether the product would suit the culture in the
society. Suppose the product is 'use and throw' type. Then people would
certainly be influenced by this feature of the product while evaluating the price
of the product. In India, such a product would never be accepted as the culture
here is to lengthen the life of every product by repairing it. Similarly suppose
the product requires some critical component from abroad. Then unless the
government policy is favourable the component has to be imported at a very
high cost, which in turn would drive the price up. .Suppose the product is only
one of its types, the organization would then emerge as a monopoly supplying
the product. This may not be tolerated by the government. Suppose the
manufacturing of the product involves advanced technology, then the type of
human resources required would be well educated and trained. Obviously this
will rule out the job 'opportunities for persons educated in rural areas. Further,
if the manufacturing process involves scope for pollution, then the organization
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has to address it in relation to the provisions of the pollution control norms.
Hence, in every decision of the organization, the external environment has an
important role to play. Any future plans of expansion and forecasting of demand
will depend upon the changes in the business environment. These changes may
include both the current and expected changes. Unless these changes are also
foreseen, decisions taken would turn out to be suicidal. In the case of
organizations which have been pro-active, the changes in the environment do
not affect them much. But those which fail to understand from their own
experience or that of the other changes would remain challenges for ever.

Among the various constituents of business environment discussed above
briefly, we will focus on the following constituents and discuss them in greater
detail. The constituents now elaborated are: Economic environment, political
environment and cultural environment.

1. Economic environment
The economic environment is composed of various set of economic policies,
economic system, strategy of economic growth and development, resource
endowment, size of market and status of infrastructural facilities in a country.
All these affect the business environment one way or the other. To understand
the impact of these on business environment, let us discuss each one of these
components in detail.

Economic policies: Economic policies include fiscal policy, monetary policy,
foreign trade policy, licensing policy, technology policy, price policy, etc. These
policies lay the framework within which every organization has to function.

A] By fiscal policy we mean, the government's tax efforts, public expenditure
and public borrowing. Through these the government can effectively encourage
consumption, investment and savings habits and also restrict them. For
example, suppose there is inflation in a country. Inflation implies that the
people have high purchasing power and so they demand goods. To curb this,
the government may raise the personal tax and also the corporate tax.
Consequently, individuals will be left with lesser disposable income and to
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minimize tax, they may start saving through various tax -saving schemes. As
far as the corporate are concerned, they have to part with more by way of tax to
the government and this would bring down the rate of profit and dividend
declared. As a result the corporate would resort to upward price revision, which
might lead to further fall in demand for their products and services. During
deflationary period, the government would reduce the tax so as to encourage
more spending and investment. Even in tax policy, the government can be
selective in taxing more of rich and exempting the poor completely. This would
facilitate income re-distribution and improve the conditions of poor.

Similarly, by altering its expenditure on various public projects, the government
would be able to influence the prevailing economic condition. Government
expenditures are incurred on infrastructural development, public utility
services like hospitals, new industrial units of very huge size, etc. For instance,
suppose there is inflation in a country. The government would reduce its level of
expenditure, thereby reducing the income of the people. With lesser income, the
demand would, go down and so the price. At the time of deflation, the
government would expand its public expenditure by investing in a number of
public projects, so that there will be income generation find demand generation
which will revive the economy.

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Public borrowing is one more instrument in the hands of the government to
influence the economic condition in a country. This involves government issuing
bonds and encouraging common public and other institutions to buy them. By
this, the government would be able to bring down the level of purchasing power
in the economy and control the inflation. During deflation, the government
would redeem the bonds and so with more purchasing power, the economy
would be able to revive.

B] Monetary policy refers to the set of policies determined and implemented
by the central bank of a country to control the economic condition. The central
bank of a country has the basic responsibility to maintain the price level and
money supply in a country. This is possible only when the central bank has
certain instruments. These instruments available with the central bank to
control the money supply and price level are called monetary policy
instruments. They are called Credit control policy. Credit controls can be of two
types: Quantitative credit controls and Qualitative credit controls. The former
aims at limiting the money supply, while the latter is used to channelize the
available credit in the country.

Quantitative credit control policy includes three tools: bank rate, open market
operations and variable reserve ratio. Bank rate refers to the rate at which the
central bank would re-discount the eligible bills already discounted by the
commercial- banks. By revising the bank rate upwards, the central bank
would be able to make the discounting by business organizations with
commercial banks costly. This would discourage discounting and thereby
money supply in the economy, would come down. Alternatively, by lowering the
bank rate, the central bank makes credit available at a cheaper rate, and so the
business organizations would go for a larger discounting of eligible bills with
commercial banks. This liberal credit policy would have expansionary effects on
the economy. Similarly, using open market operations, the central bank would
buy or sell the securities in the open market and through that increase or
contract money supply in the economy. For example, suppose there is inflation
in an economy. To bring down the money supply, the central bank would sell
the securities it has which will be bought by the commercial banks and other
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institutions. In this process the excess money with these institutions would be
siphoned off, there by they have to restrict credit. Alternatively when there is
deflation, the central bank would buy the securities and the money equivalent
transferred to the banking system would facilitate adoption of liberal credit.
Variable reserve ratio refers to the increase or decrease in the quantum of
Statutory liquidity ratio and the Cash reserve ratio which the commercial banks
have to maintain as a proportion of their total deposits. By increasing the
ratios, the commercial banks would be left with lesser volume of funds and so
they can lend less. By reducing the ratio, the commercial banks would be left
with more funds with which they can make lending liberal. All these policies
would have a direct impact on the business organizations and their operations.

Through qualitative credit controls, the central bank can : regulate consumer
credit, alter the margin requirements, resort to persuasive efforts, take direct
action on erring commercial banks, etc. Through these policies, the central
bank would be able to regulate and direct the available credit to the priority
sector and discourage credit for less priority or no priority sector. Hence,
business organizations, which fall under priority sector, would be able to
expand their business with cheap funds and assistance

C] Foreign trade policy: The foreign trade policy determines the scope for
trade between countries. It would directly affect the business prospects of the
business organizations. A liberal policy would extend the scope for exports and
imports, while a restrictive policy would narrow the scope. Similarly, if
protectionism is favored, then the business organizations will have lesser
market threats from multinational corporations. Alternatively if liberalization is
the policy, then every domestic business organization has to tune itself to every
type of challenge posed by the business giants from abroad. Foreign trade policy
also includes the exchange rate policy and exchange controls and customs
duties. All these are fundamental to the growth of a business organization. For
example, suppose there is full" convertibility, then the business organizations
would be able to export and import and make payments with lesser restrictions.
On the other hand, if there is only partial convertibility, the scope for trade is
correspondingly less and the business organizations have to go through a
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sickening process of getting licenses for export or import and route all their
payments through proper channel. Customs duties also play a vital role in
determining the volume of external trade. A rise in customs duties would
discourage domestic demand because the price of imported goods and services
would go up find remain at a high level compared to the domestically produced
goods and services, A reduction in customs duties would encourage imports
and be favourable to the domestic manufacturers.

Government frequently changes the foreign trade policy, keeping in view the
requirements of the country and the economic condition. To tide over the
Glance of payments difficulties, government may resort to various policy
measures like devaluation, exchange clearing agreements, tariffs and duties,
exchange control regulations, etc. These tools would be suitably modified to
achieve the desired goals. For example, to encourage exports and discourage
imports, the government may devalue the currency, by which the imports of
Indian goods abroad become cheaper and the imports of foreign goods in India
become costlier. Hence the business organizations have to continuously
monitor the changes in the trade policies so as to position themselves
accordingly.
D] Licensing policy: In the pre-liberalization days, India adopted licensing
policy in regulate the growth of industries in India. Since the days of
independence, India adopted licensing policy, which in effect made the
government control the growth of independence in accordance with the national
priorities. For example, in India, till 1985, the industries in India were classified
into four categories: industries completely owned by public sector, industries
where both public and private sector participation was permitted, small scale
industries and collage industries. Except the first category in all the other
categories, private sector presence was permitted through licensing. This was
resulted in several adverse effects, which were all explained in detail by the Dutt
committee report. But till 1985, liberalization was never accepted as a part of
growth strategy. But after 1985, the situation slowly changed

that by 1991
India adopted a policy of liberalization. Consequently, the business scope and
prospects of the Indian business organization changed since 1991. As has
been already pointed out they were exposed to market competition and threats
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after liberalization. Performance has become a necessity for survival. By about
the end of 20
th
century, the government also proceeded to disinvest several
public sector units thereby opening up the challenges all the more for Indian
industries. Therefore, the licensing policy and its direction have a lot of impact
on the business organizations.

E] Technology policy: One of the most important economic policies is the
technology policy. Improvement in technology is a condition for growth and
survival in any organization. From a stage of man-dependent environment, the
business organizations are all fast becoming machine-dependent
[computer dependent]. Right from the stage of enquiries down up to planning
the logistics, computers are widely used. Only from the mid -1990's the
government started adopting a favourable technology policy. Apart from
permitting free imports of computers and components as well as
telecommunication equipments, the government has devised a number of
schemes like Software Technology Park, to give a Phillip to the technology in
India. Computerization has come to stay in telecommunication, railways,
roadways, postal services, educational services, medical services, engineering,
financial services, etc. This liberal technology policy has resulted in the growth
of new industrial segment, viz., and information technology. Millions of
youngsters get trained and are gainfully employed. Indian software engineers
are considered as the best in the world and several of the multinational
corporations depend on Indian supply of trained software and hardware
professionals. The business environment has completely transformed over the
past five to six years that unless organizations also accordingly change
themselves, their survival will become a serious question.

F] Price policy: This refers to the controls that government has on the price
in a country. This is necessary, because, unless price is controlled, there is
bound to be inflation and then economic instability. Further in Indian context,
nearly 35% of the population is living below the poverty line. They do not have
any permanent employment. Especially the rural poverty is very serious. To
overcome this situation, the government resorts to price control policy. All the
essential and basic necessary goods are subjected to price control. While the
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poor and downtrodden are provided the essential goods at a controlled and
subsidized rate through public distribution, the others are expected to meet
their requirements through open market. Through demand and supply
management, the government makes all the efforts to keep the prices under--
control. For instance, by building up buffer stocks, the government overcomes
the shortage of food commodities during adverse period. Similarly, specific
concessions are given to industrial units located in backward regions and rural
areas. This helps them to run on sound basis. As regards the manufactured
products, the government adopts the administered price mechanism to control
the prices. For example, the cooking gas is supplied to the public at one price,
to the commercial establishments at a different price. This helps to minimize
the strain of the population using LPG as cooking media. Similarly till April,
2002, petrol and diesel were subjected to administered price controls. Sugar,
cement, etc., are also subjected to administered price. Hence, through price
policy the government protects the interests of the people and this policy has a
direct impact on the functioning of the business organization in our country.

2. Political environment
It is well known that the business environment in a country is very much
interlinked with the political environment. The political environment simply
means the political ideology which is adopted by the government. In a
democratic country like India, this political ideology changes as and when there
is a change in the party ruling the country at the Centre and the State level. A
number of examples could be cited to prove how the political ideology has
influenced the business environment of the country.

Before independence, under the guidance of Mahatma Gandhi, India was
wedded to the policy of Swadeshi. That is, Gandhi advocated the use of only
Indian made goods and to completely abstain from imported goods, specifically
British goods. As a result immediately after independence, Indian government
followed a restrictive, trade policy imposing very heavy customs duty on
imported goods. This was thought that such a policy would help to achieve both
the political commitment as well as protection of domestic producers from the
invasion of foreign-manufacture-s and traders. A deeper look into such a policy
19
would reveal that India never wanted to entertain a policy of allowing foreign
trading activities on Indian soil as this would lead to colonization. After all the
British East India Company entered the Indian shores under the pretext of
trading with India in 1600 AD and the country had to pay a heavy price for the
next 350 years being a colony. Hence, a restrictive trade policy was very much
favored by every one and in such an environment the business environment
was such the domestic producers could operate under the umbrella protection
of the government.

This is also evident from the Industrial policy of the government in 1948, which
clearly posed a threat to foreign interests in India. At the same time, the Indian
government was very much influenced by the Russian type of planning. Being a
declared democratic socialist country, India adopted planning as the strategy of
economic development. The First Five Year plan was formulated and
implemented without relying much on industrial development, when at the end
of the I Plan it was realized that growth is impossible without industrial
development, a shift focus was necessitated that the government gave emphasis
on industrial development. But here again, the government approached the
issue with caution. It felt that a controlled and guided industrial development
would yield better results than a free unrestricted industrial development. The
consequence was the Licensing policy. Though imports were permitted,
industrial development through collaborative efforts with entrepreneurs abroad
was subjected to a very critical scrutiny. When the Licensing policy led only to
concentration of economic power in the hands of a few private sector units like
TATA, Birla, and others, the government brought in the Monopolies
Restrictive Trade Practices Act, in 1970. This has on the one hand put a check
on growth of monopolies in India, on the other hand the industrial development
was not taking place at a desired pace. The seeds for liberalization were sown
in 1985, when the government felt that India could achieve miraculous growth
through this liberalization course, it proceeded in that direction. This
culminated in the introduction of Liberalization policy in l99l. This resulted in a
peculiar scenario in which democratic socialism with capitalistic ideologies
existed. Throughout the four decades after independence, India's policies
were more governed by the political factors rather than economic necessities or
20
compulsions. Hence, at the beginning Indian government adopted a purely
socialistic pattern of development strategy while by 1990s development by
subscribing to capitalistic pattern has become the reality. This shift has a great
impact on the business environment that domestic business today has to
realign itself to survive and grow, in a competitive atmosphere.

Having discussed the effect of political environment on business environment
let us examine how far the economic system is an important factor influencing
business environment. Economic system refers to the organizations and
institutions created for the purpose of satisfying the wants of human beings. In
a country, available resources have to be utilized to manufacture and distribute
goods and services, which would meet the needs of the people so that they are
satisfied. These institutions and organizations function with their own rules
and regulations. The economic system has certain broad characteristic.

1. The economic system always functions with scarcity of resources. How the
system effectively and efficiently uses the resources will determine the
extent to which the needs of the people are met.

2. An economic system comprises people. That is, a society of human beings
alone can constitute economic system.

3. A set of institutions are created and used for the purpose of smooth
functioning of an economic system. For example, banks, money,
technology, government, price mechanism, planning etc., are all
institutions through which the systems operate.

4. The basic objective with which an economic system functions is to satisfy
the wants of the people. Unless there is want for a commodity or service,
nothing can be produced. Hence, the economic system allocates the
resources in such a way that the wants of the people are satisfied.

5. On the basis of the above characteristics of an economic system, it should
be clear that the economic system is very dynamic in nature. That is, the
21
economic system undergoes changes with every change in the
institutions, though the rate of change would differ from institution to
institution.

The economic system functions to answer three vital questions:
a] what to produce
b]how to produce and
c] for whom to produce.

Answering these questions assumes enormous significance as that would
determine every activity within a country.

The first question 'What to produce' depends on what is wanted. The economic
system would throw signals through which the requirements of the people could
be understood. But not all wants could be satisfied. This is because; a country
may not be gifted with all the necessary resources to produce all the goods.
Hence, depending upon the resource endowment a country would decide what
it could produce. Then there is a problem of prioritizing the available resources
among the goods to be produced. Resources should not be used for the
production of unwarranted goods. The production of goods, which are harmful
to human beings, like narcotic drugs, should be prevented. Hence, considering
the availability of resources, the economic system should opt to produce only
goods that would satisfy the wants of human beings. In this context it is also
necessary to weigh the individual requirements and the national requirements
for goods. The latter should be given preference over the former.

The second question How to produce addresses basically, issues relating to
selection of right strategy, technology and investment. For example, a country
like India, with very huge population should not prefer capital -intensive
technology, as that would lead to more unemployment of human resources.
Similarly, while selecting the technology, a country should weigh a number of
considerations like relevance of technology, cost of technology, support in case
of failures, consequences of the technology used, etc. Another vital aspect is the
investment that a country has to make while selecting the strategy and the
22
technology. A very important question is whether the available funds should be
invested in sophisticated research and development or meeting the basic needs
of the people. Hence, the second question would ultimately determine the
efficiency with the available resources are utilized.

For whom to produce implies that based on the resource utilization, the
country as a whole should benefit and not a few segments. Hence, having
produced the goods and services, how they could be equitably distributed is an
important aspect. The distribution of national product would differ from country
to country depending upon the economic system in vogue.

It has been already pointed out that the way in which the above three questions
are answered depends on the economic system which functions in a country. To
understand how these answers differ among the economic systems, we should
understand the different types of economic systems. In the next section, the
details of different types of economic systems are discussed.

Types of Economic system
Economic systems may broadly be classified into three categories: Capitalism,
Socialism and Mixed economy. A number of other types also emerged but all of
them came close to any one of the above three types of systems. Such systems
include: communism and Marxism Let us now discuss the features, strengths
and weaknesses of each one of these systems.

1. Capitalism
Capitalism is an economic system based on the principle of free enterprise.
Individual ownership of resources is an important feature. With control and
command over resources, individuals can conduct any type of business. The
object in such a system is to maximize private gains. Any type of enterprise or
production of any commodity or service is permitted, so long it is wanted by the
society. In such a system the market forces determine the resource allocation
and price. That is, the demand and supply forces together determine what to
produce, how to produce and for whom to produce. Price mechanism is the
nucleus of the capitalistic society. The price mechanism clearly reflects the
23
wants of the people. Once this is known, the producers would allocate the
resources to manufacture and sell the products in great demand. While doing
so, there is no control or regulation over production. In other words, oligopoly
environment prevails. But each producer differentiates his product that he
would be able to stay in the market. Technology and innovation ensure the
stability and growth of organizations. As a result only efficient organization
would survive. The resources would be fully utilized. The system is so flexible
that it can adjust itself for any economic condition. The workers get equal
opportunities and those with skills would be able to command better wages and
salaries. On the whole capitalism offers scope for growth of efficient individuals
and organizations.

But capitalism has a number of weaknesses. The important ones are discussed
below.

1. Economic inequality is invariably found in capitalistic societies.
Individuals and organizations with ownership of resources and hold over
the market for (heir product or service, would be able to maximize their
gains. Those who have no such property would remain poor and become
poorer. So it is said that under capitalism, rich becomes richer and poor
becomes poorer. The inequality in wealth and income widens over a
period under capitalism.

2. The scope for the emergence of monopolies in capitalistic societies is very
high. Organizations by virtue of their economic power would be able to
easily eliminate rivals and competitors in the market. There is also
possibility of such monopolies influencing the government in policy
making and intervention.

3. Though it is said that capitalism would always lead to ideal allocation of
resources and fuller utilization of resources, in reality the experience is
that resources are held by individuals and organizations and under
utilization is the result. Sometimes, products which are not really
24
national priority are produced and forced on the public, through
advertisements and sales promotion techniques.

4. Though it is expected that in capitalistic societies the output would
increase to optimal level, in. practice this is never found. Producers
always restrict output to maintain a high price and also maximize profit.
So excess capacity would exist in many industries.

5. In a capitalistic society the divide between the haves and have-nots widen
that over a period. Existence of poverty among the sophisticated sections
of people is also seen. This results in built up of frustration in the
society. Over a period this might lead to revolution and social upheaval.

2. Socialism
Socialism refers to an economic system ir which the following features
predominant:

The resources are owned by the State or state owned institutions.
Production takes place in the interest of the society and not for
maximizing profits of individuals or organizations. Government decides
the type of productive efforts to be permitted. In other words, in a
socialist country, government can adopt licensing system and other types
of regulations to prevent the emergence of monopolist and exploitative
tendencies. Maximization of Community welfare is the objective than
profit maximization. Another very important feature is the government
ensures equitable distribution of national product. Public distribution
system assumes enormous significance in such an economic system. On
the whole, the socialistic society differs from capitalist society in every
sense. In the broad spectrum of economic systems, socialism and
capitalism occupy two extremes. In the world today, pure capitalistic
society is not seen in any country. Even in USA, government interference
in various economic activities is found. For example, in the field of
national defense, atomic energy, space technology, social security, etc.,
the presence of government is almost complete. Government also retains
25
the right to interfere in the market system, whenever there is deliberate
and intentional attempt to monopolize the resource ownership or the
market. Similarly, in the erstwhile Soviet Union, socialistic principles
were followed. But even here, there were instances of private ownership
of property, enterprises, etc., were reported. That is why it is very
difficult to come across pure capitalistic or socialistic societies.

The merits of socialism includes: 1. Collective ownership eliminate
emergence and existence of monopolies. 2, Resources utilization is
planned and achieved in the interest of the society. 3. Government with
its control over the resources is able to use resources fully utilized and
avoid wastage and production of unnecessary goods. 4. As equality in
distribution is the fundamental feature of socialism, there is no scope for
widening inequalities rind the government takes steps to narrow the gap
between the rich and the poor through various measures.

However, socialistic states suffer from the following limitations: 1.
Excessive dependence on government decisions often result in delay in
offering any public service. 2. Bureaucratic control becomes an integral
part of the socialistic principles. As a result the benefits and its direction
of flow is determined by the bureaucrats. 3. Government by undertaking
excessive responsibility on its shoulders, abets inefficiency and
corruption in the society. 4. No incentive and motivation for individual
excellence or achievements is possible in such a society and so
innovations and inventions do not really lake place in large scale in such
a society. 5. With governmental presence in every walk of life, efficiency
and productivity suffer. 6. Lack of support for individual liberty kills
initiative.

3. Mixed economy
Evolution of the concept of Mixed economy:

There was no reference to the mixed economic system in Economic literature in
the past. Economists were mainly familiar and advocated the Laissez faire or
26
free enterprise system, as several countries could develop fast following the free
enterprise system, in which there was no or little government intervention. The
entire economic system operated with the price mechanism at its center point.
The producers produced what the consumers wanted and this provided very
little scope for the government to intervene in the system. The Classical
economists and their ardent supporters believed that the invisible hand will
direct the economy and with private initiative and enterprise, every country
should be able to record a faster growth as proved in the case of UK, USA,
Europe, Australia, and other countries.

But over a period under the leadership of Karl Marx, a new economic system
was developed called socialism, in which there is no scope for any private
enterprise as everything owned and controlled by the government. The
government decided the type of developmental activities and me requirements of
the society and used the available resources in the provision of these
requirements. Several countries like USSR, Communist China, Vietnam, Cuba
and others preferred this socialist system in which government is made the
custodian of the society. The main reason for Die emergence of this new
economic system was the failure of capitalism during the 1929 depression to
revive every economy from depression. Keynes himself thought that capitalism
without some of its evils could certainly help economic recovery. Hence, a time
came when economists felt that cent per cent free enterprise or cent per cent
government governed economic development cannot work satisfactorily. A
compromise between these extremes was thought of as an ideal economic
system. The new system called 'mixed economic system' contained the merits of
both the capitalism and socialism and appeared to be full of promise. This
mixed economic system is adopted by India as indicated by the First Industrial
Policy Resolution 1948.

Characteristics of mixed economy:
i. Co-existence of public and private sectors:

In a mixed economy, one will find the existence of both the private and public
sectors. In such a system, the government will undertake the responsibility to
27
build and develop certain sector activities and leave the other activities for the
private initiative. In India, the government announced the adoption of the mixed
economy system through its 1948 Industrial Policy Resolution. The government
clearly earmarked the industries to be completely under the state control, the
industries which are to owned and controlled by the state as well as the private
sector and industries which are completely left for the private sector. In this
way the Resolution provided for the simultaneous existence of both private and
public sectors.

ii. State participation in economic development:

This is the second feature of mixed economy, according, to which the state
reserves its right to design and decide the type of development to be achieved.
In such a set up, the government strives to promote the welfare of the country
by ensuring social order, social justice and establishing all the necessary
institutions which are required to achieve the desired pattern of growth and
development.

iii. Distribution of ownership and control of resources:

This is the next feature of mixed economy. In this system, the government itself
enters the field of production so that the available resources are fully utilized.
This will also help to avoid concentration of wealth in the hands of a few and
enable distribution of ownership and control of productive activities. As a result
there is no scope for exploitation of any group, say labor, by any other group. In
this way the weaker section of the community is well protected and taken care
of. Only the mixed economy will enable the government to attain the objectives
of the Directive Principles of the Indian Constitution.

iv. Directing the investment in socially desirable projects and channels:

Mixed economy facilitates the flow of investment into channels which confers
the society with several benefits. For example, the Indian government has
invested huge amount in several projects to develop the infrastructural
28
facilities. This forms the basis for the development of other sectors. The
investment in these infrastructural areas will not come forth from the private
sector as the return is nil. Hence, the government in a mixed economic set up
provides the thrust by developing the necessary background and strength
which will encourage the private sector to invest in profitable opportunities. In
this way the government plays a key role in a mixed economic system.

v. Scope for achieving balanced economic development:

I Left to itself, the private sector would establish its enterprises only in urban or
sub-urban areas and that too in already well developed states. This will mean
other areas will have no scope for development. But in a mixed economy, the
government will itself undertake the initiative to set up industries in backward
areas and encourage the private initiative to set up industries in such areas by
offering several concessions and exemptions. In the absence of nixed economy,
several states in India would have remained industrially backward.

vi. Ultimate control and regulation in the hands of government:

This feature of mixed economy clearly spells out that in every activity affecting
the economy, the government will be the ultimate authority. Though the private
sector is assigned its role to perform, the government will still monitor and
control the way in which the private initiative is performing its role. Infact,
according to the 1948 Industrial Policy Resolution, the government made it
clear that the industries already established by the private sector belonging to
that category in which new industries will be established by the government
alone, the government would undertake the review of the working of these
industries in private sector after a period of ten years and if found not
satisfactory, they would be taken over by the government. Though this was
criticized as a threat of nationalization, yet through such a provision the
government underlines its authority. Similarly in the banking and insurance
sectors, the government nationalized banks emphasizing its powers to control
and regulate any sector.

29
vii. Co-operation in the field of economic development:

According to this feature of mixed economy, the government formulates the
design for development and invites the private sector to participate in the
development. It clearly spells out the guidelines which would govern such co-
operative efforts and the limits of freedom granted to the private sector. In
Indian case, the government prepares the plans for development and spells out
the areas left for the private initiative and the areas that will be under state
control. Hence, there is scope for the development of private sector, though only
according to the design developed by the government.

Planning process under mixed economy:
As has been already stated, in a mixed economy there is a need to achieve a
compromise between self-interest and social interest This is a very difficult task
as the government has to carefully foresee the type of development it wants to
achieve and closely monitor the activities of the private sector to ensure that the
social interest is never at stake. Obviously, planning is a very difficult exercise
in a mixed economy set up. The success of planning will depend upon; i) the
extent to which the public sector is able to rise to achieve the social gains aimed
for, ii) the success of the state in guiding and regulating the private sector
activities towards social goals and iii) the extent lo which (lie state is able (o
check the distortions taking place in investment by private sector affecting (he
interest of the public sector. Hence in the planning process the state has taken
up the following steps to ensure the accomplishment of the objectives of the
mixed economy,
a. By holding complete ownership of defense and heavy industries, the
government has provided an industrial base with which the private
sector is expected to plan its investment activities.

b. The state also has made huge investments in economic infrastructures
so as to help the extension of market for goods, raising the productivity
in agricultural and industrial sectors, encouragement of further
productive investment

30
c. The government has complete control of the financial institutions
including banks so that it can ensure that the banks and other
institutions play a key role in the development activities of the state.
The government could also realize the expected gains by encouraging
the priority activities in every sector. The economic institutions are
made to support the weaker sections of the community.

d. Through powerful legislations like MRTP Act, FERA, etc., the
government could ensure that there is no scope for exploitation of the
common people by the private enterprise. Such a legal framework lays
down the rules of the game and ensures fair play in a mixed economic
set up.

e. As a method of protecting the weaker and downtrodden people, the
government has policies like rationing, price controls, etc. Such
regulations are built in the planning mechanism itself, so that the
private sector cannot exploit the community.


f. Towards the improvement of welfare in the economy, the state has
undertaken several specific programs aimed at specific target groups.
For example schemes aimed at the backward and schedule tribe
providing them reservation in educational, employment and other
opportunities, rural oriented schemes for the rural folks, health for all
schemes, provision of free educational and medical facilities up to a
certain level, etc. All these schemes aim at improving the social welfare.
In all these activities the private sector is also welcome to play its role.

g. The government makes effective use of the tools of fiscal policy viz.
taxation and public expenditure, so as to achieve the objectives of
economic planning.


Distortions in the planning process :
31

We have explained above that the fundamental objective of the mixed economy
is to subordinate the self-interest for the national-interest whether this has
been achieved in Indian situation is a moot question. In spite of various types of
regulations and controls, the fruits of mixed economy have not appeared to
have reached the common men. Even after four decades after the adoption of
mixed economy principle, we come across glaring distortions which go to prove
that mixed economy in practice has not been very effective. This is mainly
because of the influence exercised by the private enterprise through political
influence, corruptive activities, dishonest bureaucrats, powerful national and
international lobbying, etc. The extent of distortions could be understood if we
study the following points:
1. One of the basic objectives of Indian planning is to eradicate poverty,
but five decades after the adoption of planning strategy, the proportion
of population below the poverty line has not significantly changed.

2. The planning mechanism has failed to check the rise in price level.
Inflation has come to stay in India with no policy being effective. When
double digit inflation is controlled and results in single digit inflation,
the country boasts of having achieved something very great.

3. The emergence and existence of black money is yet another yardstick to
prove the failure of the mixed economy. The high level of taxation has
only resulted in effective tax evasion and tax avoidance. As a result the
distance between the rich and the poor remains wide.

4. Till date there has been no effective method to prevent the
concentration of economic power in the hands of a few. The rich
becomes richer and the poor, the poorer.

5. In spite of five decades of planning, unemployment is very much on the
increase and the backlog in every plan is assuming dangerous
proportions. This is mainly because of the failure to control fee growth
32
of population and the adoption of capital intensive production
techniques.

6. The failure to achieve re-distribution of income is yet another glaring
distortion. All the efforts to bridge the gap between the wages of rural
and urban workers or increase the real wage of the working class has
not succeeded.

When we study the above points, it is clear, that mixed economy has not carried
us in the desired direction. This is mainly because of the inability of the
government as it is frequently yielding to the pressure exerted by the vested
interests. Even the recent liberalization measure could be viewed from this
angle. But a country cannot remain independent of the international pressures,
especially when India is depending upon the IMF and EBRD, all its internal
policies are indirectly governed by these lending agencies: Whether this is right
or wrong is a question that could be answered only after we evaluate the gains
of liberalization policy. But on the whole, the expected benefits of mixed
economy have not been realized as is clearly proved by the distortions discussed
above.

4. Marxism

Marxism is essentially socialism in different garb. The pure socialism is proved
to be impractical and it made role of government the center point. Most of the
government could not fit in this role effectively. Further capitalism with its
explicit goals threatened the success of socialism. It was at this juncture that
Karl Marx came up with his ideology, which led to the evolution of Marxian
socialism. Marx succeeded through his logical reasoning that economics
dominates every activity of a society. This leads to class struggle. When one
struggle is tackled another one crop up. The continued onslaught of the
capitalist on the society would result in the creation of haves and have-nots.
This division of the society would widen with the continuance of capitalism,
which ultimately will result in class struggle. Marx explained through his theory
of value that every product should be valued in accordance with the value of
33
labor contained in it. But the laborers are rewarded at a very much lesser rate
than what they create. That is,, every laborer contribute more by way of his
work to produce the product but he is paid a very low wages. The difference is
the gain realized by the capitalists. The capitalists would accumulate profits
this way at the cost of worsening labor condition. Over a period the divide
between the proprietary class and the labor class would widen that much, that
there would be social upheaval. Karl Marx predicted class war and argued that
unless the capitalist class realizes this, there would be severe impact on
production and economic condition of a country. His argument came true in
the case of France that the French revolution broke out in 1789. There were
similar problems in different parts of the globe, like in erstwhile USSR [Scissor's
crisis], and China. China, especially remained a closed economy till early
I990's. But in China, the Marxism led to the emergence of communism. This is
discussed in detail below.

Though Marxism held sway over a number of countries for some time, yet it has
inherent defects. Firstly, Marx's view that all activities in all countries are
basically economic in nature is not true. Secondly, his argument that class
struggle continuously takes place in every country did not hold water. A
number of other reasons of economic, social and cultural nature led to the
struggle and not the way Marx predicted. Thirdly, the theory of surplus value
could not be applied in practice in service industry. Fourthly, Marx never took
into the interference that a government could make in case of exploitation of
society by the capitalists.

5. Communism

Communism is Marx's prediction at the fall of capitalism. Marx argued that the
widening inequalities in a society coupled with class struggle should ultimately
sound the death knell of capitalism. He is of the view that when capitalism falls,
the communism will emerge in which, the laborers will lead the country. The
government will own all the resources and determine the needs of the society. It
will also decide various other issues of macro and micro importance.
Government will turn out to be the custodian of the society and in a pure
34
communistic society; people will lead a life where basic necessities are provided
by the government. Unemployment will be very low as every one is occupied in
some avocation or other.

But the way in which communism was practiced in China created an
impression that the government would be oppressive in its approach that the
people will lead a life of slavery. One has to work to earn his bread. Military type
of regimentation was enforced that common people were subjected to absolute
control and regulation by government. The economy remained closed without
any international relations, both economic and social. There were no two party
systems that the nominated representatives of the Communist party attended to
all the governmental responsibilities. Market mechanism is completely absent in
such a system, as government determined everything on behalf of the country.

As has been already pointed out depending upon the economic system, the
business environment will change. In a capitalist system, the environment
provides opportunities for every one who wants to maximize gains. In a socialist
system, the government undertakes the responsibility of providing everything to
the citizens. In a Marxist economy, it is ultimately the laborers who will hold the
reins. In a Communist economy, it is the group of administrators who run the
economy in the interest of the economy.

4. Cultural environment

Culture refers to the behaviour, attitude, way of living, belief, faith, law and
custom of people in a country. It; could be immediately understood that these
aspects would differ from country to country and also in different regions of the
same country. It is always said mat the culture determines the people's
preferences, which directly determines the success or failure of business.
Hence, cultural, environment has a direct impact on business. A number of
examples could be cited to prove this.

In olden days, eating in hotels was considered unhygienic and majority of the
people never used to accept food from outside. But today, even the orthodox/
35
people freely take their requirements from fast food restaurant. This change has
come about, because of the changing culture in the society. For instance, with
the presence of a large of multi national corporations, the executives working in
such organizations are very well paid that they rarely find time to spend on
food. Such executives prefer working lunch rather than lunch. So provision of
such working lunch should not take time and if food is made available readily
without any time loss, then the executives would be able to save their time.
Further when executives leave home very early, it is impossible for them to
prepare some food and get for their lunch. So when their working lunch
requirement is met nearby by their work Spot in am ambient atmosphere it
would be welcome. This has given a fillip to the growth of Fast food restaurants.
In this manner, certain new cultural practices are transmitted to the society.
Similarly, regarding the requirement of clothes, people are slowly switching on
to ready made garments of different varieties and design. Sensing this, several
international brands in ready garments are entering the market. This is how the
business adapts itself to the cultural environment in a country. Business also
conducts research continuously for the purpose of innovating and inventing
new products and uses for the existing products. It is through this process that
several consumer durable products like wet grinder, mixer, washing machine,
geysers, etc., have been introduced in the market. Having created them, the
business impress upon the people to use them as time saving devices.

Hence, cultural environment can create business opportunities. Any
organization which is able to sense the business opportunity and capitalize it,
would be able to succeed and grow. But it should be noted that changes in
culture do not affect every part of the country or people in the same way or at
the same time. It is possible to observe certain^ regions/people lag in adopting
a particular culture. This is what is referred to as cultural lag. For example,
even to day in rural areas, certain practices like untouchability is found, though
it is a crime. Such cultural lag is found mainly because of illiteracy, ignorance,
conservatism, sentimental factors, political factors and vested interests.
Business should be aware of this while addressing the requirements of people
in different regions and nations. One more aspect of cultural is the change.
While some of the changes are accepted very fast the others are resisted. While
36
in some families divorce is accepted as a common feature, in others, divorce is
viewed very seriously and extreme efforts are taken to pacify the parties in
conflict. Another important example is the women's employment. While in olden
days women were destined to domestic works, today women entrepreneur lead
several fields. Attitude towards work is yet another area when Indian culture
lags much behind the Western and Japanese culture.

In the light of the above discussion, the following case studies would make
sense and prove how business environment can either give a boost to an
organization or cause a doom.

37
CASE STUDY: 1

WILLIAM HENRY GATES, III AND THE MICROSOFT
MONEY MACHINE

Several years ago, when his fortune was a mere several hundred million dollars,
a weekly magazine labeled Bill Gates as Americas richest nerd.' In 1992, at age
36, he had passed Donald Trump, Ross Perot and others to be listed as
America's wealthiest person by Forbes magazine; the value of his holdings had
grown to an estimated $ 6.3 billion. How did the free enterprise system help
him to attain such phenomenal wealth?

After graduating from high school in Seattle in 1973, Gates went to Harvard.
While there, he learned that the personal computer [PC] was in the development
stage. He dropped out of school and threw himself completely into designing an
operating system [the program that coordinates the hardware and software of
the computer] for the PC. His system, [S - DOS the Microsoft Disk Opening
System] was so good that IBM agreed to use it in their line of, personal
computers. With IBM setting the industry standard, other computer
manufacturers quickly adopted MS DOS as well. Today it is estimated that
more than 80 per cent of all personal computers in the world use this system:
Gate's firm, Microsoft, Inc., makes money on every computer sold with MS-DOS
as the operating system.' In the 1992, the firm recorded $2.8 billion in revenue
and $ 708 million in net profit. It ranks third in size in the industry, behind
IBM and Hewlett - Packard. Gate's personal holdings of some 90 million shares
of common stock represent about 33 per cent ownership share of the company.

Microsoft also produces programs for word processing, spreadsheets, and a
variety of other applications. One of Gate's latest ventures has been to purchase
the electronic reproduction rights to thousands of art and photographic works
from museums and libraries around the world. These will be used as a part of
his plan for interactive home entertainment systems.

38
With extremely hard work, a creative mind, and a willingness to take risks,
Gates has demonstrated how the market rewards the successful entrepreneur.
He was able to produce what consumers wanted at a price they were willing to
pay the result was that both and they are better off ! This is the essence of free
market economic system.

From the above case study, it would be clear how a pro-active, imaginative and
innovative entrepreneur can, carry the business with him. Though a school
drop out. Gates has climbed the pinnacle of business world, merely by his
ability to anticipate the changes, in the personal computer industry.

Failure to read the business environment and initiate appropriate steps to
protect the business, can lead to a serious threat to existence itself. This would-
be clsar from the following case on Maruti Udyog of India and Doordarshan.

Case study : 2
MARUTI UDYOG LTD.,

When Indian car market was opened for new private players, Maruti Udyog
limited, which had till then enjoyed an enviable position in the market,
suddenly faced severe market erosion. Even though Maruti is the market leader
and has the largest range of products, cheaper cars, good service network and
better cost structures, it has been steadily losing its market share for the last
three years and the valuation of the company has halved in 4 years time from
Rs. 80 bn in 1996 to Rs. 40 bn in 2000.

A Marjti udyog rival: What MUL did to Premier Automobiles and Hindustan
motors is now being done lo it.

Empire under siege

Jagdish Khattar, MD MUL was a man in trouble. He was facing what was the
biggest setback ever for the company. With all strategies backfiring, he seemed
to be fighting a losing battle.
39

Problems were aplenty - the Maruti 800 segment was facing demand - erosion,
Zen and its arch-rival Santro were very close in terms of volumes, Esteem was
losing ground, Baleno, Wagon R and Alto were yet to prove themselves, while
Gypsy was snugly ensconced in its niche. [Gypsy was not generating many
volumes needed for MUL]

Despite the fact the fact that MUL had the biggest range of products, the
cheapest cars in the market and a service network and cost structures that
were better than anyone else, it had steadily lost market share - down from
82.62 percent in 1998 to 52 per cent in 2000. With the impending
disinvestments, [Government's. policy of disinvestments in Public sector units
includes MUEL also along with other profit making PSUs.] MD was facing flak
from the government as well. With market share declining, MULs valuation had
also come down drastically. While it was valued at Rs. 80 bn in 1996, by
December, 2000, the figure had touched Rs. 40 bn.

The building blocks

MUL was the largest car manufacturer in India with a market share of over 52
per cent. It was a joint sector corporation set up by the government of India and
Suzuki Motor Corporation, Japan. MUL was incorporated in 1981 to take over
the assets of the erstwhile MUL set up in June 1971 and wound up by a High
Court order in 1978. The assets of MUL were then acquired buy the
Government under MUL Acquisition and Transfer of Undertakings Act, 1980. In
1982, the Government signed a joint venture agreement with Suzuki of Japan.
Suzuki's stake increased from 26 to 40% in 1987, and to 50.25% in 1992. The
company was a significant exporter with exports to over 50 countries.

The company manufactured passenger cars at its factor in Gurgaon, Haryana,
with an installed capacity of 350,000 vehicles. The first product, Maruti 800
was launched in 1984, followed by the all-terrain vehicle Gypsy in 1985. Over
the years, MUL expanded its portfolio with the launch of the Maruti 1000
40
[1990]; the Zen and the Esteem [1993]; Zen Diesel [1998]p Baleno, Wagon R
and the Alto [2000].

MUL was known for its value for money pricing strategy, which had been made
possible due to the high levels of indigenization of its vehicles. While the Maruti
800, Zen, Esteem, and Omni were indigenized to the extent of over 90%, the
Gypsy was indigenized to the extent of 82% and the Alto to the extent of 76%.
The company had a network of about 375 vendors and had several joint
ventures with some of them to source its raw material requirements It's sales
[comprising 112 dealers and sales outlets in 86. locations] and service
[comprising 1010 service workshops covering 412 locations] network was one of
the largest in the country.

The Stumbling blocks

Till October 1998, MUL enjoyed a market share of 83.6% reacting to the
increasing number, of players, its-MD commented, Obviously, our market
share will decline with the entry of new manufacturers and models in
percentage terms, but not in actual volumes.


With cars ranging from Rs. 0.21 mn to s. 0.67 mn, problems associated with an
ever-expanding product portfolio constantly plagued MUL. Besides the
declining market share, cannibalization was another issue the company could
ill-afford to ignore. Forced to take stock of what went wrong, MUL realized that
it was dependent to a large extent on a single product - the Maruti 800.

The 800, along with the Omrii [build on the same platform accounted for 75% of
units sales in the car. market in 1998; it had always been the 'breadwinner' for
MUL. One of the biggest success sagas in Indian automobile history, the 800
started losing its sheen in the 1990s as newer players emerged in the market.
The entry-level segment ceased to be the center of action as easy car finance
availability and the lure of new cars made the Rs. 0.3 inn to Rs. 0.4 mn
segment the most attractive one. The fact that MUL made only minor changes
41
in the models over the years led to the perception that MUL was selling old
models.

To tackle these problems, MUL adopted a two-pronged strategy. One, to
introduce new models; two, it decided to increase the number of variants
rapidly, offering a new model with every increase of Rs. 25000. MUL also
revamped its engines and took the 800 to semi-urban and rural areas, to
compensate for the declining urban sales. The company was aiming to move
entry-level prices up without losing out on volumes by launching cars in the
segment just above the 800. As part of this, Baleno, Wagon R and Alto were
launched in quick succession. [Alto was launched in the same league as the
800. Industry observers contended that Alto's launch in the 800-cc category
signaled the beginning of a gradual phasing out of the 800. However, MUL
sources were quick to deny this- and-asserted that the 800 would be retained:]
However, despite favourable reviews, these cars did not go on to become the
saviors of MUL was hoping for.


The engine-revamp exercise for the 800 had pushed its price close the base
model of rival Daewoo's Matiz, eroding the price advantage on which the model
survived. As a final resort, MUL decided to play what it thought was its trump
card - price reduction. The move was also justified on the gorunds that the
company was following Product Pyramid Profit model. [The Product Pyramid
incorporated the distinct customer segments and their varied purchase -
behaviour in terms of style, colour, feature and price preferences. The base of
the Pyramid was occupied by low price, high volume product s. like the 800,
where the margins were slim. The apex of the Pyramid was occupied by high-
price, low volume products such as the Maruti Esteem VX. Although -profits
were concentrated near the top, the base played a crucial role as it created an
entry-barrier for competitors, and insulated the profitable area near the top
from competition. In the specific case of cars, the most common model was the
new product profits model. Thus, the profits associated with a car followed the
"s" curve of its life cycle, and declined as the product neared the end of the
42
maturity. phase. MUL's decision to drop the prices of all the versions of the
Maruti 800 came at this stage].

MUL reduced the prices of Maruti 800 and Zen by about Rs. 24000 and Rs.
51000 respectively in December, 1998, This resulted in a drop of Rs. 3 bn in net
profit for the year 1998-99. The MD justified die price cuts, saying that MUL
wanted to make up for the increase in the 800s price due to higher sales tax
figures for the period. The move was described as an attempt to "redefine the
price-value equation." MUL sources claimed that they expected lower prices to
bring an incremental growth of 25% over the next 12 months. However, despite
the price cuts, by March 1999, the company's market share decreased to
54.57%

In early 2000, MUL announced that it would pass on the cost of installing Euro-
II compliant engines with Multi-point fuel Injection [MPFI] to its
customers. There was a rush in the market for the 800. as many first-time
consumers who did not want to bear the hike, hastened their purchase. MUL
had to increase the price of the 800 from. Rs. 0,18 mn to Rs. 0.22 mn. Around
the same time, MUL decided to meet the competition head-on by having a model
or variant with every increase of Rs. 25000. The idea was to give the customer
the widest choice possible. By mid-2000, the company offered 43 models in a
market, which had only 127 models.

In June 2000, sales of the 800 stood at 5296 cars compared to the 11000 plus
cars it had been selling per month for the previous few years. MUL had no
option but to again slash prices of various models by Rs. 25000 to Rs. 30000, to
bring back the sales to normal levels. Other changes initiated by the'-company
included a transformation in its customer - interface and a revamped branding
strategy with the new cars [Wagon R and Baleno] coming with the Suzuki prefix.
The price cuts, however, only added to the declining bottom line problem. MUL
reported a loss of Rs. 6792. II on every car sold between April and October
2000. MUL sources, however, attributed this to the fact that MUL had not
passed on the cost of up-gradation to meet the Euro;I and Euro II emission
norms to its customers. '
43

The industry strikes back

The Indian car market of the early 21
s1
century was a burgeoning one with over
127 models on the roads, and many more in the pipeline. Increased competition
had radically transformed the market, manifested clearly in carmaker's pricing
strategy overhaul. Manufacturers were breaking the conventional rules of auto
pricing by moving from cost-based to value-based pricing and the market soon,
became a buyer's market.

When the new players entered the market, there were no doubts that the main
artillery for the companies in the car-wars would be the pricing strategies. It
was not just a case of competition forcing a downward revision; the players were
even ready to forego profits in the short run. Brand building and technology /
feature driven campaign were to be add-ons to the above plan. Industry
observers were quick to point out that MUL would have to get entangled in the
price reducing game.

A Business India report pointed : No one is better equipped to fight a price war
than Maruti. Its phenomenal profitability, cash reserves and efficiency in
manufacturing will allow it to slash prices on all its models without feeling the
pinch as much as others.

However, Hyundai was the first company to introduce what came to be known
as, pricing based on customer's value perceptions. It introduced the base model
of Santro at Rs. 0.29 mn, while two other versions were priced at Rs. 0.34 and
Rs. 0.37 mn. The basic version was targeted at buyers of the 800, and the other
at the Zen. Thereafter, hunches in the Rs. 0.2 mn to Rs. 0.6 mn segment by
Ford and Hyundai showed highly innovative pricing strategies being adopted.
Soon after, Ind Auto dropped the price of the Fiat Uno Diesel by Rs. 64867 and
Premier Automobiles Ltd lowered the prices of the four versions of the Premier
Padmini by Rs. 5000 to make it Rs. 53000.

44
MUL had adopted a skimming strategy for Esteem. Launched in 1993, it was
positioned as a luxury car. This continued till the arrival of Daewoo's Cielo in
1996, which started eating into Esteem's share. In 1999, the segment saw the
arrival of Fiat Siena, Opc-1 Corsa, Ford lko.n and the Hyundai Accent. MUL
resorted to price slashing and brought the prices down. While the top end
version's price was reduced to Rs. 0.52 mn, from Rs. 0.59 mn, the basic version
was brought down to Rs. 0.44 mn from 0.46 mn. However, this was possible
only because it enjoyed substantial margins over costs, being the first mover in
the market.

MUL also followed the- same modus operandi for Zen, albeit in a different
manner. The company increased the number of Zen variants to 10, with prices
ranging hom Rs. 0.3 mn to Rs. 0.43 mn. The price stood reduced for the Rs. 0.3
mn variant in terms of stripping down the models features.

The competition responded with similar moves. Daewoo offered price-variants
for Matiz, Ind Auto offered seven variants of Fiat Uno, ranging from Rs. 0.27 mn
to Rs. 0.41 mn. Hyundai's Santro offered six variants between Rs. 0.29 mn and
Rs. 0.37 mn; Telco's Indica came in the range of Rs. 0.25 mn to Rs. 0.38 mn
with four models. NK Goila, VF Honda - Sicl cars, aptly summed up the
situation : It is important to be present with grade - variation and a range to
cover the range of potential customers being targeted. The price - points in the
car market were replaced by price bands. The width of a price band was a
function of the size of the segment being targeted besides the intensity of
competition. The thumb rule being, the higher the intensity, the wider the price-
band.

Fords research, before the launch of the Ikon, a car made for the/Indian
market, revealed that over the previous two three years, the 800 segment had
graduated to the next level of Zen, Santro, Matiz, Uno and Indica. Ford's
research on the existing market segments and the consumer response to new
cars revealed that beyond the Zen segment, the choice of the consumer was
limited. Models like the Esteem and Cielo had had a long innings outside the
country and were not exactly contemporary. The other options were Escort,
45
Lancer and Honda, which were priced above Rs. 0.7 mn Between them and the
Rs. 0.45 - 0.5 run range of the Esteem and Cielo, thee was a vacuum. The gap
was identified by General Motors' Corsa and Fiat's Siena as well. All three
competitors plugged the gap by offering several versions at various price points.
Ford first launched Ikon 1.6 but later came up with a lower engine capacity
Ikon I.3CLXI at a lower price. GM and Fiat also followed the same approach.

About price reduction

The fact that 82% of the Indian market was accounted for cars priced below Rs.
0.43 mn, proved how strongly price influenced volumes. Moreover, with
domestic car sales dropping by 15.01% in November 1998 over November, 1997
manufacturers had to turn towards price to resuscitate demand.

In the prevailing conditions, the 'Second P of aulo marketing' price reduction,
seemed to be (he only factor able to rejuvenate the stagnant demand.

However, not every player had the financial-muscle to play the price card.
Instead of cutting the price of Matiz, Daewoo Motors introduced an enhanced
version with product features like power steering, and product-plus features
like better service and customer-care. Players like Hyundai and Telco did not
opt for price reduction, as they simply did not have the economies of scale to
profit from such moves. Such strategies worked best for companies with offering
in several segments of the market. Higher volumes from the combined sales of
products across segments enabled them to drive harder bargains with their
suppliers; unit marketing and distribution costs decreased; and the higher
margins on products positioned near the top compensated for the pared
margins on the basic product.

The players who chose to stay out of the race to cut prices had to convince their
customers that the higher prices they charged were justified by the greater
value they offered. A product and promotional mix had to be specifically
designed to convey the above message. Most manufacturers of mid-size cars,
including General Motors, Ford, Honda-Siel, adopted this strategy rather than
46
cut costs to increase sales. They argued that because of the 'snob-value' of a
costlier car, buyers in this segment were not that susceptible to be swayed by
price cuts.

They cited the Cielo price reduction fiasco as an example. When sales of
Daewoo's Cielo went down from a peak of 2260 cars in September 1956 to 314
in December 1997, the company slashed the price of its base model Rs. 0.13
inn in January, 1998. Daewoo also introduced zero-interet finance schemes and
its dealers gave unofficial discounts ranging from Rs. 0.08 mn to Rs. 0.10 mn,
Sales increased by 300% to 906 and 1102 by March, 1998. However, this was
far below the company's capacity of 6000 ears per month. Daewoo launched an
upper end version, Cielo Executive and an upgraded versions, Nexia at higher
price points. However, the market had discounted Daewoo by then and sales
did not pick up further, falling to a low of 148 by February, 1999.

Companies realized that only when competing brands were perceived to be
equal in all other aspects, would price be a deciding issue. As the target
segment became more affluent, upgrades as well as first time buyers did not
necessarily start at the lowest price level. Applied as a brand level strategy,
price helped the auto marketers win over only the entry level customer.

The biggest price a manufacturer would have to pay for playing the price game
continuously was undoubtedly the loss of customer loyalty. The world over,
automobile brands succeed on the basis of their relationship with fiercely loyal
customer communities, built around sharp brand images and unique value
proportions. By choosing to shift the focus to price, MUL risked the loss of
damaging its customer relations and brand valuation, as it ended up
antagonizing the buyers who had bought MUL cars just before the price
reduction. This led to a feeling of betrayal among MUL loyalist. When these
customers replaced their cars, it was doubtful whether they would turn back to
MUL or go in for a rival car with a vengeance.

Much ado about nothing ?
47
As the Indian automobile market moved from monopoly to free competition,
market share comparisons from the old era seemed to have lost relevance. The
alarm over MUL's declining market share somehow did not seem fully justified.
In its heyday, huge waiting lists for its products ensured that Marutis market
share was directly linked to the supply side of the equation. In other words, if
MUL had an 80% share of the market, that was also its share of the total
industry capacity. By the late 1990s, things changed radically with over 12 car
manufacturers having a presence in the country, with a total capacity of about
1,250,000 cars, of which MUL produced about 400,000 [33%]. Khattar
commented tell me, if we have market share of 50% out of a capacity that is
33% [of the industry], are we doing badly? Why don't you ask the others who
together have a capacity of 800,000, but cannot match our sales? All said and
done, MUL was still the leader in early -2001. It still had its early mover
advantages. Provided Khattar plays his cards right, MUL can still rule the roost
for years to come. Whether this will happen for real, is a question too early to be
answered.





Case study: 1.3
DOORDARHSAN: BROADCASTING BLUES

[DD India's national television network is one of the world's largest
broadcasting organizations with respect to the infrastructure it possesses. It
present telecasts programs on 19 channels. Over the years, DD has been losing
its advertising revenues to its competitors [private channels]. The continuously
falling Television Viewers Rating added to the problem. DD has also been facing
many problems regarding its managements, right from the time when Prasar
Bharati was created. In mid-90's, cable television reached many Indian homes
and several private channels, were launched. All of a sudden DD had to
content with a host of channels whose programs were better produced. Poor
quality of transmission and program content prompted viewers, to switch to
48
private channels. The case provides an overview of the problems faced by DD
due to mismanagement and competition from private channels.] "DD needs an
owner" - CEO, Carat Media Services India.

IS DD DEAD?

After years of falling revenues, in 1999-2000 DD had a revenue growth of 50%.
In 1999-2000, DD earned revenues of Rs, 6.1 bn compared to Rs. 3.99 bn in
1998-99. DD showed signs of revival with the launch of DD Worlds [a channel
for NRIs] and had a certain measure of success with some of its regional
channels [Table-1 DD Channels: A snapshot]. However, by the end of 2000-01,
DD's revenues were projected to grow at 6 - 15 % while private channels such
as Zee T V, Star and Sony had a projected 40 -50 % revenue growth.

According to some analysts, DD's sagging revenues were only the tip of the
iceberg. DD was plagued by several problems. By the late 1990's, most private
producers and advertisers and a good part of the audience had deserted DD.
Not even one car company advertised on DD and even two wheeler
manufacturers kept away. Advertisements of Pepsi and Coca - Cola were found
only during sports telecasts. Only FMCG companies stuck to DD, because its
terrestrial network would help them to reach the rural and semi urban
audience. Despite having over 21000 employees, DD outsourced 50 % of its
programs from private producers.

In the late I990's, DD faced allegations of large scale scams and irregularities.
Under-utilized infrastructure, improper investments and poor financial
management adversely affected DD's performance. In 1992, when the
Government opened the airwaves to private players, HD had to face competition
from private satellite channels. In Cable and Satellite [C & S] homes it was
found that DD programs had hardly any viewers. The depleting Television
Viewer Ratings [TVRs] of the DD programs was also a cause of concern as
advertisers deserted due to its low viewer ratings.

49
According to analysts, DD would need a budgetary support of Rs. 5 bn during
fiscal 2000-01 to sustain itself, as its revenues would not cover its expenditure.
Many analysts felt that privatization would be the only solution.

DD : THE INSIDE STORY
DD was launched in 1959 as the National Television Network with a modest 21
community sets in Delhi. In the year 1982, with the introduction of regular
satellite link between Delhi and different transmitters, DD began the
transmission of national programs. In the same year, DD switched to colour
transmission. Soon it had penetrated every nook and corner of the country,
cutting across demographic and geographic barriers.

DD had a three-tier program service - national, regional and local. The national
programs focused on the national culture and included news, programs on
current affairs, and science, cultural magazines, serials, music and dance
recitals, plays and feature films. At the regional level the programs were similar
to the ones broadcast at the national level, the only difference being that they
were broadcast in the regional language.

In 1984, DD introduced a second channel [DD2] in cities like Delhi, Mumbai,
Kolkata and Chennai. DD2 was targeted at urban viewers, particularly the
young viewers.

In 1995, DD launched DD - India, its international channel to cater to the NRI
population. This service covered SAARC countries.. Gulf countries, West Asia,
Central Asia, North Africa and Europe. In the same year, DD entered into an
agreement with the Cable News Network [CNN] and launched a 24 - hours news
and current affairs channel : DD News. In 1999, DD launched a separate
channel for sports.

In the early 1990s, about 479 mn people in Indian homes viewed DD and an
additional 1.5 mn watched DD on community sets. DD was ahead of the private
channels in terms of viewership with a 90% reach. However, in the late 1990s,
50
it could not maintain the lead and phase channels were catching up in terms of
revenue even though they lagged behind in viewership and reach.

Cable onslaught

In 19S4, cable television entered India. For local entrepreneurs, cable television
provided a good business opportunity, as investments required to install a cable
network were low. In the early 1990s, many-private television channels were
launched. Zee TV launched in 1992 led the pack. During 1992-94, there was
rapid increase in the number of cable connection in Western and Northern
India. In Tamil Nadu and Andhra Pradesh, a number of Tamil and Telugu
channels came up in the mid-1990s.

Though by 2000, DD had an incredible reach of 70 mn homes, in comparison to
C & Ss reach of only 30 mn homes. It could not turn this network into an
advantage [Table II for growth of cable and satellite penetration in India]. In
urban households, DD programs had hardly any viewers. DD was also behind
the private channels in terms of ad revenues, as its TVRs were very low
compared to the TVRs of programs on private channels.

Falling Revenues

During 1996-99, the TV advertisement market grew by 76%, but DD's revenue
from advertisement registered a negative growth [Table III for fall in revenues of
DD]. Though DD continued to be number one in overall audience share, it lost
out on viewership segments that had the highest purchasing power.

In 1998-99, DD's revenue from advertisements was Rs. 4 bn [25.8% of the
market], Zee TV was close with Rs. 3.85 bn, Sony had Rs. 2.53 bn and Star
channels grossed Rs. 2 bn. But the ad revenues of private channels have grown
significantly, when compared to those of DD. During the period 1996-99, Zee
registered a growth of 122% in ad revenues, Sony 299% and Star channels
206%. During the same period, DD's ad revenues went down by 70.17 %. DD's
falling TVRs were a matter of concern for clients like Hindustan Lever - DD's
51
largest advertiser. Said Ashutosh Srivastava, VP, HTA-Fulcrum, the media-
buying arm of HLL, Our only source of reaching 40% of this country is going
down. Till 1998-99, 70% of HLLs ad spend went to DD but by 2000-01, due to
tailing TVRs HLL's ad spend to DD had gone down to 50%.

During 1999-2000, producers and distributors stopped giving films to DD when
it began to demand a minimum guarantee of Rs. 10 mn to broadcast a film.
This forced DD to repeat the same old films that it had aired several times, and
the RVRs went down further.

According to some analysts, DD's revenues were going down because
advertisers considered it a down market channel, which catered only to the
lowest socio-economic groups, whose purchasing power was limited. The
revenues earned by DD showed a negative growth during 1997-99. In 1999-
2000, DD saw its revenue grow by 52.8%, but in 2000-01, it was projected to
grow only at 6% [Table III]

Identity Crisis
DD's problems were largely attributed to what Kiran Karnik, former CEO,
Discovery Communications; India called 'its loss of identity. Said Karnik, The
channel has lost its identity, What is Doordharshan : Is it a public broadcaster
or a commercial entity? Initially, DD officials had envisaged that the national
channel would play the role of public broadcaster, while DD Metro would be the
commercial channel. Private producers and advertisers pointed out that this
attitude increased the confusion. They argued that no other network had two
channels competing against each other.

With the launch of the Star News Channel, [the first independent news channel]
in 1998, DD News lost its viewers to Star news. The in-depth analysis of news
itemsby Star News caught the imagination of the viewers [Table IV Comparative
study of different news channel]. DD's image of being the propaganda
machinery of the Government also went against it.


52
Some analysts said politica
1
interference and corruption were another reason
for DD's poor performance. In 1997, The Indian Broadcasting Bill was
introduced in Parliament. The Bill was not passed, but it was enforced through
an ordinance nearly a decade after it was enacted. DD was brought under a
holding company called the Prasar Bharati. In 1998, the Government sacked
Prasar Bharali CEO SS Gill and the Government made DD answerable to a
parliamentary committee. Political interference at the top level made matters
worse for DD.

There were allegations that members of the Central Commissioning Unit of DD
look bribes from producers to air their programs. In 1998, the CBI arrested two
DD officials for taking bribes from a serial producer. This, incident focused
attention on the rampant corruption in the organization and forced
management to issue guidelines regarding acceptance of gifts by employees.

DD had a poor track record in both payments to and collections-from private
players. Over 50 companies owed Rs. 18.2 mn to DD, 45 on July 2001, Amitabh
Bachchan Corporation Limited was DD's highest debtor with outstanding dues
of Rs. 330 mn.

Another allegation that DD faced was that it had allowed International Cricket
Council's [ICC] ex-chief Jagmohan Dalmiya and World Tel's Mark Mascarenhas
to defraud it of Rs. 160 mn over the telecast of 1998 tournament in Dhaka.

The exorbitant prices that DD charged for advertisements slots also contributed
to its poor performance. DD charged the producers around Rs. 1 lakh for 10
seconds, while some of the highest rated soaps on private channels charged half
that price.

DD did not have a marketing team, which could market the advertisements
slots as a package. Private channels like ZEE and Star had their own marketing
teams/ which provided the advertisers with a package of advertisement slots on
their programs. But DD had 5o different producers with 56 different half-hour
programs slots for four hours of prime time each week. Each producer sold
53
commercial time separately, to the advertisers. But advertisers preferred
package deals, which, would give them airtime across the programs for a whole
week.

Breathing fresh life into DD

After SS Gill was sacked in 1998, Rajeeva Ratna Shah was appointed as new
CEO of Prasar Bharti. Shah began overhauling the programs of the two DD
channels and weeding out corruption in the network. He stopped
commissioning programs on DD1 and DD2. He decided to auction programming
hours to the private players who produced the programs for DD and market
them. Shah also announced the setting up of a board comprising eminent film-
makers, actors, poets, writers and people from different walk of life. This board
was to be entrusted the task of revamping DD.

In 2000, the government appointed a committed headed by Shunu Sen [CEO,
Quadra Advisory, a strategic marketing Consultancy], NR Narayana Murthy
[CEO, Infosys] and Kiran Karnik to work out a program for reviving DD. The
committee considered three options. : Privatizing of DD, continuing to run it as
a Public Service .Broadcaster [PSB], and running DD on both PSB and
commercially viable lines. Of the three options, the committee recommended the
third option. The committee felt that there was no need to privatize DD, but
recommended drastic steps for reviving it.

Some of the important steps suggested by the committee were :
Downsizing 25 % of DD's 21000 strong staff
Getting into new media
Setting up its own marketing department
Developing a sharper programming focus.

One of the recommendations was to improve the quality of broadcast. DD
sought the help of BBC to digitize its channels. Modi Entertainment Network
began distributing the five DD channels via satellite. DD went in for a revenue
sharing deal with B4U for showing movies, arid auctioned the 7:10 pm slot on
54
DD Metro to the HFCL - Nine networks. In addition to Rs. 1.21 bn that DD got
from this deal, the move helped DD to penetrate urban homes as well as C & S
homes to some extent. DD also entered into an agreement with Direct to Home
platforms like Echostar and Astra to distribute DD - World in 79 countries. DD
employed Accenture to advise it on how to go about revamping its financial,
management and administrative systems. The National Institute of Design was
employed to redesign the logo.

In 2000, DD announced that it would start its own people meter project
through a separate corporate entity in partnership with a few private channels
and some advertisers. DD felt that its programs were not getting enough
viewership ratings because the viewer samples used by the two firms doing the
ratings -IMRB - AC Nielsen and ORG MARG were largely from C & S homes.
Their ratings did not accurately reflect the viewing habits of the Indian
populace.

According to most, these steps were bound to have a positive effect on revenue.
However, for real growth DD had to be freed from political interference.





TABLE I :DD CHANNELS : A SNAPSHOT
DD 1 Primary channel with national, regional, local and
educational programs on a time sharing basis
DD2 Metro entertainment channel targeted at urban
viewers, particularly the young viewers. Programs
relayed by the terrestrial transmitters in 47 cities
DD4 to DD 13 Ten separate regional language channels :
Malayalam, Tamil, Oriya, Bengali, Telugu, Kannada,
Marathi, Gujarati, Kashmiri and Assamese
DD 14 to DD 17 Networking of the regional services of the four Hindi
55
speaking states : UP, Bihar, MP and Himachal Pradesh
DD18 Punjabi Regional Service
DD India
[DD World]
International channels
DD Sports Sports channel
DD News 24 hours news channel

TABLE : II ; CABLE TV GROWTH IN URBAN INDIA

YEAR NUMBER OF HOUSEHOLDS WITH
CABLE TV [IN MILLION]
1992 1.20
1993 3.30
1994 11.80
1995 15.00
1996 18.00
2000 22.00
2001 30.00

TABLE III: FALL IN REVENUES OF DD

YEAR REVENUE
[RS. BN.]
GROWTH OVER PREVIOUS
UYEAR [%]
1995-96 4.30 8.10
1&96-97 5.72 33.20
1997-98 4.90 - 14.30
1998-99 3.99 - 18.50
1999-00 6.10 52.80
2000-01 [Estimate] 6.50 6.00

TABLE: IV COMPARISON OF THE NEWS CHANNELS
56

STAR NEWS ZEE NEWS DD NEWS
Channel encrypted Channel not encrypted Channel not encrypted
Decoders are required Can be freely aired Can be freely aired

Content caters to the
premium segment
Content caters to the
mass market
Content caters to the
mass market
English predominant
language
Hindi predominant
language
Hindi predominant
language
Only premium brand's
ad taken. Very selective
regarding ads

All brands accepted.
Not selective regarding
ads.

No ads. Only social
messages were
broadcast


REVIEW QUESTIONS :

1. Discuss the features of modern business
2. What is business environment ? What are the constituents of business
environment ?
3. Write a short note on : a] political environment b] social and cultural
environment c] economic environment d] religious environment
4. Why should the environment be scanned? What purposes would it serve?
5. Explain in detail (he features and elements of economic environment.
6. What is an economic system? Discuss various economic systems with
their merits and limitations.
7. What are the features of mixed economic system ? Explain in detail the
working of mixe-1 economy in India.
8. What type of distortions could take place in planning in a mixed
economic system?
9. Analyse the strengths and weaknesses of capitalism and socialism.
10. Distinguish between Marxism and communism. Trace their evolution.

57

.
58
Chapter - II

Political economy- Government and business - Public control of business - Trends
and structure of Indian economy - Socio - economic problems of India

Political economy Government and business

The question of government interference in economic activities has been
debated for a very long time by the economists. While the early economists
considered economics as a handmaid of politics, the modem view is that politics
is the handmaid of economics. With the growing importance of the role of
government in economic welfare, the modem economists firmly believe that the
sphere of government in economic development has no boundary. However,
there is no unanimity among the economists about the extent and mode of state
intervention in the economic sphere. Hence, we can identify the following
political ideologies regarding the government intervention in an economy.

i. The earliest opinion was that the government has nothing to do in an
economy as the society will regulate itself. This opinion also stated that
the government will wither away over a period of time. These ideologists
are called ANARCHISTS.

ii. Opposing the anarchists view is the COMMUNISTS view. According to
them, the individuals cannot do anything on their own and there is a
need for government to supervise and regulate individuals. The state will
own everything and it is the fundamental duty of the government to
organize and direct all economic activities. Hence, government becomes
the custodian of the society and it has a very wide role to perform.
In between the above two views, there are two more views about the extent of
government intervention in an economy. While one view highlights the
individuals, the other lays emphasis on the need for the government. According
to the individualists view, the government a necessary evil. Even Adam Smith
advocated very limited functions for the State and to him the government
should confine to the maintenance of law and order. This view was holding good
59
in the case of Western countries while in most of the under developed countries
the economists themselves argued for larger intervention of the state.
Individualism was found to be exploitative and against the welfare of the
society. Hence, another ideology that emerged was COLLECTIVISM. According
to collectivism, interest of the society is more important than the individuals.
They considered that state has a very useful and desirable role to play in an
economy. So they assigned unlimited powers on the State and argued that the
state intervention is necessary to promote social welfare. The State should
therefore, play a very vital role in economic development. These two limits about
the role of government are often referred to as CAPITALISM and SOCIALISM.
The modern view is that state must play a significant role in an economy that
all the essential services should be State owned and controlled. According to the
modern view the role of government includes maintenance of law and order,
achieving equality and social justice, protecting the weak from the economically
strong, fighting against poverty, etc. The areas of government intervention in
modern state may be broadly discussed under the following heads :

1. PROTECTIVE FUNCTIONS :

By performing these functions, the modem government creates the necessary
atmosphere for performing productive activities. Protection from external
attacks and maintenance of internal peace are necessary so that economic
activities will be performed to maximize the welfare of the society. Some people
argue that this function of the government is unproductive, but without this
function, no economy can ensure performance of productive activities.
2. ADMINISTRATIVE FUNCTIONS

Government activities include a host of administrative works. All these works
are performed through various departments and so the government maintains a
large number of officials and agencies who implement the government policies.
Works of routine nature are performed by these officials and the efficiency in
the administration is a must for rapid economic growth.


60
3. PROVISION OF SOCIAL SECURITY

This is a major function of the modern government as it is concerned with the
improvement in public welfare. Maintenance of public health, provision of
unemployment insurance, free medical and educational facilities, granting old-
age pensions, provision of decent housing facilities, maintenance of public
perks, libraries, museums, etc., have become part of the government functions.
Though these functions are not in any way productive, yet they are necessary to
encourage and promote productive activities.

4. ECONOMIC FUNCTIONS

One of the basic economic functions of the modern government is to ensure
optimal utilization of the available resources. This involves both identification
and proper use of the resources. Especially these days every country needs to
put the available resources to the best use so that the society gets the
maximum benefits. Further if the resources utilization is left in the hands of the
private enterprise, they will under utilize the resources as they have only profit
maximization as their objective. There are also possibilities of the emergence of
monopolist tendencies, concentration of wealth in the hands of a few, etc.
hence, every modern state should interfere in resources utilization. Another
important function of the government is to maintain economic stability. This
means protecting the economy from the influence of business cycles. In the
process of growth, boom and depression are inevitable. But they must be under
check, as otherwise, there will be uncertainty affecting the business prosperity
and through that industrial development. Hence, the modern governments
control and regulate the working of the economic forces so as to achieve
economic growth with stability.

Another very important economic function of the government is price control
and rationing. This measure aims at preventing escalation in prices of essential
commodities and controls the price of other commodities. By resorting to retail
and wholesale price maintenance policies, the government can strive to bring
down the price level. This calls for buffer stock operations as well as efficient
61
demand and supply management of commodities which the country is badly in
need of. This is achieved by introducing rationing of essential commodities
through well designed public distribution mechanism. All these mean,
enormous efforts are required on the part of the government apart from the
willing cooperation from the traders and businessmen. In practice it is found
that price control and rationing are very difficult to be implemented during
inflationary period due to the exploitative and monopolistic attitude of the
businessmen and traders.

Yet another area where government intervention is needed is the removal of
inequality in a country. This inequality arises because of the mal-distribution of
the economic wealth and prosperity. Though national income increases, the rich
becomes richer and the poor the poorer. This tendency should be changed
through legal and political steps. For this purpose government in several
countries have enacted legislations and announced concessions in favour of
poor people. Implementation of these legislations and concessions involve a lot
of difficulties and they have to be periodically revised. The object of the
government in this connection must be to prevent concentration of economic
power and wealth in the hands of a few. Another important economic function
of the modem government is to achieve economic growth. For this purpose the
government has to plan for economic development and in this task the
government part from deciding the targets, planning process, resources
identification and allocation, etc., It should also arrange for financing the plans.
It should be noted that planning has become important in both developed
countries as well as under developed countries. In the developed countries
planning is used to achieve stability in development, while in under developed
and developing countries it is used for accelerating economic development.

The government intervention in an economy is a must for the following reasons:
1. In developing economies the vicious circle of poverty impedes the
economy from developing faster. This vicious circle can be broken only
with the government intervention. In the absence of it, any amount of
planning will fail to bring about the necessary impetus to growth in such
economies.
62

2. In the process of economic development, instability should be avoided at
any cost. Even in developed countries, such instabilities are avoided
with government intervention. In developing countries, therefore, the
government should plan for proper allocation and utilization of
resources as well as economic stability. Allowing the market forces to
operate has certainly some advantages. But in under developed
countries market forces do not operate smoothly because of external
rigidities and structure bottle-necks. To overcome these forces pinning
down economic development, government intervention is needed.

3. The basic requirement for rapid economic development is the economic
and social infrastructure. The investment requirement for the provision
of such infrastructural facilities runs to crores of rupees. This can be
provided only the government and not the private sector. Further such
investments are not income or profit yielding and so private enterprises
may not come forth to undertake such investments. So government has
a concrete role to play in inventing on such social and economic
infrastructures.

4. Investment in social overheads is undertaken by the government by
mobilizing financial resources from various sources. These sources of
government include taxation, public borrowing and deficit financing and
these sources cannot be resorted to by the private enterprises. It is also
well known that private enterprises lack comprehensive approach to
economic development.

5. Government intervention is indispensable in under developed economies
because in such economies, there are several obstacles to economic
development which can be overcome only by the government. As Mir and
Baldwin observed every under developed economy needs a critical
minimum of government intervention to reduce indivisibilities and
discontinuities in the economy, to overcome diseconomies of scale and
63
offset certain other forces that arise to depress development, once
development begins.

Public control of business
In a mixed economic set up like India, the government retains control over
strategic and key industries and operations. This is done through the creation
of public sector units. The role of public sector units is explained below.

Discuss the role of Public Sector in India

Since 1948, the public sector in India has been playing a significant role in
every sphere along with the private sector. These two sectors have been
functioning as complementary to each other, though the government policies
have been usually more favourable to public sector than to the private sector.
Inspite of this, the private sector has also emerged victorious in several fields
and since the announcement of Liberalization polices in 1991, we can
reasonably expect the private sector to reach its potential and the public sector
would also strive its best to withstand .he domestic and international
competition. Hence, the future offers excellent scope for both the sectors, but it
is clear that only the most efficient sector can survive, so how the private and
public sectors are going to react to this challenge will be known in due course.
However, let us now discuss the role of public and private sector in India in
detail.

1. Role of public sector:

First of all it is necessary to understand that the public sector includes the
autonomous corporations, the departmental enterprises owned and controlled
by both the State and Central Governments. The role of public sector would be
discussed with reference to various indicators like employment, investment,
output, national income contribution, savings, coital formation, capital stock,
etc.

a) Public sector and employment generation:
64

One of the important contributions of public sector to the Indian economy is
that it has generated huge employment opportunities and this has reduced the
problem of unemployment to a large extent. The employment opportunities in
public sector includes government administration, defence, health, education,
research and development, enterprise owned by Central and State governments.
It offered employment for 107 lakhs of people in 1971 which slowly increased to
154.8 lakhs in 1981 and it has touched 190 lakhs in March, 1991. This
constituted nearly 71% of the total employment generated in the economy, in
1991. As regards the sector-wise employment opportunities created by the
public sector, in 1989 public sector accounted for 47,8% of the total
employment generated by it through employment in government administration,
community, social and personal services, followed closely by transport, storage
and communications with 16.1% and manufacturing 10.1%

Hence, it is clear that with the growth of public sector, the country is benefited
with more and more employment opportunities.

b) Public sector and income of the public sector:

The share of public sector income in the net domestic product has been
increasing consistently from 7.5% in 1950-51 to about 25% in 1987-88. In a
matter of about 35 years the public sector contribution to net domestic product
has risen appreciably and constitutes one fourth of the total net domestic
product This is mainly because of the rapid expansion of the public sector since
1951. This 25% of contribution in net domestic product is certainly better than
9.6% of contribution by the public administration. However, the private sector
income constituted 75.1% of the total net domestic product. It should be noted
that the public sector units are run on service motive and very little commercial
motive.

c) Public sector and saving and capital formation :
This is yet another crucial yardstick to evaluate the contribution of public
sector. The percentage share of public sector in total domestic savings increased
65
from 1.7 to 2.3 of Gross national product at market prices. But in absolute
terms it increased from Rs. 169 crores in I Plan period to Rs. 7815 crores in VII
Plan. When we consider the percentage share in total sayings, the contribution
of public sector has actually gone down from 17 in I Plan period to 11 in the VII
Plan. However, the contribution of public sector in capital formation (gross
domestic) is really commendable. It increased from a modest figure of 3.5% of
Gross national product at market prices in I Plan period to 10.7% in VII Plan.
As a result the ratio of percentage contribution by public sector and private
sector in total domestic capital formation changed from 33 : 67 in the I Plan to
47 : 53 in the VII Plan. From this it is clear that the contribution by the private
sector during the same period has declined from 67% to 53%

d) Public sector and capital stock:

Capital stock refers to the total stock of plant and machinery, equipment and
tools and other capital goods available at a point of time for further production.
Based on the data available up to 1979-80, it was found that the percentage
share of public sector in total capital stock between 1960-61 and 1979-80
increased from 26 to 37 while that of private sector declined from 74 to 63
during the same period. In absolute terms, the capital stock increased from Rs.
16,377 crores in 1960-61 to Rs. 68,478 crores in 1979-80 in public sector (i.e.,
an increase by over Rs. 52,000 crores) but in the private sector the increase was
from Rs. 46,583 crores to Rs. 1,16,089. crores (i.e., an increase by over Rs.
65,000 crores). The increase is less pronounced in public sector because of the
following reasons:

1. Public sector investments are mostly in economic infrastructure which
does not contribute any output.
2. Public sector is mostly concerned with high capital intensity projects
like railways, iron and steel, power, irrigation, etc.
3. The gestation period of public sector projects are very long.
4. The capacity utilization is very much less in public sector units.
5. Most of the projects of public sector are having higher capital-output
ratio.
66

e) Public sector and infrastructure:

The economic development of a country depends on the development and
maintenance of infrastructural facilities. The essential requirement is provided
by public sector. The industrialization is accelerated only through
infrastructural development. Investment in power, roads, bridges, irrigation,
etc., is non-income yielding, long gestation period oriented, and heavy
investment projects. Hence these are not attractive for private sector. But
without them the country cannot develop faster. Therefore it is apt to state that
the public sector units are responsible for the creation of infrastructures which
constitute the backbone of economic development and industrialization.

f) Public sector and industrial base:

There is no denying the fact that public sector has provided a strong base for
our industrialization. Our industrial policy has clearly assigned a significant
role for public sector, till the end of the third five year plan; industrialization
was taking place at a slower pace because only the important public sector
units were established till then. Since the private sector could not really rise up
to meet the task, since the IV Plan the establishment of public sector units
started on a brisk rate and the industrialization has been accelerated to a
commendable level. Further private sector with its commercial objectives could
not undertake several of the projects and investment requirement of these
projects was also beyond the potential of the private sector. Hence, if at all India
today is having a strong industrial base; it is mainly due to the contribution of
the public sector.

g) Public sector and export promotion:

Public sector has responded well to the needs of the nation by taking up the
task of exporting our products and finding market for them in other countries.
In this respect the contribution of State Trading Corporation, Minerals and
Metal Trading Corporation, Hindustan Steel Limited, Hindustan Machine Tools,
67
etc., are worth noting. Infact, these units are primarily responsible for exploiting
the captive market for our goods abroad. The foreign exchange earnings of the
public sector has gone up from a modest figure of Rs. 35 crores in 1965-66 to
Rs. 170 crores in 1969-70, to Rs. 5,831 crores in 1984-85 and then to Rs.
9,198 crores in 1991-92. The increase has been more than 300 times
comparing 1965-66 figures with that of 1991-92. Though there may be
criticisms about the performance of the public sector units, yet there can be no
dispute about the export achievements of public sector units within a period of
25 years.

h) Public sector and saving of foreign exchange through import
substitution:

India's balance of payments has been a cause for worry since Independence, the
main reason being increasing imports. This trend had to be reversed and the
government rightly selected public sector to establish units to produce
domestically the goods imported so as to conserve the foreign exchange and
also utilize more the domestic resources. Units like Hindustan Antibiotics
Limited and Indian Drugs and Pharmaceutical Limited, have together effectively
checked the inroads attempted by the multinational corporations in the field of
drugs and pharmaceutical. Similarly Indian Oil Corporation Limited and Oil
and Natural Gas Commission have succeeded in bringing down our dependence
on other countries for crude to some extent. They are very active in identifying
oil deposits and natural gas. Their efforts are supplemented by research and
development to invent methods of using the natural gas and reduce the imports
of crude. In this respect the public sector works towards achieving self
sufficiency. With concerted efforts it should be possible for India to achieve self-
sufficiency in the near future. However, the poor performance of the public
sector is causing concern, as unless steps are taken to improve their
performance, the achievement of self-sufficiency' may be delayed.




68
i) Public sector and generation of internal resources :

A close scrutiny of the public sector performance will certainly make one to note
the contribution towards internal resources made by the public sector. For
example, the internal resources generated by the public sector during V Five
year plan was Rs. 3,439 crores, during VI Five year plan Rs. 11,721 crores and
during the period 1985-86 to 1989-90, the generation was Rs. 37,678 crores. In
1990-91 and 1991-92 also the public sector undertakings together generated
Rs. 24,376 crores. This indicates that the public sector units have turned the
corner and with the measures taken up already to spruce up their working we
should be able to realize still greater generation of internal resources.

j) Public sector and contribution to exchequer:

Public sector contribution to the Central Exchequer is, in terms of dividend,
corporate tax, excise duty, customs and other forms. These contributions add to
the mobilization of resources for our planned development. It is interesting to
note that the contributions totaled Rs. 27,570 crores in the VI Plan period, Rs.
70,893 crores during the VII Plan and Rs. 19,520 crores in 1990-91 and Rs.
20,366 crores in 1991-92. It may be noticed that the annual contributions
during the VII Plan period is nearly 75% of the contributions during VI Plan.
Among the different forms in which these contributions are made, Excise duty
and Customs alone constituted more than 82% of the total in the VI Plan
period, while this was 76% during the VII Plan. Subsequently, in 1990-91 these
two accounted for 82% of the total contributions and in 1991-92 it was almost
83% indicating that public sector units do make a valuable contribution to the
Exchequer. Since the performance of the public sector is poor, their
contribution in terms of dividend is very insignificant and this has to be
changed at the earliest so as to make them contribute sizably even in this form.

k) Public sector and growth of ancillary units:

Public sector also makes a valuable contribution by helping the growth of
ancillary units and small scale units. The Bureau of Public Enterprises have
69
undertaken the study to find out the public sector units which could transfer
their production and other facilities to small scale sector. Under this scheme
about 1800 units were set up till 1986. The public sector also enters into
regular contracts for purchasing the entire production or 50% of the production
of small scale and ancillary units. Such purchases from ancillary units
amounted to Rs. 451 crores in 1985-86.

I) Public sector and development of states and backward regions:

One of the objectives in establishing public sector units is to facilitate the states
and the backward region to develop faster. In this connection, public sector has
certainly creditable performance. Public sector contributes to the State
government's resources in terms of sales tax and other state level taxes. Public
sector investments are directed towards the projects in the backward regions
and industrially poor districts. In this way the public sector works in its own
way to eliminate the industrial imbalance in states and districts.

So far we have explained in detail the contributions made by the public sector
towards Indian economic development. It is often said, that even when their
performance is poor, the public sector contributions have been so much, and by
improving their performance, we should be able to make them contribute their
full potential to achieve a higher rate of economic development. It is satisfactory
to note that efforts in this direction to improve the public sector performance
have been initiated and by the turn of the century public sector will emerge as
the main contributor to our economic development.

TRENDS AND STRUCTURE OF INDIAN ECONOMY Features of India as an
under developed country

To classify a country as developed or under developed, one should study the
features of an under developed country. There are several indicators of under
development. Let us discuss each one of them with reference to India to
ultimately answer the question whether India is a developed or under developed
country.
70

1. Existence of low per capita income:

It is customary to compare the per capita income of a country with other
countries to determine whether the country in question could be categorized as
under developed or developed. The IBID is also adopting this method and it has
classified the countries as i. low income countries, ii. Middle income countries
and iii. high income countries. According to the World Development Report,
1993, the annual per capita income of these three types of countries is
estimated as under:
Low income countries $ 350
Middle income countries $ 2480
High income countries $ 21050

It is clear from the above figure that any country with just 1.5% of the percapita
of the high income countries can be categorized as low income country and as
under developed country. In these under developed countries, the per capita
income is very low because i. net national income is very low or ii. Population is
very high or iii. the national income is very low and the population is very high.
Though this used to be the basis for categorizing the countries, "recently the
IMF has measured the value of each country's national income in terms of the
purchasing power of its own currency at home, instead of the currency's value
on international exchanges. Following this India's per capita income in 1991
was assessed as $ 1150 as against $ 330 calculated following the old basis.
Hence, on the basis of the new methodology India can no longer be considered
as an under developed economy.

2. Existence of very heavy population:

The size of population is one more index of development status. It is found that
a country with low population is developed and that with a small size of
population is under developed. It should be noted that in the case of former the
annual growth rate of population is very low, compared to the growth rate in the
later. According to the World Development Review, 1993, the annual growth
71
rate of population in the low income countries was 2.0 between 1980 and 1991
while in middle income countries it was 1.8 and in the high income countries
the rate was 0.6 during the same period. Hence, it is clear that with a higher
rate of growth, the low income countries will experience population explosion
over a period of time. This population explosion will have serious impact on the
economy and impede every effort to achieve higher rate of development. For
example, the population explosion will result in increased poverty, high rate of
unemployment, scarcity for essential goods, etc.

3. Predominance of agricultural sector;

This is another important characteristic of the under developed economy. In
such economies, the percentage of population depending upon agriculture for
livelihood will easily be 70%. The contribution of agricultural sector to national
income will be high and it is estimated to be over 35%. The nature of exports
will be mainly primary goods like agricultural raw materials. In the case of India
nearly 70% of the population depends on agriculture sector (both directly and
indirectly) whereas in a developed country this used to be only about 20% The
contribution by agricultural sector to national income will be around 4 to 5% in
developed countries and the composition of exports will be mostly
manufactured goods and high-tech products. It may also be noted that in under
developed economies, the productivity in agriculture will be abysmally low due
to the use of out-dated technology, conventional method of cultivation, poor
quality seeds and fertilizers, illiteracy of farmers, very high rural indebtedness,
etc. The result is agricultural production will be low and so the contribution to
national income will also be low. Added to this, the sector depends on the
success of monsoon and failure of monsoon directly affects the economic growth
and development.

4. Existence of large scale unemployment:

In under developed country there exists very large scale unemployment due to
various factors. Further the unemployment will continue to increase over a
period of time. The unemployment is due to factors like, huge population, low
72
level of economic activity, poor technology, lack of investment, large illiteracy,
etc. Even those who are employed may not add anything significant to
production. That is there will be disguised unemployment too. The problem is
worsened by the existence of under employment, which means the available
labour power is not fully utilized. The overall effect of all these is that the labour
productivity will be very poor. The efforts to improve the productivity may rot
succeed due to resistance by labour unions and organizations. The economy
will remain under developed so long as the unemployment remains high.

5. Existence of widespread poverty:

Poverty exists in every country. But the difference is that in developed
countries, poverty exists only in certain pockets, while in under developed
countries, poverty is widespread - almost 3/4 of the country lives below the
poverty line. In under developed countries, the preponderance of agricultural
sector, large scale unemployment, income disparities, high illiteracy, etc.,
account for widespread poverty. Added to these, the lack of investment
opportunities, low productivity, primitive technology, etc., also result in poverty
as any amount of production will not generate income. The wage level is so low
that the people have very low saving. Any amount of efforts to alleviate poverty
does not bear fruit due to maladministration, corruption, etc.

6. Primitive production condition:

The excessive population pressure leads to heavy demand for land. The
available land is not put to productive use. There is very high capital deficiency,
one because of low saving and second the conspicuous consumption is very
high. In other words, the little saving is used in unproductive ways. With poor
capital formation, the government would invest heavily in capital intensive
projects as well as welfare projects. The return is very poor and prolonged. The
technology is so backward and primitive that the input output ratio is very
high. The obsolete technology also results in poor return and low productivity.
Another major weakness is that there is lack of entrepreneurial ability. Hence,
investment opportunities are not easily identified and risky ventures are never
73
undertaken. The size of market is small, the market information is absent,
market intelligence is very poor, the administrative ability is at lowest level and
there is lack of investment opportunities. All these culminate in poor utilization
of the available entrepreneurial ability and talent

7. Foreign trade composition:

The composition of foreign trade in under developed country is very much
influenced by its historical relations with other countries. Most of the under
developed countries were colonies in the recent past and naturally their foreign
trade composition clearly reflects this. They export unfinished, agricultural raw
materials and import heavy capital goods. Obviously, their terms of trade will be
unfavorable. Further there exists heavy geographic concentration in their trade.
Any failure of agricultural sector worsens the foreign trade position. With heavy
reliance on the imported machineries, these countries lack latest production
technology. The poor balance of trade and balance of payments deficits force
them to borrow heavily from the developed countries and international financial
institutions. They are caught up in the debt trap and outgo of interest on
international debt is so heavy that the county will struggle to maintain the
exchange rate. The increases reliance on other countries for manufactured
goods will subject the countries to economic and political subjugation of the
exporting countries.

8. Existence of wide disparity in income and poor standard of living:

These countries are also noted for very high income disparities because of
concentration of productive factors in the urban areas, very low mobility of
labour from rural to urban, low rate of employment in the rural areas in
relation to urban areas, high wage rate in the urban and poor wage rate in the
rural areas, etc. The income disparity is further widened by deteriorating terms
of trade between agricultural and industrial sectors. As a consequence, the
standard of living will be very poor in the rural areas than in the urban areas.
Even in urban centers, there will be growth of urban slums. As already pointed
out in these countries the population depending on agriculture is very high and
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so the employment opportunities as well as income generation is very low
compared to that in the industrial sector. As in the initial stage of development
the industrial growth will be confined to urban centers, the standard of living
will be on the whole very poor.

9. Existence of dualistic economy:

Dualism refers to the existence of a developed sector side by side with an under
developed or undeveloped sector. We will come across the co-existence of
sophistication and primitive characteristics in every walk of life. For example, in
the urban areas, one will find the use of modem technology in the production
field as well as households, while in the rural areas, the age old, antiquated
techniques will be used in the production as well as in households. This
dualism retards economic growth. That is, the subsistence sector in the rural
areas will pull down whatever little economic progress is achieved with the
developed and modem sector. Further in the urban areas, one can come across
the existence of dualism, in every activity. For instance there will be modern,
technologically sophisticated industries existing side by side with industries
with labour intensive and poor technology. There will be high wage executives
existing with poorly paid slum dwellers. Firms with international collaboration
producing ultra modem products will be found along with the domestic firms
using inferior technology. In the rural areas also the dualism can be found. We
can find the co-existence of farms with vast expansive areas using modern
production technology along with small farms where such technologies can
never even be dreamt of. The bigger farms will be using trained and skilled
laborers whereas the small farms will mostly be depending on the family labour
and untrained, semi-skilled labour. While the capital investment by the big
farms will be several times higher than those of the small farms, the rural
indebtedness will be found more with the small farms than the large farms. The
marketing strength, holding power, storage facilities, processing facilities,
bargaining power, etc., will all be very much different between large farms and
small farms. From the above explanation, it could be understood that every
effort to develop the economy should be designed so as to make it applicable to
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both the modern sector as well as the undeveloped one. Hence, the overall
growth will be more determined by the contributions of the undeveloped sector.

10. Existence of weak and inefficient administration:

Under developed countries always evince this feature. The political and social
factors influence to a large extent the efficiency of administration. In these
countries, the administrative system is noted for lethargy, red tapism,
bureaucratic interference, delay in decision making, partiality, political
influence in decision making process, bending the laws for favourable people,
etc. The result of this is inefficiency. An efficient employee never gets his due as
the rules and regulations do not permit this. The accountability at the higher
levels is very much less. The responsiveness of the administration in a critical
situation is more rules ridden or ritualistic rather than realistic. There is lack of
managerial and administrative talents in these countries. The lack of know how,
the resistance to change, lack of motivation, etc., are responsible for this
administrative inefficiency.

SOCIO ECONOMIC PROBLEMS OF INDIA
1. Discuss the features of Indian Population
The Demographic features of India can be discussed in terms of the following
ideas:
i. Trend in population
ii. Growth rate of population
iii. Life expectancy
iv. Infant mortality rate
v. Density of population
vi. Age and sex composition
vii. Rural-urban distribution and viii. Literacy and levels of development.
Let us now discuss each one of these features in detail.
i. Trend in population:

As the country with second largest population .in the world, India has been
handicapped with very large population found in a small area. It is said that
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India has 16% of the total land area of the world. This situation has been
remaining for decades as shown by the Table 1 below. It could be seen from the
table below that till about 1931, the size of population was not increasing at an
alarming rate. Specifically between 1911 and 1921, the population size almost-
remained stagnant. There was a slight increase in the size between 1921 and
1931. The decade 1931 to 1921 probably was the only period when Indian
population almost remained the same. This probably was due to the epidemics,
wars, etc., which took a heavy toll during the decade. After 1941 we find a
consistent increase in our population cruising ail concern. More specifically the
increase in population was by : about 4 crores between '41 anc. '51, 11 crores
between '61 and '71, about 15 crores between '71 and '81 and about 16 crores
between '81 and '91.

Hence, after the decade 1921-1931, we find the increase in population
remained almost the same during the decade '71 -'81 and '81-'9l. In the past
nine decades, i.e., since 1901 the addition to our population has been by about
60 crores. But with the slowing down of the population growth since 1981, we
may expect the population to grow at a slower rate in the corning decade.

TABLE 1 : SIZE OF POPULATION (in crores)

YEAR POPULATION
1901 23.8
1911 25.2
1921 25.1
1931 27.9
1941 31.9
1951 36.1
1961 43.9
1971 54.8
1981 68.3
1991 84.6
In 1993, Indias population was estimated to be 88.5 crores.
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ii. Growth rate of population:

The growth rate in population is measured as the difference between the Crude
birth rate and Crude death rate. Of course, the migration and population
should also be taken into account. But in Indian experience, the migration as a
percentage of the total population is very insignificant. Hence, ignoring
migration, we should lake the difference between the crude birth rate and crude
death rate as the normal growth rate in our population. The Table 2 below gives
the normal growth rate in our population.

TABLE : 2 NORMAL GROWTH RATE OF INDIAN POPULATION

PERIOD CRUDE
BIRTH RATE
CRUDE
DEATH RATE
NORMAL
GROWTH RATE
1901-1911 49.20 42.60 6.60
1911-1921 48.10 48.60 0.50
1921-1931 46.40 36.30 10.10
1931-1941 45.20 31.20 14.00
1041-1951 39.90 27.40 12.50
1951-1961 41.70 22.80 18.90
1961-1971 41.20 19.00 22.20
1971-1981 37.20 15.00 22.20
1981-1991 35.20 11.40 21.10

From the Table:2 above, it could be observed that the normal growth rate of
population was very low from 1901 to 1921 mainly because both the crude
birth rate arid crude death rate were high. But ever since 1921, there has been
quite notable decline in crude death rate but not such a pronounced decline in
birth rate. As a result the: normal growth rate of population has remained high
and Infact has been increasing. One sign of consolation is that during 1981-
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1991, the crude birth rate has declined by 2.00 points and the normal growth
rate has also declined by about 1.00 point. This trend, if continued, by the turn
of this century India may have lesser addition to population which is a good
sign. It is estimated that our birth rate would fall down to 27.5 during 1991-
1996 and the death rate would go down to 9.4 during the same period thereby
the normal growth rate would be 18.1 for this period. Based on this the
projection for the period 1996-2000, birth rate will be 24.9, death rate will be
8.4 and the normal growth rate will be 16.5.

iii. Life expectancy:
Life expectancy is usually used as a measure of gauging the health condition of
population of a country. A country with a high death rate and with death
occurring at early age, the life expectancy will be low and a country with a low
death rate and with death occurring at an advanced age, the life expectancy will
be high. Hence, a high life expectancy is a yardstick for health condition of the
population of a country. In Indian case, there has been a significant fall in
death rate since 1951 and so our life expectancy which was just 23 years
during 1901-1911 increased to 46.4 years during 1961-71 and further to 58.2
years during 1991. However, this is very much low compared to some of the
countries like Sri Lanka and Thailand, another interesting feature is that in
India the average life expectancy is more for female population than for the
males. The reason for this could be that the number of male deaths at early
stage is more than that of the females. The increase in life expectancy is
certainly ^ welcome sign, but i; carries with it some social problems like, the
increase in number of joint families, multi-generation families, unemployment
due to extension of service for those who retire lead to unemployment for
youngsters, increase in dependents per family, etc.

iv. Infant mortality rate:

This refers to the number of child death, from birth before reaching the first
birth day. This is measured as number of children that die before completing
first year after birth per 1000 children born. The infant mortality rate was very
high in India during the early part of this century and it was 204. But thanks to
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the development in science and concerted efforts taken by the government, the
mortality rate has come down to about 80 per 1000 in the 90's. However, there
is a variation between urban and rural areas. As on date the mortality rate is
about 50 per 1000 in urban areas and 86 per 1000 in rural areas. It is also
found that there is variation among the states in mortality rate. As for example,
in Kerala it is only 17 per 1000 while it .is 122 in Orissa. Comparing other
countries, the mortality rate is very high in India. For example, in Srilanka it is
only 32, in Philippines it is 49 and in Thailand it is 44. With improvement in
science and extension of medical facilities to rural areas, the infant mortality
rate is coming down rapidly in India, but there is much to achieve in this
direction.
v. Density of population:

This measure helps to determine the extent of burden on land area in a
country. It is measured as the ratio of number of persons per square kilometer
of land area. India's density is one of the highest among the countries in the
world with 267. This is very high compared to countries like Canada. Though
density is high, Japan has a very high per capita income of $ 25430. It is well
established that there is no relationship between density of population and the
economic development. Countries like Canada with very low density of 2.5
persons/sq. km. has very high per capita income of $ 20470 and as already
indicated Japan with very high density has also a very high per capita income.
Among the Indian states also we come across wide variation in density as for
example the Union Territory of Delhi has 6319 as density against Arunachal
Pradesh with just 10 persons/sq.km. It is said that countries which are
industrially advanced will have higher density and wherever the climatic
conditions, rainfall, etc., are good the density will automatically be high.

vi. Age and sex composition :

This information helps to determine and answer certain questions relating to
employment, dependents, birth rate, etc. Age composition in India is such that
(he young persons (0 - 40 years of age) constitute more than 65% of our total
population. Hence, even if the birth rate declines, yet the addition to our
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population because of the predominance of younger aged persons will be more
for some more years to come. The immediate implication of this feature is that
the dependency ratio will be very high. On an average it works out to be 50%.
But when the birth rate declines, this would also decline and the proportion of
working population would go up leading to increase in claimants for
employment.

As regards sex composition, in India it has come down over the decades from
962 females per 1000 males in 1901 to 930/3000 in 1971 and then to
929/1000 by the turn of this century. It is found that this sex ratio is one of the
lowest among the countries in the world. The reasons for this lowest sex ratio is
the deliberate termination of pregnancy of female child, legislation on abortion,
increasing infanticides of female children, lesser care for female children
resulting in their early death, etc. But with the spread of literacy, improvement
in medical facilities, change in social attitude, etc., the sex ratio is likely to
increase. Even now in some of the states like Kerala, and Tamilnadu the sex
ratio is high.

vii. Rural-urban distribution:

This is yet another feature of population which clearly indicates the extent of
change in the concentration of population in rural and urban areas. In the past,
the rural concentration was very high and slowly this is changing that the
urban concentration is increasing. While this is a good sign of development, yet
increasing urbanization has led to several social problems like urban poverty,
increasing number of urban slums, congestion, lack of social amenities,
artificial demand for important facilities like transport, health, education,
entertainment, etc. The proportion of population in urban areas has
consistently increased from 14.1% in 1941 to about 26% 1991. It is likely to
touch 32% by 2000. The rural-urban distribution is not even among the states.
While in advanced states, the urban concentration is high, in less developed
states the rural concentration is still continuing to be high.


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viii. Literacy level:
Literacy level refers to the number of people in the population who can read,
write and understand arithmetic. The literacy rate determines the economic
development. Any country with low literacy rate is bound to be less developed
than countries with high level of literacy. In India the literacy level was very
poor before independence and since then with all the positive steps taken the
literacy rate has gone up. This could be understood when we compare the
literacy rate of males and females in 1951 and 1991. In 1951 the literacy rate of
males was 25% and that of females was just 8% and in 1991, the literacy rate of
males increased to 52.6% and that of females 32.38%.

The substantial increase in literacy level is due to schemes like compulsory free
education for children upto 14 years of age, noon meal scheme, increasing
opportunities for educated in employment, especially among women, increasing
self-employment opportunities for women, etc. It is also to be noted that the
literacy level is high in both males and females in urban areas than in rural
areas. This is obvious because in the urban centers the facilities are more than
in die rural areas. It is also a good signal that over the period the gap between
literacy rate in males and females is narrowing down. In 1991 the female
literate formed about 61.56% of male literate as against just 33% in 1951. As in
the case of other features discussed so far, literacy rate is not uniform in all the
states. Economically developed states report a higher percentage of literacy
among males and females than the less developed states. With the increase in
allocation of fund for education with a thrust to primary education,
establishment of more and more correspondence course institutes, formal arid
non-formal education spread, etc., the literacy level is bound to pick up still
before 2000 A.D.

Nature of population problem in India and the effects of population growth
on Indian economic development

The population problem in India is a basic problem faced by the economy. The
population explosion is due to various factors. We will discuss these causes for
82
population explosion first and then understand how this affects our economic
development.

Causes:
It is convenient for us to classify the causes for population explosion by
identifying the causes for high birth rate and the causes for declining death
rate.

1. Causes for high birth rate:

It has been already discussed that birth rate in India has not shown any
significant decline over the decades. This slow fall in birth rate is one reason
why the country has population explosion. The following are the reasons for
high birth rate in India :

i) Climatic factors:

Unlike the other countries, India has a climatic condition which affects the
maturity age of girls. An Indian girl matures at an early age of 13 years which
means the reproductive span or the child bearing span is very high. In Western
countries the climate is cool that the maturity age is not so low. Obviously the
reproductive span is much shorter.

ii) Social institutions:

a) Marriage is a social compulsion in India. That is, once a girl matures, the
social opinion is that she should get married at the earliest after maturity. The
age of maturity being 13 years, the number of women in the reproductive age
group is very large. This means females in the age group of 15 to 49 years can
bear child. Once the marriage takes place at the age of 13, every woman can
bear child, at least theoretically for 30 to 34 years. This age group constitutes
47% of the total female population in India. It is also found that the percentage
of women in this reproductive age group is very high i.e., 81.44% in 1981.
However, this proportion is slowly falling over the period. One more reason for
83
high population is the practice of child marriage. Though this practice incoming
down, yet the average age of marriage among females was below 19 years even
by 1987-88.

b) The prevalence of JOINT FAMILY SYSTEM is another reason for high
population growth in the country. The main belief in a joint family system is
that the married couple should have babies. People who do not have babies are
looked down and there is a social stigma attached in such cases. Further there
is a specific preference for male babies. So until a couple gets a male baby they
tend to encourage child bearing. This preference for male baby is due to various
reasons like old age security, labour value of male child, laws of inheritance,
social customs like death rituals, getting dowry, etc. However, with the spread
of education and increased employment of women in various occupations in the
society, the tendency is to have lesser and lesser babies and the specific
preference for male babies is also on the decline. The Joint family system is
slowly disintegrating and giving place to independent small family due to
increasing cost of living, preference for remaining independent, increasing
employment after retirement, encouraging use of contraceptives replacing the
conventional techniques of birth control, etc.

iii) Economic factors:

The most important factor under this category is poverty. The poor people prefer
to have a large number of children Inspite of poverty due to the following
reasons:

(i) Whether the family size is small or big, poverty is all pervasive, hence,
an average family prefers to have more children than a few.
(ii) Children are treated as an asset in poor families as more children can
help the family in work, even at very young age, thereby raising the
income earning capacity of the family.
(iii) As the condition in the poor families is very poor, the infant mortality
rate is very high. To neutralize this every family prefers to. have more
children as this
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(iv) Would be in a way an insurance against high infant mortality rate.
(v) A large number of children in a family can look after the aged better
with large earnings and so the preference for more children,
(vi) The failure of family planning programme to convince the poor people,
as the consider the number of children as the best way to get more
income through odd jobs.
(vii) Indirect government support and subsidies for poor families like ration
quantity based on the size of family, etc
(viii) Possibility of getting pecuniary benefits on occasions like election,
philanthropic functions, free distribution of basic necessaries, etc.,
from the political parties is yet another reason for a big family size.

On die whole the economic factors indicate that Inspite of being poor, there are
several reasons for maintaining a large family size than small ones.

Let us now discuss the impact of population explosion on economic
development of India.

1. The size of population has a direct impact on the size of national income
of a country. In Indian experience, the net national product at factor
cost went up by 215% between 1961 and 1991 but since the population
increased at a rate of 92% during the same period, the percapita income
increased only by 58% during the period. As the population increases,
the increase in national income, even if it is substantial, will be spread
over a larger number of persons thereby the percapita income is low.
With lower percapita income all the other dependent variables of income,
viz., saving, consumption, investment, etc., will also be lower.

2. The most important effect of population growth is on the food supply. In
the - past, Malthus has explained this in terms of his geometrical ratio
and arithmetical ratio. He pointed out that the population increases at a
slow arithmetical ratio. Consequently over a period of time the rate of
growth of population will exceed that of food production. This leads to
food problem. In the case of India, Inspite of a spectacular achievement
85
on the food front, the scarcity for food continues as explained below. The
net availability of food grains between 1956 and 1992 increased by
140% but the population during the same period recorded an increase of
118% and so the percapita availability of food grains increased only by
10% . With ever increasing population, there is a need for the
government to maintain the public distribution system with all its
malpractices at a phenomenal cost to the exchequer.

3. Another vital aspect of impact of population on economic development is
that with rising population, the percentage of dependents also increases
apart from the increase in non-working population deteriorated between
1961 and 1981. In 1961 the number of unproductive consumers was
256 million but it increased to 464 million by 1981, which in percentage
terms is 57% and 62% respectively. The unproductive consumers are
those who do not contribute anything to national income. Hence, with
every addition to population the absolute number of unproductive
consumers increases who make no contribution to national income, but
claim a substantial share of national income. As a result the economy is
impoverished. It should also be noted that with 40% of our population in
the age group of 0 to 14 years of age and 6% belonging to aged group of
above 60 years of age, there is increase in dependency with every
addition to population. This is clearly a drain of savings of every
household and the society is denied of precious savings and the capital
formation.

4. A very significant effect of population growth is on employment. It is very
simple idea to understand. With increase in population there is sizeable
addition to the labour force, but when the employment generated is less
than the addition to the labour force, the result is unemployment and
underemployment. For instance during the VI plan period the number of
unemployed was 20.7 million accounting for 7.74% of the labour force,
while by 1990 this has increased to nearly 23 million. Inspite of eight
five year plans and generation of employment, it is proved that the
number of employment generated is clearly less than the addition made
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to the population. This means that a valuable resource is unutilized or
under utilized. This is a national waste. If we consider among the
unemployment, the educated unemployed, then the gravity of the
situation will be easily understood.

5. The increase in population makes a heavy demand on the community
facilities like education, health, housing, etc. In the case of education, in
India primary education is made free of cost and the expenditure
incurred by the government on this account alone is Rs. 2,246 crores.
Since the number of children in the age group of 6 to 14 years is about
156 million and expenditure at the rate of Rs. 144 per year per child will
mean a heavy drain on the financial resources. In the case of medical
facilities the number of people depending on public hospitals and other
medical facilities is increasing day after day causing a heavy drain on
resources for the government. Apart from the availability of education
and medical facilities being threatened by the growing population, the
quality of service rendered is also found to be very poor. The rising
population has made housing a major problem. The result is up coming
of slums in every part of the country. Leading a life of abject poverty, the
poor people neither have access to education, medical or housing
facilities. Added to these is the expenditure of the government on
populist welfare schemes like noon meal scheme, free books and note
books, free chappals, etc. All these political compulsions have denied the
economy the crucial financial resources for developmental purposes.

6. Rapid population growth affects capital formation in a country. With
rising population, it is already pointed out that the national income is
shared by a larger number of people and so the per capita income is low.
Consequently, the saving potential of the people is also low. In order to
achieve rapid economic growth, there is. a need to at least maintain the
growth in national income. But India with 2.2% growth rate (annual) of
population, national income must rise at the same rate so that the per
capita income remains the same. For this purpose capital investment
should take place at least in the order of about 12% whereas in India
87
the capital investment growth is poor because of poor saving.-Even
though it is said that our annual saving rate is about 23%, majority of
saving is used for unproductive purposes like marriage, on jewels, etc.
Hence, the capital formation is very poor and the population growth eats
away whatever increase in national income is possible.

7. Population growth has impact on environment. This was explained by
Anne Ehrlich in terms of a formula I = PAT, where I refers to
environmental impact, P stands for population, A refers to per capita
consumption and T refers to environmentally harmful technology that
supplies A. The three factors PAT have multiplicative relationship and so
their combined effect is very serious. Further with every significant
addition to population, there is misuse of resources like water,
electricity, land, etc. The result of this misuse is that a huge quantity of
waste is generated in different forms which directly affect the
environment. For example, the demand for fuel will go up with
increasing.

8. Population, then people will start cutting trees to get the cheapest fuel
available. Slowly this leads to denudation of forests leading to ecological
imbalance affecting the environment. Substitutes used also affect the
environmental purity as in the case of atomic power or plastics, etc.


9. Population explosion carries with it severe social problems. When the
population increases, we will find migration of workers from, rural to
urban centers seeking employment which directly means additional
pressure on the urban facilities. Apart from mushrooming of urban
slums, several problems like communal riots, thefts and other such
anti-social activities are committed. The crime rate goes up disturbing
the peace and mental strain, causes a change in attitude and social
values get eroded. People become more and more self-centered and such
an environment is not good for shaping the future generation.

88
10. There is a direct impact on quality of population due to population
explosion. By quality of population we mean the work potential, mental
make up, work culture, etc. With ever increasing population, every
individual family is unable to maintain the standard of living and this
affects the health and mental conditions of people. Automatically these
would affect the productivity of workers. The work force is so weak
physically and mentally. With pressure of family, the workmen demand
for more wages and salaries. They try to earn maximum by carrying out
inferior quality work or working in more places with lesser efficiency.
The work culture is tampered that every person wants to minimize work
and maximize leisure. The effect of all these is the productivity is very
low and the country loses.

11. In an agricultural oriented country like India, the increasing population
exerts a heavy pressure on limited land resources. With millions
depending on agricultural sector, the pressure would be more and this
leads to sub-division and fragmentation of land holdings making them
unfit for adopting modem methods of cultivation. This affects the
productivity of land. Though this is neutralized through scientific
methods like using high yielding variety of seeds, application of
fertilizers and pesticides, multiple cropping, etc. All these depend on
availability of water. With environmental degradation, the monsoon fails
and the increasing demand for drinking water, etc., will result in
scarcity of water for multiple cropping: Further more frequent use of the
same land even with application of fertilizers, would result only in the
operation of law of diminishing returns.

Therefore, without controlling population growth it is not possible for any
country to achieve rapid economic growth, and maintain it if achieved. For this
a suitable population policy is very much needed.




89
Population policy of government since independence

During the first five year plans, the government was not sufficiently
concentrating on a sound population policy. It was merely allotting funds
through every five year plan for family planning. From a modest sum of Rs. 65
lakhs during the I Plan, the amount increased to Rs. 5 crores in II Plan, Rs. 25
crores in III Plan, Rs. 277 crores in the IV Plan. With such a serious problem on
hand viz., control of population, the amount allocated till the IV Plan was
sufficient enough to sustain the family planning programs but not for extending
it to the rural areas in a big way. During the V Plan the allocation touched Rs.
409 crores which was increased to Rs. 1,448 crores in the VI Plan, hence, only
V Plan onwards, was there any concrete attempt to control the population. Till
the IV Plan the government was focusing on the following lines of action to
control population:
1. Spreading knowledge of family planning technique.
2. Supply of contraceptives to all in the rural and urban areas.
3. Financial incentives for people who undergo family planning operations.
4. Conducting a large number of camps for sterilization operation for both
males and females.

After the lifting of emergency the government seriously considered the following
for controlling population:
(ii) raising the minimum marriageable age of males and females
through legislative provisions
(iii) raising the level of education among the females
(iv) raising the monetary compensation for sterilization operation
especially in the rural areas
(v) making sterilization operation compulsory for couples with two
children etc.

But such coercive tactics failed to yield the fruit, as in most of the cases, the
officials were more concerned about the target fixed for them than the public
sentiments and reaction.

90
The VI Plan fixed the target for net reproduction late as one to be achieved by
1996 against the present level of 1.67. The target for sterilization operation, IUD
insert ion and CC usage, could not be reached due to the following reasons:
absence of infrastructural facilities, political compulsions, cultural values,
religious sentiments, high infant mortality rate, etc.

During the VII Plan certain basic understandings about our population as given
below made the government to approach the problem from a different angle.
(i) It was understood that the majority of Indian population is living below
the poverty line and it is this group which has a very high birth rate.
(ii) In a democratic set up it is necessary to set the minimum age for
marriage and also the prescription of sterilization operation through
legislation.
(iii) To increase the acceptance of sterilization operation, the infant
mortality rate should be brought down.
(iv) Using other incentive like priority in housing, increase in salary,
preference in employment, adult ration for child, etc., as followed by
China, which could successfully bring down its birth rate significantly
in a decade.

The VU Flan accordingly fixed the following targets :
(Current level given in brackets)
i. Population growth rate 1.2% (2.03%)
ii. Crude birth rate21/1000 (30.6/1000)
iii. Crude death rate 9/1000 (10.3/1000)
iv. Infant mortality rate 60/1000 (91/1000)

With these targets, the Plan formulated the Family planning and maternity and
child health strategies. Through this the Plan also aimed at reducing the
maternal mortality rate. .The family planning programs were re-oriented to
make them family welfare programs, thereby giving emphasis on every aspect of
the family than on'/ the birth rate and reproduction rate. However, mere was a
heed for orientation of everybody concerned in order to achieve that target set.
The government on its part made a hefty contribution through plan allocations.
91


Population policy in the VU Plan :
With the findings of the Census conducted in 1991, the government has
decided lo formulate an Action plan on following lines :
i. To extend the family welfare services to more areas and improving the
quality of service.

ii. To give more autonomy for States to manage these programs so as to
avoid the target focused action.

iii. To introduce innovative programs for achieving higher level of family
welfare especially among the urban slums.

iv. To identify the districts with birth rate above 39/1000 and develop
special programs for these districts.

v. To invite and appreciate the involvement of voluntary and non-
governmental agencies to these programs.

vi. Relating the grants to the village panchayats and the State
government for rural development with the achievement in bringing
down the birth rate.

vii. To encourage small family concept.

viii. To dispel the son-preference attitude.

ix. Devising schemes for post-retirement period so as to discourage
unnecessary issue of children.

x. To improve the political will in implementing all these programs.

92
With these policy options, one may expect that during the VIII Plan, the rate of
growth of population would slow down so as to bring down the net reproduction
rate to 1 as targeted already.

Balance of payments position since 1991 and critical evaluation of the
New export-import policy 1992 - 1997.

The balance of payments position, which had reached a point of near collapse in
June, 1991, slowly stabilized during the course of 1991-92. Although new
policies to deal with the situation were quickly formulated by the new
government and implemented within a few months the external payments
situation took time to stabilize primarily because it had been allowed, to
deteriorate to a state of near bankruptcy in June 1991. Foreign currency
reserves had declined to $ 1.1. billion despite heavy borrowing from the IMF in
1990-91 and a substantial part of this was held in illiquid deposits which could
not have been easily mobilized if needed. International confidence had all but
collapsed, commercial borrowings had dried up-and even letters of credit
opened by Indian banks were being generally rejected unless accompanied by
confirmation by foreign banks.

The strategy for the management of the balance of payments outlined in the
Budget for 1991-92 which was presented in July, 1991 relied upon a
combination of macro economic stabilization and structural reforms industrial
and trade policy. It was recognized that in the medium term, the solution to the
balance of payments problem would have to come from a much stronger export
performance, but in the shorter run the strategy had to be underpinned by
mobilization of external financing from the multilateral agencies and from
bilateral donors. Restoration of access to imports through liberalization had to
depend initially upon additional financing since the export efforts would take
time to show results. Since access to external commercial borrowing was
constrained the only other sources of funds were the bilateral and multilateral
agencies. Visible support from the multilateral agencies was important for
restoring international confidence.

93
Accordingly, the government negotiated a standby arrangement with the IMF in
October, 1991 for $ 2.3 billion over a 20-month period, a Structural Adjustment
Loan with the IBRD of S 500 million and a Hydrocarbon Sector Loan with the
ADB for $ 250 million. Parallel with the effort to draw on multilateral sources,
the government also launched the India Development Bonds aimed at
mobilizing NRI sources of funds.

With the assurance of external support through these efforts, there was a
gradual stabilization of the balance of payments position in the course of 1991-
92. Foreign exchange reserves were restored to more normal levels increasing
from $ 1.1 billion in June, 1991 to $ 5.6 billion at the end of March, 1992, The
entire amount of drawls from the IMF in 1991-92 with the accretion from India
Development Bonds together amounted to an inflow of $ 2.87 billion. This was
less than the increase in reserves of $ 4.51 billion from June 1991 to end
March, 1992. In effect, the exceptional financing mobilized in 1991-92 was used
primarily to build up reserves.

Import restrictions were gradually lifted in the course of 1991-92 as the balance
of payments stabilized. By the end of 1991-92 the new Liberalized Exchange
Rate Management System introduced in the Budget for 1992-93 eliminated
import licensing in most capital goods, raw materials, intermediates and
components and introduced a dual exchange rate system with one rate
effectively floated in the market. The Budget for 1992-93 also reduced the
customs duties in line with declared Government policy in order to make the
Indian economy more competitive and gradually exposing Indian industry to
external competitive pressure. The trade and exchange rate policy regime for
1992-93 was therefore characterized by major progress in eliminating
unnecessary administrative and discretionary controls over foreign trade which
were contributing to making our economy uncompetitive.


The year 1992-93 saw a revival of imports to more normal levels. The total value
of imports in US $ in the period April-December 1992 increased by 16.5% over
the level in the corresponding period of 1991-92. The increase appears large
94
only in comparison with a highly depressed level prevailing in 1991-92. In fact
the level of imports in 1992-93 as a whole is expected to be around $ 25 billion
which is somewhat lower than the level in 1990-91.

Exports in 1992-93 performed far better than in 1991-92. Total export growth
in the period April-December was 3.4% in dollar terms compared with an
observed decline of 1.5% in 1991-92, The performance of total exports is
depressed by the decline of more than 60% in exports to Russia and other
States of the former Soviet Union in 1992-93. The growth of exports to the
general currency area in the period April-December was 11.4%. The average
growth rate in April-December, 1992 has been adversely affected by a decline in
exports of I2.5%
!
in December, reflecting the disturbed conditions prevailing in
that month, figures for January are also likely to be depressed by the riots US $
19 billion. But it is hoped that the export performance in subsequent months
will return to the high growth rates of 15 - 16 per cent observed during
September-November.

The current account deficit in 1992-93 is expected to be around $ 7 billion,
reflecting the revival of imports to more normal levels. This deficit is being
financed through a combination of traditional financing sources and exceptional
financing.

However, there are important uncertainties in the balance of payments. The full
impact of the disturbances in December, 1992 and January, 1993 on exports
and-imports is difficult to assess at this stage. Clearly, the receipts on account
of tourism would be less than anticipated. The inflow of NRI deposits has in any
case been small this year. The inflow of external assistance is also subject to
some uncertainties consequent upon constraints that affect the rate of
utilization. A step up in commercial borrowings was, in any case, not
envisaged. Finally, there is the uncertainty arising from leads and lags.
Interest rates and, exchange rate expectations do affect the timing of receipt
of export proceeds and payment of import costs. However, while these
uncertainties justify a measure of caution in assessing prospects, the balance of
payments in 1991-92 has performed more or less as expected.
95

New export-import policy 1992 -1997 :
On March 31, 1992, the Government announced a new export-import policy for
the period 1992-1997. This policy has the following objectives:

1. To institute the required framework for globalization of the India's
foreign trade.
2. To improve the export capabilities of our industry, the policy aims
at promoting the productivity, modernization and competitiveness.
3. To facilitate improvement of image of our products in foreign
markets, the policy encourages the attainment of high quality in the
export products.
4. By allowing liberal access to raw materials, intermediates, components,
consumable and capital goods etc., in the international market, the
policy wants to achieve higher exports.
5. The policy provides for deregulation to achieve self-reliance so that
the domestic producers can improve their efficiency and become
competitive internationally.
6. The policy also lays emphasis on research and development as
well as technological advancements so that the domestic producers
will benefit from globalization.
7. A significant object is to simplify the procedure for exports and imports.

Subsequently, the government announced further modification to the above
policy by April 1, 1993. The important features of this modified policy are:

(i) The duty-free export benefit given to the Export oriented units
and the units in Export Processing Zones is extended to units
engaged in agriculture and allied activities provided they export
50% of their total production.
(ii) The government removed 144 items from the negative list of
exports leaving only prohibited items, items requiring license
and canalized items.
96
(iii) As a step to tap the potential of farm sector, professionals,
hotels, travel agents and diagnostic centers, the government
extended the Export promotion capital goods scheme to them.
(iv) For more than 2200 items, standard input-output norms are
fixed to enable the issue of license under the duty exemption
scheme.
(v) The criterion for recognizing export houses is now based on the
foreign exchange earning to FOB values of physical exports.
(vi) The procedure relating to export and import has been further
simplified.
(vii) Compensation would be given for unutilized import licenses for
duty free license scheme and exam scrip holders.

These provisions in the latest export-import policy would certainly enable India
to improve her exports and bring down imports. This has been experienced
during the first half of 1994 itself.

Structural composition of national income in India. The limitations of
National income estimation in India.

According to the First report of the National Income Committee, "National
income estimate measures the volume of commodities and services turned out
during a given period, counted without duplication." This means the total
volume of goods and services produced in a year in a country is valued in
monetary terms to obtain the National income of the country concerned.

Regarding the measurement of National income, it could be done in three
different ways depending upon the interpretation of concept of national income.
If National income is considered as a flow of goods and services, then the
method used is called Product method. If National income is treated as a flow of
income then the relevant method of measuring it is called Income method.
Alternatively, if National income is treated as a flow of expenditure, the method
used is called the Expenditure method. Apart from these traditional methods of
measuring National income, one more method is evolved and it is called the
97
Value added method. Let us now look into the contents of each of these
methods.

i) Product method: In this method, the value of goods and services
produced in an economy during a year is found at the market prices,
to obtain the gross national product at market prices. By subtracting
indirect taxes and adding subsidies, we obtain the Gross national
Product at factor cost. By deducting from Gross national product the
depreciation, we obtain the Net national product.

ii) Income method: When we aggregate the income received by various
factor services, like rent, wages/salaries, interest and profit we obtain
the National income at a factor cost. By deducting depreciation from
this we obtain the Net National income at factor cost.

iii) Expenditure method: By classifying expenditure as consumption
expenditure and investment expenditure, and then adding them will
get is the National income. This could be calculated at market prices
or at factor cost as in the other methods.

iv) Value added method : .In all the above methods, there is a possibility
of double counting and to avoid this the best method is to sum up
only the value added to the product or services at every stage. In that
manner only the net accretion in value of a product or service will be
taken into account to arrive at the final value of all goods and services
produced in a year. This method is by far considered as the best
though it bristles with certain problems and-difficulties.

In India we adopt a combination of the product method and income method for
measuring National income.




98
Trend in National income since 1951 :

The growth of National income in India since 1951 can be understood from the
Table given below.

RATE OF GROWTH OF NATIONAL PRODUCT-IN INDIA
(Figures in percentage)

PLAN ACTUAL TARGET
FIR5T 3.6 2.1
SECOND 4.0 4.5
THIRD 2.4 5.6
FOURTH 3.3 5.7
FIFTH 5.0 4.4
SIXTH 5.4 5.2
SEVENTH 5.7 5.0
EIGHTH --- 5.6

Analysis of the National income in India has yielded the following trends :

1. There has not been a consistent increase in our National income as
revealed by the growth figure given in the table above. Our real national
income was going up at an annual average rate of 3.9% while the
population was also increasing at an average annual rate of 2.13%
Consequently the per capita income increased at an annual rate of only
1.8%

2. It could be observed that the rate of growth declined over the decades.
While it was around 3.8% during 50's, it came down to 3.5% during
60's and then further to 3.1% during 70's. I980's witnessed a reversal of
the trend by recording 5% per annum. But again in the first three years
of 90's the rate came down to 3.5% , A similar movement was also
observed in the per capital income.
99

3. Changes and fluctuations in the growth rate of National income was
very nigh between years. The main reason for this is that we continue to
depend on uncertain monsoon to succeed every year. A successful
monsoj3fi boosts up the rate of growth while an adverse monsoon
brings down the rate. In Indian experience, the failure of monsoon is a
regular feature and so the growth rate in National income has been
declining over the decades.

4. As years rolled, it was observed that the fluctuations in growth of
national income also widened. For instance during the first decade the
fluctuation was between - 1.7257 and + 8.1568 while it widened in the
second decade lying between - 4.7565 and + 9.2071. Fortunately there
was negative growth rate in the eighties and the fluctuations were
ranging between + 2.2 to + 11.2 but early nineties repeat the earlier
performance with the growth rate varying between + 1.5 and + 5.8. The
fluctuations widening over the decades clearly indicate that our
planned efforts are not really bearing fruits and that we still depend on
uncertain monsoon.

5. An interesting observation is that this overall fluctuations over the
period is quite consistent with the fluctuations recorded by the primary,
secondary and tertiary sectors. In other words, these basic sectors were
not free from fluctuations and in a way the fluctuations in them cause
the over all fluctuations. Among the sectors, the primary sector
understandably recorded wide fluctuations followed by the secondary
and then the tertiary sectors. This observation is more confirmed when
we study the sectoral contribution.

6. Composition of Net Domestic Product (NDP): The contribution by
different sectors to the NDP will vary from country to country and even
for a country from time to time depending upon the stage of economic
development. It is usual that in the initial stage of development the
contribution by primary sector will be very much higher than in the
100
other sectors and over a period this would change. In Indian case also
this has become true. For example in the table given below the;
contribution of the three sectors underwent a change over a period of
four decades.

It would be clear from the table below that the contribution by the tertiary
sector is on the increase over the period followed by the secondary sector and
then the primary sector. This is because the rate of growth of the tertiary and
secondary sectors has been more than double that of the primary sector. The
secondary sector which accounted for a higher growth rate till the end of the II
Plan started receding and the tertiary sector has retained the lead in growth
rate.

1. COMPOSITION OF NET DOMESTIC PRODUCT
(In percentage)
SECTOR 1952-53 to 1955-56 1985-86 to 1989-90 1991-92
PRIMARY 56.06 34.58 27.00
SECONDARY 15.63 26.57 29.00
TERTIARY 28.31 38.95 41.30

2. When we study the compound growth rate of commodity and non-
commodity sectors, we find that the rate of growth is higher in the case of latter.
This tendency is welcome because the primary and secondary sectors can only
generate limited employment opportunities while the service sector or the
tertiary sector or the non-commodity sector has greater potential in respect of
employment. With economic development, the share of transport,
communication, energy, banking and insurance to the national product would
automatically increase as is experienced in India.

3. The study of per capita distribution of GDP in agricultural and non-
agricultural sectors indicates that over four decades the per capita distribution
is more in the case of non-agricultural sector than the agricultural sector. The
reasons for this are that:
101

a) the growth rate is high in the non-agricultural sector than in the
agricultural sector and
b) as the population increases, there is no significant shift taking place
from the agricultural to non-agricultural sector.

This is clear from the table given below:

PER CAPITA DISTRIBUTION OF GDP
(Amount in Rs.)

SECTOR 1950-51 1960-61 1970-71 1980-81 1990-91
AGRICULTURAL 860.83 956.17 955.60 940.48 1143
NON-AGRICULTURAL 1886.52 2573.32

3302.69

3506.47

5189


4. Share of the rural and urban sector to NDP is also used to understand
the composition of NDP. In Indian case, the contribution by the urban sector to
NDP is very much higher than that of the rural sector. Similarly the per capita
income in the rural and urban sectors in terms of ratio shows that the per
capita income was high in the urban sector and low in rural sector. The ratio
increased from 1: 208 in 1951 to 1 : 241 in 1970-71. But subsequently it
declined because with the increase in population, the size of urban population
increased and that of rural population declined. Hence, in 1980-81 the ratio
was 1 : 232 and 1 : 246 in 1989-90.

5. The analysis of the share of organized and unorganized sectors in the
NDP in terms of the factor income revealed that the share of factor income in
the organized sector increased consistently over the last three decades, but that
of the unorganized sector remained dormant even in 1990. This is because the
size of unorganized sector consisting of agricultural sector, corporate sector and
service sector. The share of factor income in the organized and unorganized
sector is given in the table below.
102

SHARE OF ORGANIZED AND UNORGANIZED SECTORS IN NDP
(In percentage)

SECTOR 1960-61 1970-71 1979-80 1989-90
UN-ORGANIZED 74.40 72.28 64.81 63.35
ORGANIZED 25.60 27.82 35.15 36.65

6. To study the share of public and private sectors in-the GDP let us look
into the table below:

SECTORS 1960-61 1970-71 1980-83 1990-91
PUBLIC 10.56 14.49 19.80 26.40
PRIVATE 39.34 85.51 80.20 73.60

The table above clearly indicates that the share of private sector in GDP
remains high and constitutes nearly 75% of GDP even in 1990-91. But the
share of private sector has declined from about 90% to about 74% between
1960-61 and 1990-91. On the other hand, with the emphasis on public sector,
its share in GDP has shown a consistent increase in the past three decades and
it is constituting more than 25% by 1990-91. The reason for the low share of
public sector in GDP is mainly because that it started developing late, and that
the agricultural sector is mostly in private sector.

Based on the above indicators we may come to a conclusion that over the past
four decades, the secondary and tertiary sectors have emerged as important
sectors with the tertiary sector occupying the top position. The urban sector is
continuing to hold a more important place than the rural sector. The
unorganized sector still remains in the predominant position and the public
sector is yet to make a significant leap in contribution to GDP.




103
Limitation of national income estimation in India :

The conceptual confusions associated with national income estimation have not
been cleared satisfactorily and so the estimation process is subjected to various
interpretations. Apart from these the following limitations are also found in the
estimation:

1. The existence of non-monetized sector and the output flowing from it has
remained outside the computation of national income. In Indian case, in
the agricultural sector the barter system still continues that a sizeable
quantity of produce does not enter into the market system at all. For
example, the wages paid in kind itself is substantial quantity and it is
not included in the valuation process.

2. Lack of data relating to the income of small producers and household
enterprises is yet another serious limitation. Most of the households
engage in alternative occupation and the income earned through that is
never accounted for. For example, the services of cook, household
preparations of edible items, etc., are valuable but the income earned
through such occupations is never known, similarly in the rural areas,
the small producers never maintain details of income, expenditure and
other data relating to their production. It is reasonable to expect that the
income generated through these sources is substantial and when it is not
included in national income the estimate of national income is very much
less.

3. Difficulty in differentiating (he economic functions performed is yet
another limitation in. the estimation of national income. For example, an
agricultural peasant during the season may work in his own field, and
also in the farm yard of the neighbour, during the off-season he may
work at a match factory, or just rear cattle of others, etc. Then how to
classify his income? The usual practice is to classify the income earned
under industry origin. but with a sizeable section of the people depending
104
on agricultural sector where the occupation is seasonal, it is very difficult
to estimate the income earned from various occupations.
4. Existence of black money and unaccounted money is another major
hurdle in the estimation of national income. Of course this problem is
experienced by every country. In India the National Institute of Public
Finance and Policy h:ts estimated in 1983-84, the size of beck money to
be around 18 to 21% of the total income. With every possible increase in
this category of income over the period, the estimation of national income
is bound to be very much less.

5. The compilation of data for national income estimation is taking place in
a very loose manner. Usually the data at the village level are compiled by
the village head man who may not collect these data in the scientific way
in which it should be collected. Obviously the aggregation of these data
will involve lot of inaccuracies. Further there is more than one official
agency supplying the data which rarely tally. Another bad practice is to
round off the data in an unscientific manner. All these have serious
implications on the data base for national income estimation.

On the whole, the national income estimation is subjected to the above
limitations. Efforts are being taken at every stage to improve the estimation
process, computerization of data, has been started only recently and with tins a
reasonable j level of accuracy in the data can be expected. Further centers like
Center for Monitoring the Indian Economy have been established and their
work is integrated. With these, national income estimation should become
satisfactory in future.

PROBLEM OF POVERTY
1. Distinction between absolute and relative poverty. Poverty line in
Indian context. The causes for poverty in India and
evaluate the various poverty eradication programme.

105
Absolute poverty is a state in which a person lacks resources even to meet or
his family's biological needs,-lives in a condition of isolation with a high degree
of insecurity. This condition is likely to be hereditary.

Further the person may neither be educated nor have anyone to care for him
and may live in poor or inadequate housing and work in inhuman conditions.
Basically such persons may not be able to meet the fundamental costs of living.

Relative poverty is a state in which the position of a person or a family can be f
expressed in relation to others in the society, especially in terms of the living
and f working conditions. This clearly picturises the inequalities in the society.
The poverty of a person or a family is always explained and understood with
reference to the average level of the society. Those people who are found to live
with low income, less remunerative employment, poor living conditions, etc
compared to the average determined for the society are said to be living under
poverty.

In Indian context, we examine absolute poverty to understand the extent of
poverty and also the causes as well as the eradication programs undertaken by
the f government. In order to estimate the poverty and the number of poor
people in the country, the concept of poverty line' is used. In defining the
poverty line usually three important factors are considered viz., i) minimum
nutritional level for subsistence, ii) cost of this minimum diet and iii) per capita
consumption expenditure. .While using these factors, care is taken while
making inter-year comparison of poverty by using appropriate deflators to
neutralize the effect of inflation. Most of the studies on poverty have used the
data supplied by the National Sample Survey. But all these studies have been
able to make only a rough measure of Indian poverty. Hence, for our purpose
we will consider the measure adopted by the Planning commission.

The Planning commission has used the nutritional requirement as the basis for
computing the poverty line. According to the Commission, there is a need to
define poverty line for rural areas and urban areas separately. Accordingly,
interms of calorie requirement per person per day, the Commission fixed 2400
106
calories for rural areas and 2100 calories for urban areas. In terms of monetary
unit, it works out to be Rs. 10,890 for rural areas and Rs. 12,570 for urban
areas (at 1991-92 prices).

On this basis the Economic survey 1992-93 estimated the percentage
population below the poverty line as shown in the table below :

AREA 1987-88 1989-90
RURAL 33.40 28.20
URBAN 20.10 19.30
ALL INDIA 29.90 25.80

The estimate of poverty given in the above table by the Planning Commission is
contradicted by various studies undertaken by research scholars. For example,
while the Planning Commission estimated about 22% points fall in poverty
between 1972-73 and 1987-88, Prof. Minhas and others have pointed out that
the decline during the above period was only by 12% points.

Another aspect of the poverty estimate is that there is a significant regional
difference as well as inter-state difference. For example, in 1988, the percentage
population living below the poverty line in different regions is as given below:

REGION 1970 1983 1988
SOUTH 61.0 46.2 43.2
EAST 61.8 57.3 51.3
CENTRAL 46.9 40.2 37.2
WEST 46.1 38.2 34.9
NORTH 12.6 9.8 8.3

Based on the above tables, it could be understood that "the poverty has
declined over a period and significantly during the 80's. This is attributed to
the following reasons :
107
i. The GNP increased by 5J% during the 80's compared to about 3.5%
increase till the 70s.
ii. The poverty eradication programs undertaken by the government has
started yielding the fruits.
iii. The increasing urbanization has resulted in the increase in income,
especially the urban migrants remit sizeable amount of money to their
relatives in the rural areas resulting in improved standard of living in
rural areas.
iv. The spread of education and impact of education together have
contributed to the reduction of poverty.
v. The development of non-farm activities in the rural areas has also
helped to improve the status of the rural poor.

Causes of poverty
1. The ever increasing population: This is one of the basic reasons for
poverty, especially the rural poverty. It is well known that the annual
addition to population was more than the rate of economic growth.
The quality of our population, especially the productivity and health
condition, is so poor that population growth merely adds only the size
of claimant to the available resources without making any significant
contribution to the output.

2. The large scale unemployment is the next factor which is both a
cause for poverty as well as the effect of poverty. It is a cause in the
sense that when millions of people remain without employment, their
contribution to output is nil but they claim a share in the output.
When the claimants to the limited output is high, then the per capita
availability -is so low which causes poverty. Unemployment is the
result of poverty in the sense that when the poor people, mostly
unskilled, want employment, they do not get employment Even if they
manage to get the employment is purely seasonal and temporary.

3. Another important reason is the under utilization of the available
resources. Inspite of technological advancement, scientific
108
improvements, etc., the utilizationis very much far from satisfactory.
As a result the total output is less whereas the claimant is more
which causes poverty.

4. The growth strategy adopted by the country through Five year plans
has not yielded the desired or the targeted results. Most of the
schemes of poverty

5. Eradication has touched only a small segment of the population. The
agricultural sector is still remaining in the same position that it is
unable to contribute significantly through increased production and
productivity to our national income.

6. The existence of inequalities in income is yet another reason for
poverty. The inequalities are mainly due to the concentration of
wealth and property in the hands of a few. As a result the percapita
income is very low resulting in poverty.

7. Ecological degradation and deforestation are also causing poverty.
The urban poor reed forest based resources mainly wood for fuel
purposes. This they obtain by indulging in indiscriminate felling of
trees and denudation of forests. This directly affects the earning scope
for the rural poor, as they depend mostly on the forest resources and
agricultural lands for their livelihood. With the fast denudation of
forests, the rural poor become poorer.

8. The distribution of resources in the country is not even and this is
evident from the inequalities existing among the states. For example,
even in the 90's Orissa remains a backward state while Maharashtra
is in the forefront like Punjab, Haryana, Uttar Pradesh, etc. This is
one of the reasons for the prevalence of poverty in certain states.



109
Measures to alleviate poverty
1. The first step towards eradication of poverty is to achieve fast economic
growth. It is realized that poverty in India is more due to institutional
factors and so there is a need to attack directly poverty through
programs aimed at particular group of people. That is why programs like
Integrated Rural Development Programme, Jawaharlal Rojgar Yojana, etc
have been introduced.

2. The large scale producers have to be oriented towards v/elfare of the
community and the small scale industries should be Moro employment
generating and help in the removal of unemployment, especial in the
rural areas.

3. At the national level, the country should improve the rate of surplus
generation by increasing resources mobilization. But this will be difficult
when the propensity to save and invest is very low among people and the
tax rates are very stiff. This could be achieved by achieving better
utilization of resources, using better techniques, improving the
technology, etc. All these will help to generate the income in the economy
and the percapita income will also go up.

4. With the application of improved technology, use of high yielding variety
.seeds, fertilizers and insecticides, it should be possible to increase the
production and productivity in the agricultural sector which directly will
increase the income of the farmers. This in turn means higher per capita
income for the rural folks thereby reducing poverty in the rural areas.

5. It is well known that nearly 70%, of Indian population is depending on
agricultural sector and the agricultural sector is completely depending
on monsoon, Monsoon is most uncertain that the famous saying is
Indian agricultural is gamble with monsoon. There is a need to improve
the irrigation facility .and relieve the dependence on monsoon so that the
agriculturists will have good production and achieve a higher level of
productivity with which they can be relieved from poverty.
110

6. Several other measures like a forestation, massive rural employment
generation, improving soil conservation, adopting latest technology in
production process, improving the allied occupation to provide
alternative employment opportunities for the farmers during the off-
season, etc., can certainly bring down the level of rural poverty.

7. As recommended by the World Bank, the rural employment schemes
should be more oriented towards women as it is found that in nearly
35% of the rural family womens share in the family income is quite
significant. Special schemes could be devised to improve the employment
opportunities for women so as to supplement the income of the family
with womens earnings.

8. The rural credit system needs review, especially after nearly 25 years
after nationalization of banks. The banks should be involved more in the
rural schemes and new employment oriented schemes have to be
identified and liberal financial assistance should be provided for such
schemes so as to help remove poverty in the rural areas.

9. Efforts should be made to discourage conspicuous consumption among
the people and encourage them to make productive investment. This,
calls for a change in life style of the people and their consumption
behaviour. Though it would fake a long time to achieve this, yet steps
should be initiated at the earliest in this direction.

10. Encouraging co-operative efforts in various fields, improving and
spreading educational opportunities, creating the awareness among the
people that the poverty is only a stage and it could be overcome with
consistent efforts, devising new schemes targeting specific group and its
peculiarities, rigorous implementation of land reform policies, etc are all
other measures which would bring down poverty in India.

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All the schemes were in operation for quite some time and an evaluation of
these schemes has brought out certain deficiencies of them. Efforts have to be
taken up to overcome these deficiencies so that these schemes would help to
eradicate poverty in India.

(i) The first deficiency is that these schemes are weakly integrated with
other plans for area development.
(ii) The community assets created through various schemes has not been
employment generating in nature.
(iii) The welt to do farmers and people in the rural areas are found to be the
beneficiaries of the schemes aimed at eradicating poverty.
(iv) The delay in the implementation of the schemes and the allotment as
well as release of funds for these schemes is robbing the expected
benefits of these schemes.
(v) Politicians interfere in the process of identification of the beneficiaries
that the fruits of these schemes do not reach the targeted group of
people.
(vi) Failure to provide adequate training to the persons: in-charge of
implementing various schemes is also another reason for the schemes
not being effective.
(vii) Poor flow of communication and details about the various schemes to
the rural folks is one more reason for the deficiency of these schemes.
There is a need to strengthen the publicity for these schemes so that
the needy will be benefited.

As has been already stated, the government has introduced various schemes
aimed at eradicating poverty, especially in the rural areas, but the above
mentioned deficiencies should be viewed seriously so that the efforts to
eradicate poverty will start bearing fruits.

Problem of unemployment in India
Unemployment is of different types. Every type of unemployment is found in
India. Before we analyse the nature of unemployment, we should understand
the types of unemployment
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1. Structural unemployment: This is a type of unemployment caused
'mainly by the change in the development strategy adopted by an
economy. For example, suppose a country basically agricultural in
nature, plans to adopt industrialization as a strategy. This will result in
displacement of labour in agriculture and not all of them can be
accommodated in the industries. This type of unemployment caused is
called Structural unemployment.

2. Cyclical unemployment: Every economy goes through the ups and downs
in the process of development. This type of economic fluctuations is
studied through the behaviour of business cycles. Hence, during the
period of inflation, the unemployment will be less and during the period
of depression unemployment will be more. Such type of unemployment is
caused mainly because of the deficiency of effective demand. Keynes has
discussed this type of unemployment in his theory. Such unemployment
is caused due to the economic fluctuations and every country will
experience this type of unemployment.

3. Frictional unemployment: This is another type of unemployment which is
caused by shift in the productive effort. For example, during war time,
workers are absorbed in war-time industries. Once the war is over, these
workers are rendered unemployed as the war-time industries and
production do not continue. Such an unemployment is called factional
unemployment. An economy which is flexible can quickly solve this type
of unemployment.

4. Seasonal unemployment: This type of unemployment is very closely
linked with the seasonality in production in any sector. For example, in
the agricultural sector, during the harvest season, there is heavy demand
for labour. All unemployed laborers will get work. But once the harvest
season is over, these laborers remain unemployed.

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5. Under-employment or disguised unemployment: This is the type of
unemployment which is never practically seen, but only experienced.
Suppose a job which can be performed by just 10 worker, has in reality
has 20 workers, then the excess 10 workers who are not actually
required are said lo be under employed or disguised unemployed. In
other words, the surplus labour do not make any addition to the output.
Technically, their marginal product is zero. Such a situation is called
wider-employment or disguised unemployment. In India this is the type
of unemployment which is found in large scale in agricultural sector and
public sector. Alternatively, when a Post-graduate qualified person is
employed as a peon, then he is said to be under employed as his true
potential is not really put into use.

6. Educated unemployment: This type of unemployment is found among the
educated persons. Though there are different levels of education, at any
level, if a qualified person is unemployed, then he adds to the number of
educated unemployment.

7. Rural and urban unemployment: Depending upon where there is
unemployment, we may classify unemployment as rural an.1 urban
unemployment.

TREND IN EMPLOYMENT IN INDIA
When we analyse the growth rate of employment by sex and residence we
observe the following trend:

1. The employment on the whole has been growing at the rate of 2.21 per
annum during the 15 year period (1972-73 to 1987-88).

2. The rate of growth in urban employment was found to be more than that
of the rural employment, the respective rate being 4 per cent and 1.75
per cent. As a result, the share of employment in the total employment
had gone from 16% to 22% during the 15 year period studied.

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3. It is of interest to note mat unemployment among male and female
increased more or less at the same rate and their share in total
employment also remained the same over the 15 year period.

4. However, the rate of growth of employment had been declining when we
divide the 15 years into three 5 year period.
5. As regards the growth rate of employment in organized and unorganized
sectors, it was found that in both the rate of employment was on the
decline, though the rate of employment in the unorganized sector was
greater than that of the organized sector during the 15 years studied.

6. Among the sub-sectors in the organized sector, the rate of employment
was more in public sector than in private sector. While in public sector
the rate of employment was growing at the rate of 3% per annum the
employment in private sector increased at a lower rate of 0.5% per
annum.

7. The study of growth rate of employment in major sectors of our economy
indicated that in terms of growth rate of employment the sectors could be
listed in the following order: Construction, Electricity, gas and water
supply. Mining, Transport, storage and Communication, Manufacturing,
Services and Agriculture.

NATURE OF UNEMPLOYMENT IN INDIA

Even before we discuss the extent of unemployment in India, it should be
noticed no accurate estimate of the problem is available. This is mainly because
of various types of unemployment and lack of data base on unemployment even
agencies like Directorate General of Employment and Training or Census or
National Sample Survey or the Employment exchanges can give accurate
information on unemployment. However, the available estimates could be used
to understand the magnitude of this problem.

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Looking into the Plan documents one can get the information about the backlog
of unemployment at the beginning of each Plan. This is given in the Table
below.

BACKLOG OF UNEMPLOYMENT DURING FIVE YEAR PLANS

PLANS I II III Annl VI VII
Back log - at the start of
the Plan
3.3

5.3

7.3

9.6

11.3

7.8

Addition to the labour
force during the Plan
9.0 11.8

17.0

14.0

32.1

36.3

Total (1+2) 12.3 17.1 24.1 23.6 43.4 44.1
Additional employment
generated
7.0

10.0

14.5

11.0

35.6

40.4

Back log - at the end of
the Plan
5.3

7.1

9.6

12.6

7.8

3.7


From the Table it could be seen, that the unemployment at the end of every
Plan has gone up to the Annual Plans and after that the Backlog had come
down during the VI and VII Plans, This implies that efforts taken to generate
employment have yielded the desired result, though the entire backlog could
not be erased completely.

It may be noticed that this reduction in backlog need not be taken as an
indicator of the problem being solved.

It is necessary to study the unemployment sex-wise, and residence status-wise
to understand the problem in right perspective. This are being studied below.

The analysis of unemployment rates sex-wise and residence status-wise
indicated that:

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(i) The current daily status unemployment rates was found to decline
both in urban and rural areas for both males and females
(ii) A current weekly status unemployment rate was found to increase for
males whereas among the urban females this rate was almost
constant while in the case of rural females it was found decline.
(iii) The usual status of unemployment was found increasing among
males and females in both the rural and urban areas.

CAUSES FOR UNEMPLOYMENT
The problem of unemployment in India is caused by various causes. Let us now
discuss the main causes for this problem:

1. The first cause for unemployment is the steady increase in population.
The rate of population growth is around 2.2% per annum while the rate
of employment growth is hardly matching with it. Hence, the
unemployment situation worsens with every addition to population.

2. The rate of labour absorption in the organized sector in India is very
limited as most of the segments in this sector are already full with
labour force. Hence, the best way to absorb the surplus labour is by
expanding the small scale units which are highly labour intensive.

3. The low productivity in agricultural sector is another reason for
unemployment. With a large scale under-employment and disguised
unemployment in the rural sector, there is limited addition to the
output. As a result majority of the rural folks remain unemployed and
they cannot also be absorbed by the industrial or other sectors as they
do not have training.

4. The indiscriminate increases in the number of graduates coming out of
the universities and the lack of link between the curriculum and the
actual requirement by the industries are the next set of reasons for large
scale unemployment among the educated persons.

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5. The mushrooming of technical institutions throughout the country is yet
another reason for the unemployment among the technicians.

6. The large scale failure and sickness among the small scale units in the
country is another reason for unemployment.

7. The failure of several schemes for generating employment is itself a
reason for the existence of large unemployment.

8. The lack of co-ordination among various agencies engaged in generating
employment also results in unemployment prevailing.

9. The delay in identifying the potential sectors for generating employment
has resulted in the building tip of huge backlog of unemployment.

10. The lack of training facilities and the lacunae between the training
institutions and employing agencies is another reason for unemployment
among the trained persons.

11. The inherent resistance to mobility among the laborers itself is a reason
for unemployment For example; laborers do not prefer to go to places
where jobs are available even if it amounts to remaining unemployment
otherwise.
Solutions to solve the problem of unemployment:
The unemployment problem needs solution at different levels. The solution for
this problem at the urban level is different from those at the rural level. Hence,
steps are to be taken at both the levels to bring this problem under control. We
discuss below the solutions for this problem under urban level and rural level
separately.





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Suggestions for solving urban unemployment:

1. The foremost step is to make education relevant to the society. Instead
of continuing with the purely academic orientation, efforts should be
made to spread vocational education.

2. Industries with low capital intensity should be started in large scale so
that they can generate more employment. Though the small scale units
have come into existence in large scale, yet the failure rate among them
is very high. Steps should be taken to minimize this sickness among
small scale units so that they can generate employment in large scale
and help to solve this decades old problem.

3. The import of technology should be discouraged and the domestic
technology should be updated so that it can generate more
employment.

4. Industrial units with short gestation period should be encouraged in
large scale.

5. Decentralization of units and incentives for location outside the urban
limits to industries, would help to relieve the urban unemployment to a
large extent.

6. Financial assistance to self-employed persons should be made more
liberal that such types of employment will help to minimize the
intensity of the unemployment problem.

7. Considering the potential of the service sector, organized and co-
coordinated efforts are required to encourage establishment of units in
the service sector which can take the load to a large extent.

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8. Productivity in industrial sector should be improved that more
opportunities arc automatically created.

Solutions for rural unemployment includes the following points :
1. Establishment of small scale units to utilize the locally available
resources is one important step.
2. Providing training facilities for the rural folks in various areas will help
them to improve their skills so that they can get employment in
various sectors.
3. Extension of rural oriented jobs will also help to solve the problem.
4. Large irrigation schemes with excellent capacity to generate large scale
employment should be started
5. Community development projects should be initiated with guidance to
effectively tap the rural man power.
6. Several agricultural oriented small units like dairy farm, poultry farm,
beekeeping, etc., should be set up in large scale so as to provide off-
season employment and also supplement agricultural income.
7. Spreading vocational education among the rural folks will also help
them to improve their skills with which they can get employment.
8. Liberal financial assistance, managerial and technical guidance will go
a long way to minimize rural unemployment.
9. Effectively monitoring the rural employment schemes to
prevent malpractice and wrong diversion of funds will, help in
realizing the objectives of these rural employment schemes arid
projects.
10. Establishing links with the urban market to ensure ready market for
the products from the rural areas will help to ease the unemployment
among the self-employed rural folks,

The problem of rural unemployment Measures to solve this problem

The agricultural sector offers livelihood for millions of people in India. One
segment of these dependents is the agricultural laborers. There is no parallel to
the sufferings of these agricultural laborers. This is a unique group of laborers
120
with certain peculiar characteristics. Infact it is because of these peculiarities of
agricultural laborers that they remain always in object poverty.

One of the peculiarities is that these agricultural laborers remain unorganized.
Unlike the laborers in industrial sector, the agricultural laborers have no
opportunity to come together. They remain independent that once a laborer gets
the work on a day he does not bother about others. When he remains
unemployed no other laborer takes any interest or shows any concern. Being
illiterate these laborers have not understood the importance of collective
bargaining.

Another peculiarity of the agricultural laborers is that they mostly remain
unskilled. This is because of their nature of occupation, which is seasonal and
mostly temporary. Further there is no specific work that any laborer
concentrates and every laborer is prepared to do any type of work connected
with cultivation. Hence, no specialization or skill is acquired by them. The
extent of illiteracy among them also stands in their way of improving their skill
through training.


The agricultural laborers are highly migratory in nature unlike the industrial
workers who are more stable in their jobs. This is a peculiarity that could be
found only with agricultural laborers. The nature of their occupation is such,
that these agricultural laborers get temporary job wherever they go. Being
unskilled they go in search of job and accept any offered to them. Further,
unlike the industrial workers who do more specialized and specific work, the
agricultural laborers have several, odd jobs that they need not stick on to a
particular job or employer for ever. It is because of this migratory nature of their
work, that they are unable to command any remunerative reward for their work
and get organized.

A very important peculiarity of the agricultural laborers is that their employers
in most of the circumstances also are poor and so they do not offer
remunerative wages. Further the employer and his family members also involve
121
themselves in every work along with the hired workers. This results in very
close contact between the agricultural laborers and their employers. Till very
recently, there is no codified rule or regulation for protecting the interest of the
agricultural laborers. In the case of industrial workers, several legislation are
enacted at various points of time to protect their interest. In the absence of
such well defined rules and regulations, agricultural laborers are subjected to
various types of exploitations and they are denied of their dues. Further these
workers have no appellate authorities to appeal and get their grievances
redressed. Mostly, the disputes relating to agricultural laborers are settled at
the village level where the money power is found to be final. In other words, the
rich farmers and landlords always decide cases against the interest of the
workers and the latter also do not react to such one-sided judgments, lest they
should remain unemployed for ever.

With all the above peculiarities explained it is not a surprise that the
agricultural laborers lead a .life of misery. This is clearer when we study their
economic condition.

(i) Majority of the agricultural laborers do not own any land. Even those
owning land, the average size of landholding is just 1.33 acre.

(ii) The employment that the laborers get is temporary and purely
seasonal. It is well known that on an average an agricultural worker
gets employment only for about 4 months per year and this too not at
one stretch. Obviously, the laborers borrow heavily and remain in
debts forever.

(iii) With no fixed hours of work and regular wages, these laborers lead a
life of penury and they are never able to balance their income and
expenditure. It is estimated that more than 52% of the agricultural
workers are in debts which range between Rs. 244 in West Bengal
and Rs. 1808 in Rajasthan. Inspite of the minimum wages legislation,
the wages of the laborers remain abysmally low as in most of the
places the legislation has no relevance. Further, the agricultural
122
wages do not go up on par with the industrial wages due to the
absence of collective bargaining, exploitation by landlords, illiteracy of
laborer, etc.

(iv) A very significant feature of the agricultural laborers is that most of
them come under bonded laborers. This means, when a laborer is
unable lo meet his family expenditure with his meager income, he
borrows from the money lenders or landlords at very high rate of
interest. The repayment does not arise with his income level. Hence,
the entire family is indebted to the money lender or the landlord, who
uses these laborers through generation for cultivation and other
purposes. This if, how the agricultural laborers families become
bonded laborers.

(v) With very poor economic back ground, the agricultural laborers lead a
life of misery. Naturally, their productivity is very low. This affects not
only their ability to command better wages, but also the country with
lesser productivity in the sector.

So far we have discussed the peculiarities and the economic conditions of
agricultural laborers. What are the reasons for this? The causes; for the poor
position of the agricultural workers are as follows:

1. The excessive growth of population is the basic reason for this
condition of agricultural laborers. With sizeable addition every year, the
dependence on agricultural sector increases which in turn increases
the unemployment. As a result the laborers arc prepared to work even
for very low wages. The employment that they get is not permanent and
purely seasonal. They migrate from place to place in search of good
employment but not permanent employment. With large scale
unemployment, they lead a poor life and they have very little strength
to be productive. Another outcome of this dependence on land is
indebtedness.

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2. It is well known that the agricultural laborers are paid poor wages and
the wages are paid even today in kind. This affects the purchasing
power or the capacity of the workers. Immediately after the harvest,
when the laborers are paid their wages in terms of the crop, these
laborers try to dispose of this in the market, or the village shops and
they realize lesser money value much less than what they would get if
they are paid in cash. Hence even if the agricultural laborers get their
wages", their purchasing power is relatively low.

3. The tenure of employment is highly uncertain in the case of agricultural
workers. In the absence of any rule or regulation the employment of
laborers is subjected only to the personal likes and dislikes of the
employer. They are exploited to the maximum extent by the land lords.
There is no bargaining power in the absence of any organization to
protect their interest. This in turn has encouraged bonded laborer
system. The laborer? Always live in poverty and in the absence of
alternative occupation work under suppressing conditions. This affects
their productivity as well as initiative to get organized. They remain
unskilled being satisfied with what they get.

4. One more important reason for the pathetic condition of the
agricultural laborers is that they do not get any protection from the
government also. Whatever legislation are there, they all only help the
powerful landlords who are able to circumvent the legislation finding
loopholes. Further, State is a silent spectator to the exploitations of the
laborers, as without the aggrieved protesting, there is no scope for the
government to intervene. The poor laborers also do not have any other
alternative source of income. Another problem is even if the
government is able to relieve the bonded laborers from their bondage;
the expenditure on their rehabilitation is very huge that States hesitate
to accept this burden. Once the laborers are free to work, they do not
get job as they mostly are unskilled. There is also no scope for
accommodating, them in any other productive sector as they do not
possess any other skill. Assuming that the government is able to allot
124
them land so that they can cultivate it and survive, these laborers do
not have the wherewithal to use the land and survive. In several cases,
these laborers who are given land, are found to pledge the land with
the money lenders and once again remain agricultural laborers.

Hence, when we consider the above explanation, we find that the agricultural
laborers have no scope for leading a normal life. However, we may suggest the
following ideas with which their problems may be solved at least to some extent.
The National Commission on Rural Labour has also made certain
recommendations to improve the position of these laborers. Let us now discuss
these in detail.

1. On its part the government has passed the Minimum Wages Act to
ensure that the agricultural laborers are not exploited. While the Act has
provisions to pay minimum wages, it has no teeth. In other words,
though the Act has been passed, it remains ineffective, in the sense that
the government is not able to enforce this Act. The main reason for this
is that agricultural laborers are highly unorganized unlike the industrial
workers. In the absence of unions, the provisions of this Act are not
effectively implemented. Further the laborers are in debts and in certain
cases these debts have been incurred in the past by their forefathers.
They do not come forward to rise against their employers for fear of
losing their occupation. Hence, mere passing of Minimum Wages Act
would not help the workers, unless the government follows it up with
measures for effective implementation.

2. In order to protect the interests of agricultural workers, the government
has launched several special programs like Small Farmers Development
Agency, and Marginal Farmers and Agricultural Laborers Development
Agency. These are specific programs to protect a particular group of
laborers falling in small farmers, marginal farmers and agricultural
laborers category. These programs are implemented to start with in
certain areas so that slowly they could be extended to other areas. In the
past the government launched community development programs to
125
protect the weaker sections in the agricultural sector. With such
programs, the benefits ma^ flow to the target group, but there is a need
to extend these programs to others in other areas and also to come up
with corrective steps wherever these programs do not reach the targeted
group.

3. Another important step taken to mitigate the condition of the
agricultural workers is land reclamation and settlement. The
government as well as service organizations are engaged in the process
of reclaiming lands from the big farmers .and rich land lords. These land
are pooled and then* redistributed among the agricultural- workers and
landless peasants. Bhoodan movement was started by Vinoba Bhave
mainly to encourage philanthropic land lords to donate voluntarily lands
which were redistributed among the landless peasants and workers.
These efforts met with very little success and the lands mobilized in this
way either were found to be not fit for cultivation or in litigation. Further
there were several problems in the redistribution process. For instance,
proving die identity and domiciles bf agricultural laborers were main
problems. In several cases after the lands were redistributed, the
laborers either retained the lands uncultivated for want of funds for
cultivation or pledged them for raising funds for running their families.
Hence, there is an urgent need to attend to this problem of reclamation
and resettlement and eliminate all the obstacles and hurdles in the
process.

4. Several new rural employment programs have been launched by the
government-at different points of time. Certainly these programs have
helped to bring down the problem of unemployment in the rural areas
and divert the surplus manpower in the agricultural field to the of her
closely related occupations. These programs range from laying of roads
to minor irrigation, canal construction, soil conservation, social forestry,
etc. As lakhs of people are involved in these programs, to some extent
there is scope for using the idle manpower in the rural areas. However,
these schemes themselves cannot eradicate poverty or unemployment in
126
the run

areas. Apart from the shortage of funds for implementing such
schemes the government has to monitor several such schemes at the
same time which adds to the administrative burden of the government.
Possibility of making the local rural agencies responsible for the
administration and operation of these schemes would help to make the
benefits flowing from such schemes to reach the targeted group.

5. A very significant improvement in this connection is the passing of The
Bonded Labour System (Abolition) Act, 1976. This Act has completely
liberated all the bonded laborers at one stroke. But the effectiveness of
this Act is still in doubt, because laborers themselves have preferred to
stay with the landlords or their employers for fear of losing their
livelihood and the difficulty for the government to find them alternative
employment. Hence, Inspite of this Act, the bonded labour system is still
found in several parts of the country. The government should now
seriously think of implementing this legislation and simultaneously
create agencies which will arrange for the rehabilitation of the released
bonded laborers. The contribution of the voluntary organizations can
also be invited as government alone cannot attend to this task. As a step
towards rehabilitation these agencies can train the displaced bonded
laborers in simple works like printing press, book binding, stitching,
carpentry, etc., so that the released laborers can start with a new
occupation instead of once again coming into the fold of agricultural
occupations.

6. Another positive step in this direction has been the Central government
coming out with the insurance scheme for ails-the agricultural laborers.
The premium of Rs. 10 per year is paid by the government and the
insurance cover is for Rs. 1000. Every head of a family is insured, and
this is a small beginning. This scheme should be slowly extended so that
the family of agricultural laborers will have some tort of protection after
the death of bread winner.

127
7. With the establishment of the National Backward Classes Finance and
Development Corporation recently, the government has shown its
determination to attend to the problems of the poor and downtrodden
agricultural laborers. This Corporation will help to generate self-
employment' opportunities, provide concession in finance and assist to
improve the technical skill of laborers belonging to Backward Class.

8. A major development in alleviating the problems of agricultural laborers
is the setting up of the National Commission on Rural Labour by the
government, which submitted its report in July, 1991. The Commission
has gone into the depth of the conditions of the small fanners, marginal
farmers and the agricultural laborers and made a number of
.recommendations. Basically the Commission felt that the level of living
of the agricultural laborers should be improved and they should be
involved in the development process.

In this connection the following are the recommendations made by the
Commission:
(i) Free and compulsory education for all children in the rural areas upto
the age of 14.
(ii) Prohibition of child labour in every form in any industry.
(iii) To provide collateral - free loans to women, a separate National Credit
Fund has to be set up from which loans could be given to women.
(iv) Fixation of minimum wages as Rs. 20 per day with a provision to
change it by linking the wages with Consumer Price Index.
(v) Provision of liberalized credit to laborers through co-operative banks.
These suggestions are being examined by the State governments and
the Central government and when they are accepted, then we may
expect the condition of the agricultural laborers to improve.

THE INFLATIONARY TREND IN INDIA AND THE STEPS TAKEN BY THE
GOVERNMENT OF INDIA TO CONTROL INFLATION IN INDIA.

128
Immediately after independence, the inflationary pressure was controlled by the
government by taking the following measures:

1. The government imposed new taxes and increased the rate of old taxes
to absorb the surplus purchasing power in the hands of the people.
2. The government also simultaneously reduced the money supply.
3. The public expenditure was also reduced to some extent.
4. The government announcement of increase in bank rate from 3 to 31/2
per cent in November, 1951 had a good impact.
5. Government also simultaneously took several steps to increase the
volume of production. In spite of these efforts during the period five year
plans the inflationary pressure continued.

During the I Plan period in spite of the increase in agricultural and industrial
output, the inflation set in mainly because of the failure of monsoon in 1955
and a heavy dose of deficit finance to the tune of Rs. 420 crores. In the II Plan,
the increases in prices of ail commodities continued to be experienced. There
was very limited success on the control inflation. However, the government
could resort to a lower level of deficit finance to the tune of Rs. 948 crores
against a target of Rs. 1200 crores. The III Plan witnessed further spiraling up
of prices. During this plan several factors contributed towards the inflationary
pressure. Specifically the Chinese aggression, increased money supply, increase
in government expenditure and acute shortage of foreign exchange fuelled the
inflation. The actual deficit finance was Rs. 1133 crores much above the
provision of Rs. 550 crores. The reliance on deficit financing continued during
the annual plans the government resorted to nearly Rs. 682 crores of deficit
financing. The IV Plan period witnessed some efforts on the part of the
government to bring down the inflationary pressure. For instance, the
government decided to finance its public expenditure through non-inflationary
means as far as possible, the bank rate was raised from 6 to 7% The cash
reserve ratio was jacked up from 3 to 5%. The minimum rate of interest to be
charged by the commercial banks on their loans and advances was fixed at 10%
But all these steps failed to bring the desired result as the government resorted
to a huge dose of deficit financing to the tune of Rs. 2150 crores against the
129
original target of Rs. 850 crores. During the V Plan period there was no let up
on the price front. The inflation rate was so alarming that the government had
to introduce several measures. Through several ordinances, the government
froze all profits and wages at current levels and through the third ordinance,
the compulsory deposit scheme for the income tax payers was introduced.
So prices slowly started declining. By March, 1976 the price level in India rose
by 11 % To control this high rate of inflation, the government resorted to supply
management policies. It curbed further increase in money supply and the effort
was to increase the supply of wage goods. But the policies failed because the
government gave a greater emphasis on controlling credit rather than
controlling money supply. During the VI Plan the deficit finance was to the tune
of Rs. 5000 crores and so the inflationary pressure continued to build up. the
government came up with its anti-inflationary policy by laying emphasis on:
increasing the production, better capacity utilization, imports of essential
commodities in short supply, regulated exports of those needed domestically,
curbing the activities of hoarders and black marketers, constant monitoring of
the prices of essential good and making permanent the Compulsory Deposit
scheme and enhancing the rate of this deposit. The RBI increased the Bank rate
from 9 to 10% and it also increased the CRR to 7% from 6% and the Statutory
liquidity ratio from 34% to 35% It raised the minimum margin for the food
credit to 10% inspite of all these tasks the inflationary pressure not only
continued but became more aggravated. During the VII Plan period also the
government continued with most of the above mentioned measures with greater
seriousness. But even at the end of the VII Plan period the inflation rate was
hovering above 10% which taken is really high. It is to be noted that there is
nothing wrong with the measures taken up by the government of India to curb
inflation in India. The main problem is the implementation of these measures.
In practice there is no co-operation from the public and other financial
institutions especially in the unorganized sector. As a result all the efforts of the
RBI are nullified. Large scales smuggling, hoarding, black marketing, etc
continue to take place in the economy without any check. Further large scales
tax evasion and existence of black money and the working of the parallel
economy, etc., have also posed serious challenges to the effective
implementation of the policies of the government. On its part the government is
130
unable to brig down the size of deficit finance due to its commitment to the
welfare activities. Hence, the time has come to take a drastic decision in the
interest of economic stability to put an end to all the evils nd evil practices in
the economy.

THE PRICE MOVEMENTS IN INDIA SINCE INDEPENDENCE AND CAUSES
FOR RISE IN PRICE IN INDIA

Price movements in a country can be analyzed only when the wholesale price
index is available. In India, though this wholesale price index was computed
after independence, yet the price quotations were not complete as they did not
include all the commodities. Further the government had been changing the
base year frequently with an anxiety to prevent people from really comparing
the purchasing power over a period of time. Hence, in India the base year
originally was 1950-51, which was changed to 1960-61 and then to 1970-71
and finally to 1980-81.

Of course, now the wholesale price index is more comprehensive as it includes
almost all the commodities traded. We will discuss the price movements in four
phases: phase I : 1951 to 1971, Phase II : 1971-1980, Phase III : 1981-1990
Phase IV : l990s.

Phase I (1951-1971) :
In this phase, roughly we study price movements through the first three five
year plans and the annual plans. During the I Plan, the price movements were
very much less and the wholesale price index was 99 (base year 1952-53 =
100). As regards the food articles, the price index was hovering around 90
which indicated a very comfortable position during this Plan. But encouraged
by this trend, the government undertook various new projects by resorting to
deficit financing. The result of this was that during the II Plan the price level
went up by 20 per cent. The price position worsened during the III Plan as this
was the time when there was Chinese aggression and Pakistan invasion. As a
consequence the defence budget went up leading to soaring up of prices. For
instance, between 1961 and 1966, the prices of foodstuffs went up by 40 per
131
cent, the price of cereals was up by 45 per cent and in the case of pulses it went
up by 70 per cent. There was inflationary spiral. Fortunately in 1967-68, with
the sudden spurt in food production (Green Revolution), the price level came
down and in 1968-69, there was a marginal fall in prices by one percent.

Phase II (1971-1980) :

This is a very crucial period as far as Indian price situation is concerned. It was
during this period that India witnessed a very steep rise in price level. Though
the rate of increase in price level was very much less (around 5 to 7 per cent) in
the first three years of the III Plan, it soared up by 19 points in the fourth year
and by 47 points by the last year The reasons for this were: heavy influx of
refugees from Bangladesh and the expenses incurred on them, the failure of the
kharif crop in 1972-73, the failure of the take over of the wholesale trade in
wheat and the rise in crude oil price. For the first time in India, the wholesale
price index touched a peak of 331 in September, .1974. The government
initiated a number of measures like compulsory deposit scheme, nabbing of
black marketers, smugglers and hoarders invoking the provisions of the
Maintenance of Internal Security Act (MISA), etc., which together resulted in the
decline" in the price level. The wholesale price index stood at 309 by March,
1975 and then further dropped to 283 by March, 1976. Though immediately
after the pronouncement of-emergency the price level declined, it once again
started increasing at the September, 1974 level by March, 1977. After the
emergency period, the Janata government came to power and following various
policies it succeeded in arresting the price rise. It could maintain the price at
185 points applying the demand - supply management, higher buffer stock,
high foreign exchange reserve, increased food production as well as industrial
production. But the inflationary budget of 1979, contributed to the reversal of
trend in price that by January 1980, the wholesale price index stood at 234.

Phase III (1980-1990)

In January, 1980, the Congress (I) government came back to power and it kept
controlling inflation as the prime objective. The government tried to achieve this
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through demand and supply management. All the anti-inflationary policies were
brought in to contain inflation. The temporary price stability found by the end
of 70's did not continue as the inflationary spiral resulted in the alround
increase in prices. The whole sale price index increased from 218 in 1979-80 to
338 by 1984-85. The demand side adjustments announced by the government
included altering the cash reserve ratio of commercial banks, ceiling on lending
by commercial banks, ban on recruitment by government, reduction in the
money supply, etc. On the demand side, the government attempted to increase
the supply of goods and services using short term and long term measures.
With all these measures the annual increase in price was around 7 to 8 per
cent.

However during the later part of 80's, the situation did not continue to be the
same. The wholesale price index which came down to 125 by 1985-86 started
increasing and by 1989-90 it was around 166. The annual rate of inflation
which was just 4.7 per cent by 1985-86, shot up to 8.1 per cent by 1989-90.
The main reasons for this was the serious shortfall in the production of
essential agricultural goods like edible oils, cotton, pulses, etc. Government
resorted to tightening of selective credit control policies, and also used the
supply management side by side. Specifically, it used the buffer stock built up
over the previous years effectively and even imported edible oils, introduced
employment schemes, relief programs, etc.

Phase IV (po.st-1990) :

This phase was marked by hefty increase in price right from 1990. Several
reasons could be attributed to this viz.: high administered prices, gulf-
surcharge on petroleum products, high dose of deficit financing, high indirect
taxes, etc. The combined effect of all these was that the wholesale price index
stood at 180 by 1990-91 and increased to 229 by 1992-93. The annual rate of
inflation, however, came down from 12.1 per cent in 1990-91 to 13.6 per cent in
1991-92 and then to 9.9 in 1992-93. Having experienced a decline in price rise,
the government announced reduction of excise duties, customs duties, etc., in
1993-94 budget to achieve a further fall in price by 1993-94.
133

DEMAND-PULL FACTORS THAT CAUSED INFLATION IN INDIA.
The demand-pull factors which caused inflation in India are : Demand-pull
factors:

The demand-pull factors are responsible for increase in price, because, when
the demand for goods and services increase at a higher rate than the rate at
which the supply of these goods and services increase, there will be shortage
which results in price rise. Under demand-pull factors we may mention the
following factors to be very important:

a) Heavy government expenditure :
The administrative expenditure of the Central and State governments increase
from a mere Rs. 740 crores in 1950-51 to nearly Rs. 2 lakhs by 1991-92. Added
to this was the increase in; government investment on several welfare schemes
and programs from Rs. 1000 crores in 1950 to Rs. 50000 crores by 1990. Apart
from the plan expenditure, the non-plan expenditure of the government
increased at a greater speed. With higher government expenditure, more money
entered into circulation of the economy which fuelled inflation.

b) Deficit financing:

Deficit financing-is one basic reason for the drag in our development and the
inflation prevailing in the economy. The justification that in the initial stage of
development every country is bound to have deficit financing is no longer
reasonable in Indian case, as the time has come that our Five year plans should
lead us to generate more resources from other sources instead of depending too
much on deficit financing. The amount of deficit financing has increased from
Rs. 330 crores during the I Five year plan to a huge amount of Rs. 20,000
crores during the VIII plan. This implies that our planners have started using
deficit financing as the main source of funds for meeting our plan expenditure.
It should be noticed, that over the five year plan period since I plan there has
been an increasing reliance on deficit financing that the peak is found during
the VII Plan. With consistent efforts, the planners are hoping to bring down this
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quantum of deficit financing to around Rs. 20,000 crores during the VIII Plan.
Whether this is going to be achieved or not can be found out only in future.

c) Existence of black money :

One of the reasons for the existence of too much money supply in the economy
is the circulation of black money in -the economy in very large quantity. There
is no reliable estimate of the extent of black money in circulation in India.
According to one estimate the quantum is about the same size as that of the
legal tender money. The large scale tax evasion, tax avoidance, black marketing,
hoarding, corruption, buying and selling of real estate in the urban centers,
etc., are the reasons for the existence of black money. While the source of this
type of money cannot be easily found out, it is very difficult to bring to book
those who are indulging in such illegal activity. With uncontrollable volume of
black money in circulation, the price level continues to rise, and any measure to
control the price will not be effective. So inflation will continue to remain in the
economy.

d) Population explosion :

Ever since independence the growth of population has eaten away all the fruits
of development. With the annual rate of population increase hovering above 2
per cent, the scarcity for foodstuffs and essential commodities will persist. As a
result the prices continue to spiral up inspite of efforts to check the price level.
Basically the size of population will work on (he demand forces and so the
available quantity of output is proved to be inadequate always. As a result the
prices continue to soar.


THE COST-PUSH FACTORS CAUSED INFLATION IN INDIA.

There are factors which act on the cost of production. These factors push the
cost upwards and once the cost of production is high, the producers and
manufacturers have to raise the price to recover the cost of production. As a
135
result the price level will go up. There are several reasons for the operation of
the cost-push factors. They are:

a. Erratic fluctuations in the supply of goods

In Indian situation, as agriculture is a gamble with the monsoon, die food
production depends on the successful monsoon. Except a few years, there had
been failure of monsoon. The shortage in agricultural output affects the supply
of not only the food grains but also the raw materials to agro-based industries.
Added to this are the power shortage, fuel shortage, labour problems, strikes
and lockouts, transport bottlenecks, etc., The end result is that both the
agriculturists and the industrialists experience rise in cost of production. They
recover this by fixing a higher price for the finished product The position is
worsened by the operations of the black marketers, smugglers, hoarderers,
middlemen and others.

b. Imposition of heavy taxes

Taxation in India is itself a reason for the inflationary situation. There has been
all-round heavy taxation on individuals, corporate bodies as well as
commodities. With higher taxes, the cost of production only increases leading to
rise in price. Whenever a fresh tax is imposed, the manufacturers simply pass
this on to the consumers by raising the price more than the amount of tax.
Added to this is the heavy allocation of funds by the government to public
sector which added a precious little to the coffers of the government.
Considering the investment in the public sector units, the return from them is
meager that even the available funds are fritter away that the government
simply imposes new levies to augment funds. This in turn affects the cost and
the price.

c. Administered prices

In a socialist economy like ours, the market forces are intervened by the
government in terms of administered price policy. As per this policy the
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government stipulates the minimum price for most of the essential commodities
and raw materials. For example the railways have been revising their freight
rate and passenger fare that the cost of transportation is going up adding
significantly to the cost of production and in turn the price level. In the case of
steel, cement, coal, etc., the government fixes a higher price which inflates the
cost of production in almost every sector indirectly contributing to the
inflationary spiral.

d. Rising oil price

The heavy import bill on petroleum crude itself makes a significant addition to
our price level. The international price has been going up and to meet the
import commitment, the government raises the internal price of petrol, diesel
and petroleum products. One argument given for the stiff rise in the price of
these products is that it would discourage the consumption of these products.
But the increasing sale of two wheelers, three wheelers, cars, trucks and Lorries
prove that there has infact been an increasing demand for oil. Further the
major consumer of oil is government. As a result the overall rise in price cannot
be controlled with any measure. Any change in international oil price
immediately affects the domestic price of oil. For instance in 1980 alone, the oil
price went up by 130 per cent in the international market followed suit by the
domestic price. The gulf surcharge which was imposed also caused the rise in
price of petroleum products. On the whole the fuel price adds fuel to fire.

METHODS OF CONTROLLING INFLATION

Inflation has to be controlled, otherwise the extent of damage done to the
economy will be something substantial and the economy would take a long time
to recover from the effects of inflation. In this direction of control of inflation,
the following are the theoretical measures available. These measures could be
classified into three groups viz., 1. Monetary measures, 2. Fiscal measures and
3. Other measures.

I. MONETARY MEASURES :
137

Monetary measures are steps taken by the Central bank of a country as the
head of the monetary system. These measures are usually refereed to as the,
quantitative credit controls and qualitative credit controls. The former include
bank rate, open market operations and the variable reserve ratio. The, latter
include margin requirements, moral suasion, direct action, control through
directives, Consumer credit regulation or rationing, publicity, etc.
a) Quantitative credit controls : Bank rate is the first, measure to curb
credit creation activity of the commercial banks, as during inflationary
period the volume of money supply has to be reduced. Bank rate is the
rate at which the central bank of a country re-discounts the bills already
discounted by the commercial banks. When the central bank wants to
control credit creation by commercial banks, it would simply increase the
bank rate. Correspondingly the commercial banks would increase the
discount rate which acts as a disincentive for the businessmen and
others to approach the commercial banks for discounting their bills.
However, the success of this policy depends on the co-operation of the
commercial banks. Open market operations are another quantitative
credit control measure. In this, the central bank would buy or sell
securities in the open market which are sold or purchased by the
commercial banks for cash. During inflationary situation, the central
bank would sell securities;

in the open market, and when the commercial
banks purchase them, for cash then capacity of the commercial banks to
create credit will be very much restricted With less credit created, the
money supply in the economy will come down bringing down the
pressure of inflation. The third: policy is variable cash reserve ration. As
per statute, every commercial bank should maintain a certain percentage
of its total deposits in terms of cash reserve with the central bank. The
percentage of reserve to be maintained, called as cash reserve ratio, is
determined by the central bank. By increasing the cash reserve
requirement, the central bank can reduce the cash available with the
commercial hanks thereby controlling their capacity to create credit.

138
b) Qualitative credit controls : Qualitative credit-controls aim at
channelising the available funds in the most productive uses or
applications. In terms of various measures the central bank can govern
the credit policies of the commercial banks. The first of these control
measures is the margin requirements. According to this policy, the
central bank specifies the amount of margin that each commercial bank
should maintain while lending on securities to the common public. By
increasing the margin requirements, the central bank can discourage
borrowings on certain securities. If the central bank wants to help the
priority sector it can accordingly instruct the commercial banks to
maintain a lower margin on securities offered for borrowing for priority
purposes. Moral suasion refers to the persuasive technique adopted by
the central bank with; the commercial banks in making the later
understand the need to pursue a particular type of credit control policy.
Though the central bank is empowered with statutory powers to regulate
the commercial banks, yet the central bank believes persuasive policies
rather than using its statutory authority. Central bank can also issue
directives to the commercial banks outlining the details of the objectives
of the various credit control policies, the need to follow them, the
expected result of them, etc. This will help the commercial banks to
understand and co-operate with the central bank in times of financial
crisis. Central bank also regulates the flow of credit towards consumer
requirements. This called as regulation of consumer credit The central
bank can even specify the types of consumer credit which could be
encouraged and those that could be discouraged. On receipt of directions
from the central bank, the commercial bank act accordingly, either by
liberalizing consumer credit or restricting consumer credit. Direct action
may also be taken by the central bank to control the commercial banks.
This can range between issuing warning to cancellation of license. But in
practice central bank never resorts to this measure as all the commercial
banks invariably follow the policies of the central bank.


2. FISCAL MEASURES
139

By fiscal measures we refer to the steps taken by the head of the fiscal system
viz., the government. The fiscal measures include .
a) government expenditure b) taxation c) public borrowing and d) debt
management e) Over valuation of currency.

a) Government expenditure : This is also known as public expenditure. It
is well known that in a socialist country like India, the government undertakes
several activities ranging from defence to welfare activities. All these mean that
government pumps in a lot of money into the economy which ultimately adds to
the money supply and fuel inflation. During the period of inflation, the money
supply is high, the purchasing power of the people is also high and so the
private consumption and investment expenditures will be of the high order. If
the government also continues to invest heavily then the inflationary spiral will
be worsening. To avoid this the government should slowly reduce its
expenditure during inflation so that at least to that extent, the money supply in
the economy will be reduced. But in practice such a policy is not at all possible
as with ever rising prices, the poor and downtrodden needs protection from the
inflation and this will be lost if the government reduces its expenditure.
However, this is considered as one of the measures to control inflation by
combining it with the other measures.

b) Taxation: Taxation is a well conceived measure against inflation. Under
this the government will be able to achieve two purposes at the same time.
Firstly, it will be able to augment the revenue of the government and secondly it
will be able to curb unwanted consumption expenditure of the people by
bringing down their purchasing power and disposable income. During inflation
the government should increase the taxes so that it can achieve both the
purposes mentioned above. Further the government can also design its tax
policy in such a way that the lax burden is more on the rich and less on the
poor. This is achieved by imposing heavy direct taxes which will directly affect
the rich people. By imposing moderate indirect taxes, the government will be
able to collect more from those who spend more. The rich as well as poor will be
contributing towards the exchequer. However, it is often said that imposition of
140
indirect taxes will only add to the increase in prices, especially when the
producers shift the burden of tax to the consumers. But the object of indirect
taxes is to curb the consumption of unwanted commodities. Hence, with the
direct and indirect axes, the government should be in a position to redistribute
the income in the economy which is a must during inflationary period.

c) Public borrowing : Public borrowing or public debt is one more method
of controlling inflation. According to this policy, the government aims at
siphoning-off the excess purchasing power in the economy by encouraging
people to lead to the government. This can be done either making lending
voluntary or compulsory. Under the voluntary lending, the government
educates the people of the need to lend to the government especially during the
inflationary period. However, sometimes compulsory lending is to be resorted to
because, the people may not respond to the calls of the government.
Compulsory lending can be i different forms. But it is often said that such
compulsory lending will affect only the salaried class and not the rich people. In
that case, the salaried class is worst affected during inflation and making them
to surrender whatever little surplus that they have with them amounts to
double taxing them. Further compulsory saving or lending may also encourage
people to find ways of evading Such policies. In general, economists have
favored only the voluntary saving or lending by the public.

d) Debt management : Debt management refers to the way in which the ,
government deals with the retirement or repayment of the public debt. This has
to be done in such a way that brings down the money supply in the economy.
So when there is inflation, the government should retire or refund the debt to
the commercial banks by encashing the securities only out of the budget
surplus. This will help to curb the commercial banks' ability to create credit.
But a major problem with this policy is that during inflation budgetary surplus
is not so easily created. Alternatively, the central bank can retire the debt by
sales of bank ineligible bonds to non-bank investors like insurance companies,
savings bank individuals, etc. This will take away the spend-able money from
the public thereby reducing the inflationary pressure. But even this method
141
can fail as the non-bank investors can always refuse to exchange the spend-
able money for these bonds.

e) Overvaluation of currency : This is another method used to control
inflationary pressure in an economy. According to this method, the value of the
currency is revised upwards so that exports will be costlier and imports
cheaper. This will help in increasing the stock of domestically produced gods
and encourage more imports. This will mean the availability of goods int he
country will increase [hereby the price level of them will have to come down. But
this measure has to be cautiously adopted as it carries with it seeds of
deflation.

3. OTHER MEASURES :

Apart from the measures discussed above, the government can also implement
the following policies :

a) Increase output : This policy may appear to be very easy one but in
practice this involves several difficulties. To make the producers increase their
output, they should be assured of their profit as otherwise they will not be
inclined to increase the output. Further the increase in output can be brought
about by fuller utilization of the existing resources, prevention and settlement of
industrial disputes, updating the technology, lending liberally to expansion and
new establishment purposes of the industry, maintaining industrial peace by
activating all the machineries of settlement of industrial disputes, etc. Mere
increase in output will not bring down the inflation, it has to be followed by
increased availability of products for the consumers. This calls for curbing and
punishing black marketing, hoarding and smuggling activities so that the
benefits of increased production will be enjoyed by the economy.

b) Wage policy : This is another important control measure. This is often
misunderstood as wage freeze policy. This means that the government should
not stand in the wage increase sanctioned to the employees if their productivity
is very high. The government can encourage the employees to make
142
voluntary contributions and reduce their expenditure. Simultaneously,
through other measures, the government should bring down the cost of living so
that the laborers will not demand higher wages. Wage policy cannot be effective
unless it is coupled with several other policies.

c) Price controls and rationing: This is one of the most popular policies
applied in every country while they face inflation. Under this measure, the
government should prevent escalation in prices of essential commodities and
control the price of other commodities. By resorting to retail and wholesale price
maintenance policies the government can strive to bring down the price level.
This calls for buffer stock operations as well as efficient demand and supply
management of commodities which the country is badly in need of. This is
achieved by introducing rationing of essential commodities through well
designed public distribution mechanism. All this mean, enormous efforts are
required on the part of the government apart from the willing co-operation from
the traders and businessmen. In practice it is found that price control and
rationing are very difficult to be implemented during inflationary period due to
the exploitative and monopolistic attitude of the businessmen and traders.
However, with stringent penal measures the government can make this policy
effective in controlling inflation in a country.

143
Review questions
1. Assess the need for government intervention in an economy.
2. Discuss the role of public sector in India
3. Comment whether India is an under developed country
4. Discuss the features of Indian population
5. Examine the nature of population problem in India and the effects of
population growth on Indian economic development
6. Outline the population policy of the government since independence
7. Analyse the Balance of payments position since 1991 and critically
evaluate the New export-import policy 1992-1997.
8. Discuss the structural composition of national income in India. Explain
the limitations of National income estimation in India.
9. Distinguish between absolute and relative poverty. Discuss the concept
of Poverty line in Indian context. What are the causes for poverty in India
and evaluate the various poverty eradication programme.
10. Analyse Problem of unemployment in India.
11. Discuss the problem of rural unemployment and the measures to solve
this problem.
12. Examine the inflationary trend in India and discuss the steps taken by
the government to control inflation in India.
13. Discuss the causes for inflation in India and suggest measures to arrest
inflation.

144
CHAPTER III

Government controls and regulations - Regulating economic and industrial
activities- Industrial Licensing policy- Control of monopolies - Capital issues
control - Government control over FDI and collaboration - Distribution and price
control - New EXIM policy - Foreign exchange flow regulation -Technology transfer

GOVERNMENT CONTROLS AND REGULATIONS

Since independence, Government of India introduced a number of controls and
regulations so as to lead the country on the path of progress. Originally these
controls and regulations were considered to be a part of development strategy.
But subsequently, they emerged as the need of the society. While the 1948
Industrial policy resolution did not lay much emphasis on the controls and
regulations, in 1951 the government brought in the Industrial [Development
and Regulations] Act. This Act made licensing a part of industrial development.
The objectives of licensing were stated as:
Facilitate desired pattern of industrial development
Provide for development of backward regions
To encourage broad based ownership of industries
To prevent concentration of power in the hands of a few
To offer protective environment for the small scale industries
To regulate inflow of foreign capital and technology
To provide for the use of appropriate technology
To eliminate industrial pollution
To encourage more of exports and adopt import substitution
measures
To ensure conservation of foreign exchange resources and to ensure
proper allocation of the exchange resources
To achieve high growth in employment opportunities

With the above objectives, the government passed the Act. Consequent to this
Act, the following categories of industries were required to obtain license:
145

New undertaking
Manufacture of new article
Expansion of existing capacity substantially
Continuation of certain category of business in certain areas
Changing the location of the industry

This licensing policy continued for a long time till 1991 Industrial policy
adopted the policy of liberalization. The licensing policy has resulted in a
number of malpractices among the large industrial houses. This was brought to
light by the Dutt Committee report in 1967 The revelations of the Dutt
committee led to the enactment of Monopolies and Restrictive Trade Practices
Act in 1970. In 1991, the government changed the contents of the Licensing
policy and the important provisions are spelt out hereunder.

The Dutt committee identified 20 larger industrial houses, 53 large industrial.
houses and 60 large independent concerns through its study. Some of the
important findings of the Committee are given below:
1. a] 73 large houses accounted for 56 % of the total proposed
investment on machinery by the entire private corporate sector
b] 60% of the value of import of capital goods by the entire private
corporate sector was accounted for by these 73 large industrial houses
c] 20 larger industrial houses accounted for 41 % in the total
proposed investment on machinery and for 40 % in the total approved
import of capital goods.

2. The percentage of unimplemented issued licenses was the highest for
the large independent companies and other foreign companies. The
largest number of unimplemented licenses was for the house of Birlas
[168] followed by Tatas [41J. The Birlas were also leading on charges of
preemption.

3. The private sector was allowed to participate in areas reserved
exclusively for the public sector,
146

4. The four industrially advanced states namely Maharashtra, West
Bengal, Gujarat and Tamilandu were able to acquire 62 % of the J0tal
licenses issued. This was against the spirit of balanced regional
development.

5. There was no indication as to which industries could be treated as
specifically reserved for the small and medium sector.

6. Foreign collaboration was allowed even in non-essential consumer
goods. The Committee observed that: as a matter of fact, by permitting
foreign collaborations sometimes in multiple numbers, and thus
permitting capacities to be created, an inevitable demand for import of
various components and raw materials for feeding plants is set up.
This, combined with the allocation of other scarce materials, helps to
satisfy the demand of the higher income groups, but it is not
necessarily a contribution to economic growth nor is it the best way of
utilizing the scarce foreign exchange resources of the country.

7. Financial institutions showed a distinct preference to the large
industrial houses over the public sector.

All these would help to judge that industrial licensing system failed to achieve
the objectives of planned economic development as well as of preventing
concentration of economic power.
The Dutt committee made the following recommendations
To set up a core sector consisting of industries of basic, critical and
strategic importance to the economy
To adopt the concept of Joint Sector or undertakings where both the
public and private sectors acted as partners in a project. The Joint Sector
could have collaborations with foreign concerns as well as with the
private sector in India
To change the basis of financial assistance by nationalized banks and
147
public sector financial institutions i.e., away from the large industrial
houses
The government to have the right to convert its loans and debentures
into equity
The middle sector to be kept open for new entrepreneurs

INDUSTRIAL LICENSING POLICY

To achieve the objectives of the strategy of the industrial sector in the 90s a
number of changes in the system of industrial approvals have been brought
about. The domestic producers will be able to withstand the competition in the
country as well as abroad only through procedural reforms. Hence, the role of
government will be changed from that of exercising control to one of providing
help and guidance. Changes in the policy towards public sector in the last few
years have clearly indicated that private sector enterprises will be allowed to
compete in many areas hitherto earmarked for public sector. Consequently, the
new policy has completely reclassified the Indian industries as below:

a) Eight industries have been completely reserved for the public sector.
They are: i. Arms and ammunition and allied items of defence
equipment, defence aircraft and warships, ii. atomic energy, iii. coal and
lignite, iv. mineral oils, v. mining of iron ore, manganese ore, chrome
ore, gypsum, sulphur, gold and diamond, vi. mining of copper, lead,
zinc, tin, molybdenum and wolfram, vii. mineral specified in Schedule to
the Atomic Energy Order, 1953 and viii. railway transport

b) Eighteen industries have been listed as industries which require
compulsory licensing. However, this provision would not apply in
respect of the small scale units taking up the manufacture of any of the
items reserved for exclusive manufacturing in small scale sector.
Compulsory licensing would be required in the following industries:

i. coal and lignite, ii. petroleum other than crude and its distillation
products, iii. distillation and brewing of alcoholic drinks, iv. sugar, v.
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animal fats and oils, vi., cigars and cigarettes of tobacco and
manufactured tobacco substitutes, vii. asbestos and asbestos based
products, viii. plywood, decorative veneers and other wood based
products such as particle board, medium density fibre board, block
board, ix. raw" hides and skins, leather, chamois leather and patent
leather, x. tanned or dressed fur skins, xi. motor cars, xii. paper and
newsprint except bagasse based units, xiii. electronic aerospace and
defence equipment of all types, xiv. industrial explosives, xv. hazardous
chemicals, xvi. drugs and pharmaceutical xvii. entertainment
electronics and xviii. white goods like domestic refrigerators.

As regards the provisions of the industrial licensing policy,

i) Industrial licensing has been completely abolished for all projects except
for the industries classified above, i.e., the area reserved for public sector
,and the list of 18 industries and the areas reserved for small scale
industries will continue.

ii) Public sector will continue to maintain monopoly in industries coming
under the areas of security and strategic considerations.

iii) In projects where imported capital goods are required, automatic
clearance will be given provided the foreign exchange availability is
ensured through foreign equity. Or alternatively if the value of imported
goods does 1101 exceed 25% of the total value of plant and equipment
subject to the ceiling of Rs. 2 crores, automatic clearance will be given.
However, this would come into effect only from April, 1992 in view of the
current balance of payments position. In all the other cases, the prior
approval and clearance from the Secretariat of Industrial approvals in the
Department of Industrial development will be required.

iv) Except the list of industries requiring compulsory licensing, the other
industries will not require any approval from the Central government for
their location in ares other than cities of more than one million
149
population. In cities with more than one million population, non-
polluting industries like electronics, computer software and printing will
be permitted outside 25 kms. of the periphery. If such cities require
industrial re-generation policies will be made more flexible. However, the
existing zoning and land use regulation and environmental legislation
will continue to regulate industrial locations. All efforts will be made
through incentives and other methods like infrastructural development,
to disperse the industry to rural and backward areas.

v) New Broad banding facility will be provided to the existing units so as to
enable them to produce any article without additional investment. The
exemption from licensing will be applicable to all substantial expansion
of existing units.

vi) The mandatory convertibility clause will no longer be applicable for term
loans from the financial institutions for new projects.

vii) A very significant step is to abolish all the existing registration schemes.

viii) In case of substantial expansions and new projects, it is enough if the
entrepreneurs file the information memorandum.

ix) The list of industries requiring compulsory licensing and industries for
automatic approval of foreign technology agreements will be notified in
the Indian Trade Classification (Harmonized system).


As a result of the wide changes in the Licensing policy, the government also
brought about changes in the MRTP Act. The following is the summary of the
changes effected in that Act.

MRTP ACT

150
A major deviant of the new policy is in respect of the MRTP Act. The new policy
aim at removing the unnecessary bureaucratic controls and allow the industries
to breathe in an atmosphere of freedom. The efforts of the government in the
past intervening in the investment decisions of the MRTP companies; have been
proved to be counter-productive. Hence, the newly empowered MRTP
Commission will enquire into complaints received from individual consumers or
classes of consumers. The following is the essence of the provisions in the new
policy regarding MRTP Act.

i. The limits of assets in respect of the MRTP companies and dominant
undertakings have been removed and suitable amendment in the
MRTP Act will be made in due course.

ii. The need to obtain the prior approval of the central government for
establishing new units, expansion of existing units, merger,
amalgamation and take over as well as appointment of Directors have
all been removed.

iii. The MRTP Act will be used only for controlling and regulating
monopolistic, restrictive and unfair tarde practices. As a follow-up the
MRTP Commission will be authorized to inquire suo moto or
complaints lodged by individual consumers or classes of consumers
regarding monopolistic, restrictive and unfair trade practices.

iv. All the necessary amendments will be made in the MRTP Act to give
more punitive and compensatory powers to the MRTP Commission.

Control of capital issues

Since independence, capital issues in India have gone through different types of
control mechanism. Initially control of Stock exchanges was contemplated and
accordingly Securities Contracts [Regulation] Act was passed in 1956. It aimed
at centralization of control, regulation of the stock exchanges and the
transactions entered therein, the avoidance of illegitimate and manipulative
151
speculation and the protection of genuine investors, The Act applied to all
transactions whether forward or ready and it prohibited or regulated factors,
which facilitated speculation in stock exchanges. But the Act could not abolish
forward trading which ultimately caused erratic behaviour of the Stock
exchange. The government basically depended on two institutions to control the
capital market viz., the Controller of Capital Issues [CCI] and the Directorate of
Stock Exchanges. CCI gave consent to the issue of non-government companies
consisting of equity and preference shares, partly and fully convertible
debentures, bonus shares and right shares. It also gave consent to the issue of
bonds of public sector undertakings. But on the recommendations of the
Narasimham committee, the government abolished the office of CCI and freed
the primary capitol market from the government regulations.

The recommendations of Narasimham Committee II on financial sector
reforms

The main recommendations of the Narasimham committee are:

1. Phased reduction of Statutory Liquidity Ratio to 25 % over a period of
five years
2. Progressive reduction in Cash Reserve Ratio
3. Phasing out of directed credit programs and redefinition of the priority
sector.
4. Deregulation of interest rates so as to reflect emerging market
conditions
5. Stipulation of minimum capital adequacy ratio of 4% to risk weighted
assets by March 1993, 8% by March 1996 and 8% by those banks
having international operations by March, 1994.
6. Adoption of uniform accounting practices in regard to income
recognition, asset classification and provisioning against bad and
doubtful debts.
7. Imparting transparency to bank balance sheets and making full
disclosures
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8. Setting up of special tribunals to speed up the process of recovery of
loans
9. Setting up of Asset Reconstruction Fund to lake over from banks a
portion of their bad and doubtful advances at a discount
10. Restructuring of the Banking system so as to have three or four large
banks which could become international in character, 8 to 10 national
banks and local banks confined to specific regions and rural banks
including RRBs confining to rural areas.
11. Setting up one or more rural banking subsidiaries by public sector
banks
12. Permitting RRBs to engage in all types of Banking business
13. Abolition of branch licensing
14. Liberalising the policy with regard to allowing foreign banks to open
offices in India
15. Rationalisation of foreign operations of Indian banks
16. Giving freedom to individual banks to recruit officers
17. Inspection by supervisory authorities based essentially on the internal
audit and inspection reports
18. Ending duality of control over Banking system by Banking division and
RBI
19. A separate authority for supervision of banks and financial institutions
which would be a semi-autonomous body under RBI
20. A revised procedure for selection of Chief Executives and Directors on
Boards of Public Sector banks
21. Segregation of direct lending functions of IDBI to a separate institution
22. Obtaining resources from the market on competitive terms by DFIS
23. Speedy liberalization of capital market by removing restrictions on
premia dispensing with prior government approval etc.
24. Supervision of merchant banks, mutual funds, leasing companies, etc.,
by separate agency to be set up by RBI and enactment of separate
legislation providing appropriate framework for mutual funds and
laying down prudential norms for such institutions.

153
After the abolition of CCI, the government set up the Securities and Exchange
Board of India [SEBI] in 1988 which became a statutory body since 1992. SEBI
has the following objectives:
Regulating the business in stock markets and other securities market
Registering and regulating the working of the stock brokers, sub-
brokers, share transfer agents, bankers to an issue, trustees of trust
deeds, registrars to an issue, merchant bankers, bankers to an issue,
trustees of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers and other intermediaries associated
with the securities market
Registering and regulating the working of collective investment
schemes including mutual funds
Promoting and regulating the self regulatory organizations
Prohibiting fraudulent and unfair trade practices relating to securities
market
Promoting investors education and training of intermediaries of
Securities market
Prohibiting inside trading in Securities
Regulating substantial acquisition of shares and take over of
companies
Performing such functions and exercising such powers under the
provisions of Capital Issues [Control] Act, 1947, and Securities
Contract [Regulation] Act, 1956, as may be delegated to it by the
Central government

Since its inception, SEBI has achieved the following: guidelines to suing
companies, regulation of portfolio management services, regulation of mutual
funds, action for delays in transfers and refunds, action for delays in transfers
and refunds, issue of guidelines to protect investors, ensuring proper
functioning of the Stock exchanges, regulation of foreign institutional investors
and periodical review of the working of the capital market.

FOREIGN CAPITAL AND THE POLICY OF GOVERNMENT REGARDING THE
USE OF FOREIGN CAPITAL
154

Foreign capital or investment has become significant part of sources of funding
for various projects in every country. This source of funding has received the
attention of both the government as well as the corporate sector that there has
been increasing reliance on this source for planning and execution of projects
by the government as well as the corporate sector. Foreign capital can come into
a country in different forms. Let us first understand these forms of foreign
capital before discussing the need for foreign capital.

Forms of foreign capital:

(a) Direct entrepreneurial investment: In this form of foreign capital, the
foreign investors can start a company abroad mainly for the purpose of
establishing its branches and subsidiaries in other countries. For
instance an American business group may invest in a new project in
India directly and start its own affiliate or branch or even a subsidiary.
Sometimes, the investors abroad may participate in the stocks or share
capital of Indian companies. Whenever the Indian companies go for
public issue of shares or debentures, the foreign investors may respond
by participating in such public issue. This is also called foreign capital.
In the past external business group used to invest in new companies
and that form of foreign capital used to flow much, but now-a-days
participation in the equity or debenture of companies by foreign
investors and non-resident Indians is becoming more predominant.

(b) Foreign collaboration: Foreign collaboration is another form of foreign
capital. Under this a domestic company may join with the foreign
company, mostly the reputed one in the industry, and start with the
joint operation in India. Usually this type of effort is undertaken to get
the state of the art
1
or the latest technology available abroad in the
Indian companies. Foreign collaboration may be only for technology or
for funding or both. Accordingly we may have technical collaboration,
financial collaboration or mixed collaboration. The collaboration may be
between private parties or companies in the two countries, or the
155
foreign company with Indian Government or between the foreign
government and the Indian government.

(c) Inter-government loans: This type of foreign capital refers to the loans
granted by the government of one country to that of the other for a
specific purpose or for general economic reconstruction. For example
under the Marshall plan, USA gave loans to various European
governments to help them in the reconstruction of their war-shattered
economies. The developed countries also grant loans and grants to the
under developed countries to help them in economic development
programme.

(d) Loans from international institutions: This source of foreign capital has
emerged as a very important source in the recent years. Most of the
developing countries get sizeable quantum of funds from this source.
International institutions like International Monetary Fund (IMF),
International Bank for Reconstruction and Development (IBRD), Asian
Development Bank, Aid India Consortium, and others have all become
very important providers of funds for developing countries. The role of
IMF and IBRD in tiding over the balance of payment difficulties and
execution of power and irrigation projects, cannot be exaggerated. The
Asian Development, Bank has also been a major provider of funds for
development in Indian case.

(e) External commercial borrowing: Another source of foreign capital is the
borrowing in the capital market of other countries. This can be done
either directly or indirectly by the government. In both ways, the inter-
government understanding and political relationship apart from the
domestic investment climate are all important. Such capital is normally
used for international trade purposes and specifically for export credits.
Agencies like US EXIM bank, Japanese EXIM bank, ECGC of UK, etc.,
are all playing vital role in this segment of foreign capital.

Need for foreign capital:
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No country can be self-sufficient today. Even developed countries have to
depend on the developing countries for certain purposes and also for marketing
their products. Further the specialisation in finance has become world wide,
that every investor wants to maximise return on his investments and minimize
the risk. This is applicable both to government investment as well as corporate
and private investments. These are days of multi-national corporations and
giants that closed economic system can no longer be realistic. In this situation,
flow of capital from one country to another in different forms takes place for
several reasons. From the view point of a country, there is a need to execute
their plans for economic development. Specifically in Indian case, the need for
foreign capital cannot be exaggerated. This could be explained in terms of the
points given below:


(a) The availability of funds for execution of plans and achieve rapid
economic development determine the objective of such plans. Domestic
availability of funds, especially in the developing countries is becoming
difficult with the government in these countries undertaking increasing
responsibility for the welfare activities. Hence, these countries have to
tap the source lying outside to get the funds required for their
development purposes. In this respect the foreign capital should be
attracted at any cost and in any form.

(b) Domestic investors and managers of funds available, may not have the
required expertise or entrepreneurship in identifying the right and
profitable avenues for investment. This may be due to lack of
experience or inability to identify opportunities. When foreign capital is
allowed to flow, the benefits of the experience of the foreign
technicians, finance specialists, production specialists, marketing
wizards, etc., are made available to the domestic ventures. This will
improve the efficiency of the domestic projects which is directly
benefitting the country. On this count foreign capital should be
welcomed.
157

(c) One of the basic requirements for achieving rapid economic
development is mobilising savings. Savings depend upon income and
income depends on the level of economic activity. Hence, any attempt
to increase savings should start with attempts for increasing income
which necessitates increasing investment If the domestic rate of
savings and the purpose for which savings is used is unproductive,
then efforts should be made to obtain the necessary investment from
abroad. This would accelerate economic development leading to income
generation and increased savings. Hence, in the process of economic
development foreign capital becomes an essential ingredient.

(d) Foreign capital is necessary for one more reason. In every developing
country, the economic development requires investment in certain
projects relating to infrastructural development, basic industries, etc.,
which are long gestation projects, low income yielding, but accelerating
economic development. No private investment or corporate investment
in these projects will come about in the early stage of development
either because the investors have no inclination or because the capital
market in such a situation is not developed. But the government has
to initiate development activities, for which foreign capital becomes
essential. Once the economic engine is activated, in due course, the
economic development will start taking place. Until then foreign capital
is needed.

(e) Foreign capital can be in different forms as has been already explained.
Countries like India having high rate of savings, but low investment in
productive projects, with large human force but with less employment
opportunities, have to seek technical know-how and technology
available abroad. These can be slightly modified to suit the domestic
conditions so that the production can take place in large scale, cost
can be minimized and employment opportunities can be generated in
large scale. Further there are areas like atomic energy, automobile
industry, management, marketing and others where we do not have
158
the best of experts or expertise. The best available talent or technology
available abroad can be imported so that we can improve our strength
in these areas and become a force to reckon with. This will also help us
to achieve higher level of economic development.

(f) One of the methods of achieving higher levels of development is
through mutual co-operation with other countries through bi-lateral or
multi-lateral agreements which provide excellent scope for transfer of
technology, etc., between countries. Political wisdom warrants use of
such agreements for mutual benefits which leads to flow of foreign
capital from one country to another.

Problems of foreign capital:

So far we have discussed the need for and role of foreign capital in Indian
economic development. Let us now study the problems that are associated with
the foreign capital.

1. The foreign investors are choosy in extending their funds to projects
floated in our country. It is found that foreign capital flows easily
towards the private sector projects but with a lot of hesitation to the
projects of public sector. While there is justification for hesitant flow
towards public sector, our government has been giving pride of place
only to pubic sector in achieving rapid economic development Hence, it
is clear that there is no lack of investment opportunities, but there is
difference in ideology. Therefore, flow of foreign capital is not uniform to
all sectors. This trend has to be observed so that corrective measures
can be taken to attract more foreign capital to public sector projects.

2. Another serious problem of foreign capital is the domestic technology is
simply duplicated due to over indulgence and dependence on external
assistance. There are several areas where India has achieved excellence
as in electronics industry, but there are collaborations with foreign
159
products in this field. Such duplication is in no way beneficial to the
country. This has to be corrected.

3. One more experience is that under the pretext cf transferring
technology, foreign countries simply Jump their obsolete technology in
India. Apart from importing inappropriate technology, there are also
situations when the technology not required is imported. Further, there
are tie-up agreements with such imported technology which are
unfavourable to India. But such agreements have been approved much
against the interest of our domestic manufacturers and technologists.

4. Often me complaint about foreign capital is the restrictive conditions
imposed by the exporting country. It may be relate to spares or
technicians or repatriation of profits, etc. An increasing number of such
agreements would only be against our own interest

5. Heavy remittance of profits, dividends, etc., is yet another problem
under foreign capital. In Indian experience, there were cases when the
inflow of foreign capital was less than the remittance of profits, the
classic examples being ESSO and CALTEX, the two oil companies of US
origin. Such remittances cause severe strain on our already strained
balance of payments and foreign exchange reserve position. Even if the
agreement provides for such remittances, the country cannot afford to
lose the hard earned foreign exchange resources under this type of
remittances.

6. One more consequence of foreign capital is that it causes serious
balance of payments problem. When foreign capital in different forms is
permitted, with the preference of the foreign investors, the private sector
is able to attract more than the public sector. As a result the private
sector indulges in importing heavily their requirements which results in
heavy outflow of earned exchange reserves on the one hand and leads to
balance of payments deficits on the other. Even if the government has to
ultimately approve of such imports, yet the private sector is able to
160
appease the officials through liaison officers and get the necessary
approvals.

7. One of the essential conditions laid by the government while approving
the foreign collaboration is that in due course there should be
Indianisation of personnel. This policy is easily defeated in practice. In
the past under the provisions of Foreign Exchange Regulations Act,
every foreign multinational company is made to dilute their ownership
to 74% and in case of branches of foreign companies their total holding
should not exceed 40%. It is found that these foreign companies have
very high profitability, as in the case of Colgate Palmolive with 89% of
profit rate, are able to very easily raise capital from the Indian capital
market. Their shares are being quoted at very high rate that they raise
the necessary funds easily. The shareholders of these companies
indirectly support the company through political lobbying. The
Indianisation of personnel is easily by-passed as these companies retain
the powers to appoint their own Chairmen and Managing Directors.
Obviously even with a holding of only 26% of the shares, these foreign
companies have control over the companies easily by-passing the policy.
Whenever the multinationals become Indian companies they stand to
gain. So long they remain multinationals they are subjected to heavy
taxes. But once our Indianisation of Personnel policy is invoked, these
multinationals become Indian companies and pay less tax. Hence, our
policy is in no way affecting the foreign companies, in tact, the policy is
turning out to be unfavourable to India itself

Government policy:
Since independence, the government has been declaring its policy towards
foreign capital of different types. The policy declared in April, 1949 has
remained the main framework for the subsequent policies. The salient features
of the 1949 policy are:
(i) Foreign capital will have the same treatment as given to domestic
capital.
(ii) The investors will be allowed to remit the profits earned.
161
(iii) The ownership and control of the foreign companies should in due
course be in the hands of Indians.
(iv) In case of take over of the undertaking, a fair and equitable
compensation would be paid.
(v) In case a foreign company wants to have control for some time, the
government may examine this in each individual case before giving
permission.

This policy in nut shell means that there will be no discrimination against the
foreign companies or their investments in India. This remained as the basic
framework of foreign policy all through. With this policy, the government
pursued its foreign policy making minor changes at times. Broadly we may refer
to three phases through which our foreign policy relating to foreign capital and
investments evolved. In the first phase which lasted from 1951 to 1965, the
government was liberal in its attitude towards foreign capital. This included
concessions and incentives to foreign capital which helped us to achieve
industrial development. The second phase which started from 1965, is a period
in which the government was very strict and imposed several restrictions and
regulations. Once again in Phase III, starting from 1991, a liberal policy is
introduced. The salient features of the latest policy towards foreign capital
(199i) is given below:

Foreign investments:

Foreign investments carry with it the benefit of technology transfer, marketing
expertise, modern managerial techniques and new possibilities for promotion of
exports. As this requirement is felt in this world of industrial change and co-
operation, the New Industrial Policy (NIP) has clearly contained the following
provisions relating to foreign investments:

1. In high priority industries approval will be given for direct foreign
investment upto 51% foreign equity and all the bottlenecks in this
process will be removed. Clearance in such cases will be given if the
162
foreign equity covers the foreign exchange requirements for imported
capital goods. The necessary amendments to the FERA will be made.

2. The general policies governing the domestic units in regard to import of
components, raw materials and intermediate goods and payment of
knowhow fees and royalties will also be applicable to the high priority
industries in which foreign investment is limited to 51% However, the
payment of royalty will be routed through the RBI to enable it to
monitor the outflow of foreign exchange on payments are balanced by
export earnings over period of time.

3. All the other foreign investments not included in the category 1 stated
above will require prior clearance.

4. Trading companies primarily export oriented will also be permitted
under the foreign equity proposals as indicated in 1 above. However, the
provisions of his export-import policy applicable to the domestic units
will also be applicable to such trading companies.

5. To encourage substantial inflow of foreign investment, a Special
Empowered Board would be constituted. This Board would negotiate
with the large international firms and approve direct foreign investment
in select areas. This is expected to fetch foreign technology and open the
industries in India to wider world market. Such investments will be
subjected to favourable treatment based on the merits irrespective of
the rules, regulations and procedures in practice.

As regards foreign technology agreement, a welcome change in the outlook of
the government is the realisation that the sophisticated technology from abroad
can be brought in only through liberal and less restrictive procedures and
policies. The interference of the government in this regard is to be reduced so as
to enable the domestic industries in achieving a high rate of industrialization.
As a result of this liberalization, automatic approval for technology agreements
related to high priority industries will be made with respect to certain specific
163
parameters. Other industries which can enter into such agreements without
incurring the expenditure of foreign exchange will also be extended liberal
treatment. The industrialists are left to themselves to decide and enter into
foreign technology agreements depending upon the commercial viability of their
enterprises. In due course this measure is expected to pave the way for
exchange of superior technology from India with other countries. With the
overall liberalization, the competition will be high and it is expected that
industries will invest much more in research and development activities.
Keeping in view all these expectations, the government has announced the
following changes in regulation governing foreign technology agreement:
1. No prior permission is needed for hiring foreign technicians, foreign
testing of indigenously developed technologies. Such activities involving
payments will be governed by the guideline of the RBI and such
payments can be made through blanket permits.

2. Automatic permission will be given for foreign technology agreements,
relating to the high priority industries. The royalty payments through
such agreements will be subjected to certain provisions. Upto the
payment of Rs. 1 crore royalty will be at the rate of 5% for domestic sales
and 8% for foreign sales or exports. However, the total royalty payment
should not exceed 8% of the sales over a 10 year period from the date of
agreement or 7 year period from the date of commencement of
production.

3. In case of industries not covered in the high priority list automatic
permission will be given for technology agreement provided it does not
entail any foreign exchange payment commitment.

4. In all the other cases, the general procedures in practice will be adhered
to and such industries will require specific approval.

Foreign assistance and Indian five year plans:
In the Table given below we find that the external assistance is playing a vital
role in the financing of our five year plans. Right from the I Five Year Plan, we
find that in absolute terms the inflow of foreign assistance is very much on the
164
increase. While it was a modest figure of Rs. 190 crores in the I Plan, it was Rs.
15,139 crores by VII Plan and during the VIII Plan it rose to nearly Rs. 28,700
crores. Hence, it is clear that the external assistance or foreign capital has
become a major component of financing of Indian five year plans. In terms of
percentage, the external assistance went up from a mere 9.6 in the I Plan to
28.2 in the III Plan, 35.9 during the Annual plans. From the IV Plan onwards,
the percentage of external assistance declined from 13 to 8.2% during the VIII
Plan, but this decline should not be misunderstood as declining importance of
external assistance in the financing of our five year plans. The table given below
will clarify this aspect

FOREIGN ASSISTANCE AND INDIAN FIVE YEAR PLANS
PLAN AMOUNT
(Rs.crores)
Percentage
FIRST 190 10
SECOND 1,090 24
THIRD 2,390 28
FOURTH 2,090 13
FIFTH 5,830 15
SIXTH 10,930 11
SEVENTH 15,139 8.4
EIGHTH 28,700 8.2

POLICY ON FDI

The government policies on Foreign Direct Investment [FDI] have been changing
since 1991 - 92. Analysis of these policies would help to place in proper
perspective the prospects and problems of FDI. This was also taken into
consideration while suggesting methods of improving the inflows of FDI.

As apart of the structural adjustment policies introduced in the Indian economy
by Government of India since July 1991, policies relating to foreign financial
participation in Indian companies and those relating to foreign technology
agreements have also undergone a radical charge. Briefly stated, three tiers for
165
approving proposals for foreign direct investment in this country were
introduced: (1) the Reserve Bank's automatic approval system; (2) Secretariat
for Industrial Approvals for considering proposals within the general policy
framework but outside the powers delegated to Reserve Bank; and (3) Foreign.
Investment Promotion Board, specially created to invite, negotiate and facilitate
substantial investment by international companies that would provide access to
high technology and world markets. The foreign investment policy was further
liberalized during the period under review. Fully owned foreign enterprises will
hence forth be allowed to set up giant power projects without the requirement
to balance dividend payments with export earnings.

The general permission granted by the Reserve Bank under the provision
of.: the Foreign Exchange Regulation Act, 1973 has brought the FERA
companies (i.e. those having more than 40% foreign equity) on par with the
Indian companies and thus provides a level playing field to all. The existing
FERA companies have also been extended the facility of 51% equity. Also, the
use of foreign brand names and trademarks on goods for sale within the
country has been permitted. Significant amendments to the FERA for relaxing
several of its restrictive provision have been contemplated.

The following measures were introduced in the recent period to further
liberalise the foreign investment policy:

(1) Except for 22 industries in the consumer goods sector, the earlier
stipulation that dividend remittances of companies receiving approval
under the foreign equity up to 51% scheme, must be balanced by
export earnings over a period of 7 years, was scrapped in respect of all
foreign direct investment (by non -NRIs) in June 1992. The measure
was extended to investment by NRIs /Overseas Corporate Bodies
(OCBs) in September 1992.

(2) For the purpose of investment in oil refineries and development of
discovered oil fields, foreign private equity participation to the extent of
26 per cent is considered as sufficient. For making investment in
166
Indian companies, NRIs/OCBs have been granted automatic approval
by the RBI to invest, with full repatriation benefits, up to 100% in the
issue of capital or convertible debentures of a private/public limited
company engaged in or proposing to engage in high priority industries,
subject to certain conditions.

The existing scheme of 100% NRI investment in cent per cent export oriented
units and also for the revival of sick units will continue cent per cent NRI
participation in power generation has also been permitted. In the context of
such revisions, the earlier 74% scheme has been discontinued.


The Government has set up a Bureau, officially known as the Interface for NRI
Scientists and Technocrats (INRIST), that will bring NRI scientists and
technocrats in contact with Indian industries which would benefit from the
expertise of NRIs.

The Department of Industrial Development has set up an investment
promotion and project monitoring cell popularly known as facilitation ceil, to
provide pre and post investment services for different industrial approvals and
respond to queries relating to various ministeries / departments.

RBI has granted general permission to foreign citizens of Indian origin, whether
resident in India or not, to acquire / hold and transfer by scale or inheritance,
residential properties situated in India subject to certain stipulations.

General permission has been granted to Non-resident Indian citizens and
foreigns citizen of Indian origin to let out their residential properties acquired
for their bonafide residential purpose but which on account of their residence
abroad, are not required for their immediate residential purpose. The rental
income or proceeds of any such income shall both be repatriable outside India
at any time in future and such funds should be credited to the owners
Ordinary Non Resident Rupee account maintained with an authorized bank in
India.
167

In order to simplify and remove regulations which hinder free flow of foreign
capita! in to India as also investment by Indian companies in joint venture
overseas, restriction imposed on FERA companies (i.e. companies incorporated
in India in which the non-resident interest is more than 40%) under sec 26 (7),
28, 29, and 31 of FREA, 1973 have all been removed as outlined below, there by
placing them on par with other Indian companies in regard to their operations
in India. FERA companies are now permitted.

a. To borrow money or accept deposits from persons resident in India.
b. To accept appointment as agent or technical or management advisers
in India, of any person or company.
c. To allow their trademarks to be used by any person or company.
d. To carry on in India any activity of trading, commercial, or industrial
nature except agricultural and plantation activity.
e. To acquire any undertaking in India carrying on any trade, commerce
or industry or purchase the shares of any such company, and
f. To acquire, hold, transfer or dispose of by sale, mortgage, lease, gift,
settlement or otherwise any improvable property in India.

Person of Indian nationality or origin and others (returning home after a
minimum stay of immediate preceding 6 months abroad) have been granted
general permission to bring into India as part of their baggage, gold, in any
form, up to 5000gms, provided duty is paid at the rate of Rs220 / per 100 gms.
(earlier Rs, 450/- per 10 gms ) in any convertible foreign currency (I).

168
As part of the continuing efforts to provide an investment friendly environment
in India for foreign investors, the following policy initiative were undertaken
during the year 1992-93.

(I) To keep pace with the ever expanding global technological revolution
in the field of computers, an Electronic Hardware Technology Park
(EHTP) scheme was set up allowing for 100% equity participation,
duty free import of capital goods and a tax holiday i.e. exemption from
corporate income tax for block of 5 years commencing from the date
of the starting of commercial production.

(II) In the new National mineral policy, the ceiling on foreign .equity
participation in Indian companies engaged in mining activities was
hiked to 50%. In the area of non-captive mines, equity participation of
over 50% by foreign partners could be considered on a case by case
basis.

(III) Authorized dealers were delegated powers to allow remittance of
dividend (including interim dividend) on equity/preference shares to
non-resident shareholders of all Indian companies, as also those in
which investments have been made by NRIs/OCBs under the 40%
scheme or any other scheme with repatriation benefits.

(IV) NRIs were allowed to invest up to 100% on non-repatriation basis, in
any partnership / proprietorship concern or in private / public
limited companies (expect in agricultural / plantation activities)
without seeking prior approvals of other RBI. However, OCBs are not
permitted to invest-In proprietorship / partnership concerns (2).

In keeping with the objective of attracting funds from the NRIs in the form of
deposit and foreign investment several steps were taken during the year 1993 -
94, such inflows, even while adhering to considerations of cost effectiveness and
dampening of volatility. Major policy initiatives undertaken during the year were
as follows:-
169

(I) Deposits Under Foreign Currency Non Resident Account (FNCRA) scheme
proved to be volatile during the payments crisis, of 1990-92. They were also
relatively costly given the spread above international interest in the prescription
of interest rates for these deposits as also the cost implicit in the provision of
exchange guarantee for such deposits. In this regard, the Bank's Annual Report
for 1992-93 had observed: "attempts have been made in the recent period to
restructure the existing FCNRA scheme and to put in place new schemes which
(a) reduce the reliance on the FCNRA scheme, (b) make exchange risk cover a
commercial proposition, and (c) reduce volatile components of deposits under
the existing FCNRA scheme. In pursuance of this objective deposits of four
different maturities i.e. 6 months and above but less than one year", one year
and above but less than two years two years and above but less than three
years, and three years only" were completely withdrawn effective from May
15,1993, Oct. 12,;993, Feb 15, 1994 and August 15, 1994 respectively.
Furthermore, interest rates prescribed on FCNRA of various maturities were
fine-tuned from time to time to secure alignment with movements in
international interest rates. Interest rates on Non Resident (External) Rupee
Accounts (NR (E) R) deposits were also revised downwards effective Oct 18,1994
while the interest rate on savings deposits was brought down from 5% to 4.5%
those on term deposits are not allowed to exceed 8%.

(II) In consonance with the move toward full convertibility in the current
account, the interest accruing on deposits under Non Resident (Non -
Repatriable) Rupee Deposits (NR (NR) RD) was rendered eligible for repatriation
effective from Oct 1, 1994. The principal amount under the scheme will
continue to be non-repatriable

(III) The Foreign Currency Ordinary Non-repatriable (FCON) scheme,
introduced in June J991, under which the principal as well as interest earned
were not repatriable, was suspended with effect from August 20, 1994. Interest
accruing on the existing FCON-scheme from the quarter beginning Oct 1, 1994
was however made eligible for repatriation.

170
Major policy changes were, effected with a view to ensuring that investment
flows were channelled in a manner consistent with overall Macro-economic
requirements. The following policy guidelines were drawn out in this regard:

(IV) With a considerable improvement in the external payments position and
the level of reserves, it was considered necessary to follow a restrictive policy
towards Foreign Currency Convertible Bonds (FCCBs) as they constitute a part
of the country's external debt till their conversion in to equity. As per the fresh
guidelines of the government (issued on May 11. 1994 ) for Euro issues,
companies were allowed to issue FCCBS only on merits as a part of the external
debt restructuring programme which was intended to lengthen maturity and
soften terms.

(V) Under the automatic approval scheme for foreign investments, new
guidelines were issued for determining issue price of preferential shares issued
10 foreign investors to increase their stakes up to 51% in the business of any
Indian company engaged in the high priority industries shown in the Annex-Ill
to the statement on industrial policy of July 24, 1991.

Consequent upon the abolition of the office of the Controller of Capital Issues
(CCI) and subsequent guidelines issued by the Securities and Exchange Board
of India (SEBI) on June 11 and 17,1992, existing companies wishing to raise
foreign equity were to make the issue at a price decided by the shareholders in
a special resolution. In certain proposal received from the existing companies
for enhancement of foreign equity, however, the companies were found to be
issuing foreign equities at a large discount to the market price, (set out in the
last year's Report). This mismatch in the price of shares for investment and dis-
investment could cause distortion in the inflows and outflows of foreign
exchange under the head of foreign investment.

With the objective of preventing a few shareholders from getting substantial and
undue enrichment and unearned gains, to ensure higher foreign equity flows,
and to make both investment and dis-investments market-related, It was
decided with effect from August 4, 1994 that preferential allotment of shares by
171
companies must be at market related price applicable to all foreign investment
proposals whether approved by the RBI or by the SIA / FIPB subject to the
following, guidelines:

The issue price of shares under preferential allotment (other than allotment on
rights basis), would have to be at the market value of the shares determined on
the basis of their average price during the immediate preceding six months at
the main listing center calculated on the monthly average of the high and low
rates quoted for the shares at such centres. In the absence of a market price,
however, (as in the case of Unlisted companies, Listed companies, where shares
are not regularly traded, etc) the RBI would be guided by the net asset value
and earnings per share.

(V) Indian companies engaged in or proposing to engage in housing and real
estate development, i.e. (1) development of serviced plots and construction of
built-up residential premises, (2) real estate covering construction of residential
and commercial premises including business centers and offices, (3)
development of townships, (4) city and region level urban infrastructure
facilities including roads and bridges, (5) manufacturing of building materials
and (6) financing of housing development were allowed to issue
shares/convertible debentures to NRIs up to 100% of the new issue on
repatriation basis. Repatriation of original investment in such cases would be
permitted by the RBI only after a lock in period of three years from the date of
issues of shares / debentures.

The above facilities which were not available to OCBs, have now been extended
to them on the same terms and conditions as applicable to NRIs

VII) NRIs / OCBs were so far permitted to invest in schemes of domestic
Mutual Funds floated by public sector banks / financial institutions on non-
repatriation basis. With a view to providing further incentives to NRIs / OCBs to
invest in domestic Mutual Funds, they were permitted to invest on repatriation
basis also. As a new policy measure, such investments were also permitted
to be made through secondary market.
172

(VIII) Under the Oct 1993 guidelines for issue of bonds by Public Sector
Undertaking (PSUs). Government have allowed PSUs to issue bonds under its
public issues to NRIs / OCBs through prospectus by private placement with the
facility of repatriation of both principal and interest on the bonds. No limit,
however has been specified for NRI / OCB investments in such bonds.

(IX) Besides the various investment facilities extended to NRIs / OCBs on
repatriation basis and under various non repatriable schemes, the NRIs / OCBs
were permitted to make investment in partnership/proprietorship concern,
shares, debentures of Indian companies, Indian mutual funds floated by public
sector banks/financial Institutions, deposits with Indian companies, real estate,
etc. Neither the investment/deposit amount nor the income/interest thereon,
was eligible for repatriation. Further, the investment/deposits held in India by
Indian nationals who have become non-residents on account of their going
abroad on employment/immigration, as well as income/interest earned on such
investment / deposits was not allowed earlier to be repatriated abroad. The
income /interest on such investment / deposits are, however, now permitted to
be repatriated in a phased manner over a period of three years, as indicated
below:

(I) Income accruing during 1994-95 and thereafter to the extent of US Si000
per annum is remittable with immediate effect (b) income earned over
and above US $1000 in a year would be allowed to be remitted as
follows:-
(1) One third of the annual income earned during the financial year
1994-95, (2) Two third of the annual income earned during 1995-
96 and (3) the entire amount earned during 1996-97 and onwards
Remittance of such income, However would be allowed only after
the payments of tax as per the provision of the Income Tax Act (3).

With a view to opening more areas for investment by NRIs / OCBs RBI has
decided to allow them to invest, on a repatriation basis, in all activities except
agriculture and plantation activities, subject to certain conditions during 1994 -
173
95. Accordingly, existing or new Indian companies (both private and public
limited companies) engaged/proposing to engage in any activity including
financial, hire purchase leasing, trading other services etc. (except
agricultural/plantation activities) are allowed to issue equity shares/convertible
debenture's on repatriation basis to NRIs/OCBs provided the aggregate
allocation of shares/ convertible debentures qualifying for repatriation benefits
to such non-residing investors does not exceed 24% of the new issue. Earlier
NRIs and OCBs were permitted to invest on a repatriations basis in new issues
of shares/convertible debentures made by companies engaged in industrial or
manufacturing activities and also in certain other sectors such as hotels,
hospitals, shipping development of computer software and oil exploration. It has
also been decided to permit authorized dealers to grant loans to NRIs holding
Indian passports for acquisition of a house / fiats for residential purpose
against security of immovable property proposed to be acquired by them subject
to certain conditions.

(II) As a process of further liberalization , general permission has been
granted to NRIs/OCBs to purchase the shares on repatriation basis of Public
Sector Enterprise (PSES) dis-invested by Central Government subject to the
condition that (a) the holding of share by a NRI or by an OCB, at any-time, does
not exceed one percent of the paid-up capital of the PSE concerned, (b) the
purchase consideration/bid money is received by way of remittance from
abroad through normal banking channels.

174
(III) NRIs resident in Nepal will be permitted hence forth to make investment
in India provided the funds for the purpose are remitted in free foreign
exchange through proper banking channels. Such investments will either be on
repatriation or on non-repatriation basis depending on the terms and
conditions applicable under the existing schemes under NRI investment.

(IV) In the context of on going economic liberalization, the policy and
procedures governing approvals under the schemes for 100% Export Oriented
Units (EOUS) and Export processing Zones (EPZs) were further revised. All
proposals conforming to the parameters presented vide press note No 13 (1991)
series dated Oct 9,1991, Department of Industrial Development, Ministry of
Industry, shall receive automatic approval within two weeks from Secretariat of
Industrial Approvals (SIA), Ministry of Industry (Department of Industrial
Development) in the case of 100% EOUs and from the Developments
Commissioners (DCs) concerned for units to be set up in EPZs. All other
proposals which do not conform to the parameters for automatic approvals,
shall be considered by the Board of Approvals (BOA) and disposed within 45
days from SIA

(V) Under the National Telecom Policy, 1994 which enunciates the guidelines
for the entry of private sector into Basic Telecom Services, joint venture between
an Indian and a foreign company is allowed subject to a maximum of 49%
equity participation from the latter.

(VI) It has been decided that foreign investment up to 51% and foreign
technology agreements in the cast of bulk drugs, their intermediates and
formulations thereof (except those produced by the use of recombinant DNA
technology) will be granted automatic approval subject to the parameter of RBI.

Since the second half of 1993-94, the Indian economy has experienced surges
in capital flows which took the forms of foreign investment flows both direct and
portfolio, and inflows into various deposit schemes for non-resident Indians.
With current account deficits remaining modest during 1993-94 and 1994-95,
the policy response to the capital flows was accommodative and this enabled on
175
unprecedented build up of international reserves. With the consequent
attenuation of monetary targets threatening the objective of inflation control,
the policy stance switched to one of throwing sand in the wheels in the second
half of 1994-95. Various measures put in place were progressively tightened
during the first half of 1995-96 in support of the conduct of monetary policy.
With the widening of the current account deficit and the onset of volatility in the
foreign exchange markets in the second half of 1995-96, the restrictive stance of
policy was eased and a number of measures were taken to relax controls and
allow for a larger inflow of foreign capital. As in the past, these measures were
related to foreign investment flows and deposits by NRIs and the policy objective
of attracting capital flows has been carried forward during the first half of 1996-
97.

Policy changes in 1996 - 97 were: Under the Automatic route, the ceiling for
lump sum payments of technical know-how fee was, increased from Rs. I crorc
to US $ 2 million, effective Nov 5,1996. With a view to liberalizing the existing
facility for investments by NRIs in India, it was decided to allow investments by
NRIs to establish schools and colleges in India subject to certain regulations.
With a view to expanding the coverage of investment proposals considered
under the Automatic Approval Route effective Jan 17,1997, the Government
announced the inclusion in Annexure III of the statement of Industrial Policy
1991 (i) 3 categories of industries / items relating to mining activities for foreign
equity up to 50% (II) 13 additional categories of industries/items for foreign
equity up to 51% and (III) 9 categories of industries / items for foreign equity up
to 74%

Foreign Direct Investment was allowed into sixteen non-banking financial
services (merchant banking, underwriting, portfolio management
services, investments advisory services, financial consultancy, stock
broking, asset management, venture capital, custodial services, factoring,
credit refinance, credit rating, leasing and finance, housing finance, forex
holding and credit card services) during the year 1997 98, through the Foreign
Investment Promotion Board (FIPB) subject to guidelines relating to minimum
capitalization norms, schedule of capitalization and domestic equity
176
participation. In a major drive to simplify procedures for foreign direct
investment under automatic route, the Reserve Bank dispensed with the need
for its prior approval for such proposals. In order to simplify procedures further
in respect to foreign direct investment cases already approved by the
Government of India (SIA/FIPB), the Reserve Bank dispensed with requirement
for its in-principle permission before receiving overseas investment or for
issuing shares to foreign investors. Indian companies satisfying the conditions
stipulated in the letter of approvals issued by SIA / FIPB could issue shares /
securities to foreign investors and file one copy of the application together with
required documents with the concerned Regional office of Reserve Bank within
30 days from the date of issue of shares. Expanding the scope of automatic
route for foreign direct investments, the government of India approved 13
additional categories of industries / items under services sector for foreign
equity participation up to 51% of the equity, three items relating to mining
activity up to 50% foreign equity participation and nine categories of
industries/activities up to 74% foreign equity participation.

As a part of liberalization process, Reserve Bank of India decided to permit
foreign banks operating in India to remit their profits surplus to their head
offices without the approvals of the Reserve Bank. The permission is subject to
the banks complying with the provisions of Banking Regulation act, 1949.

Financial turmoil in the world economy, imposition of economic sanctions and
sluggishness in domestic activity had some bearings on foreign investment
during the year. The Union Budget, 1999-2000 announced the establishment of
Foreign Investment Implementation Authority [FIIA] in order to rationalize and
simplify approval and implementation procedures of foreign1 investment
proposals. With a view to further facilitating inflows of foreign direct investment,
expansion of automatic list of approvals and a more dynamic role for Foreign
Investment Promotion Board were also announced.

Foreign investment recovered during 1999 - 2000 reflecting the stability of the
domestic currency, broad-based industrial revival, easing of economic sanctions
177
and return of orderliness in the financial markets coupled with strong stock
market performance.

A number of policy initiatives were taken during the year to further facilitate
inflows of foreign investment. In August 1999, a Foreign Investment,
Implementation Authority (FIIA) was established for speedy conversion of
approvals to actual flows. The Insurance Regulatory and Development Act
(IRDA) was passed in December 1999 permitting foreign equity participation in
domestic private insurance companies up to 26% of the paid-up capital.
Moreover, investments in all sectors, except for small negative list, were placed,
in February 2000, under automatic route for direct investments. Indian
companies vere allowed, subject to specified norms, to raise funds for
investments through issue of ADRs / GDRs without prior government approval
and up to 50% of these proceeds were allowed for acquisition of companies in
overseas markets. Indian companies could acquire companies engaged in
information technology and entertainment software, pharmaceuticals and bio -
technology in the overseas market through stock - swap options up to $ 100 m
on automatic basis or ten times the export earnings during the preceding
financial year as reflected in the audited balance sheet, whichever is lower.

FDI is seen as a means to supplement domestic investment for achieving a
higher level of economic growth and development. FDI benefits domestic
industry as well as the Indian, consumers by providing opportunities for
technological up-gradation, access to global managerial skills and practices,
optimal utilization of human and natural resources, making Indian industry
internationally competitive, opening up export markets, providing backward
and forward linkages and access to international quality goods and services.
Towards this end, the FDI policy has been constantly reviewed, and necessary
steps have been taken to make India a most favourable destination for FDI. The
major initiative taken to attract FDI during 2000 -2001 & 2001 - 2002 are as
follows:

In pursuance of Government's commitment to further facilitate Indian
industry to engage unhindered in various activities, Government has
178
permitted, except for a small negative list, access to the automatic route
for FDI, whereby, foreign investors only need to inform the Reserve Bank
of India within 30 days of bringing in their investment, and again within
30 days of issuing any shares.

Non-Banking Financial Companies (NBFCs) may hold foreign equity up
to 100% if these are holding companies.

Foreign investors can set up 103% operating subsidiaries (without any
restriction on number of subsidiaries) without the condition to disinvest
a minimum of 25% of its equity to Indian entities, subject to brining in
US $50 m out of which US $ 7.5 m to be brought upfront and the
balance in 24 months. Joint venture operating NBFCs that have 75% or
less than 75% foreign investment will also be allowed to set up
subsidiaries for undertaking other Non Banking Financial Company
activities, subject to the subsidiaries also complying with the applicable
minimum capital inflow.

FDI up to 49% from all sources is permitted in the private banking sector
on the automatic route subject to conformity with RBI guidelines.

In the process of liberalization of FDI policy, the following policy changes
have been made:
(i) 100% FDI permitted for B, to B e-commerce
(ii) Condition of dividend balancing on 22 consumer items
removed forthwith
(iii) Removal of cap on foreign investment in the Power Sector
(iv) 100% FDI permitted in oil-refining.

Automatic Route is available to proposals in the Information and
Technology Sector, even when the applicant company has a previous
joint venture or technology transfer - agreement in the same field.
Automatic Route of FDI up to 100% is allowed in all manufacturing
179
activities in Special Economic Zones (SEZs), except for the following
activities:
(i) Arms and ammunition, explosives and allied items of defence
equipment, defence aircraft and warships;
(ii) Atomic substances;
(iii) Narcotics and Psychotropic substances and hazardous
chemicals;
(iv) Distillation and brewing of alcoholic drinks;
(v) Cigarettes/cigars and manufactured tobacco substitutes.

FDI up to 100% is allowed with some conditions for the following
activities in Telecom Sector:
(i) ISPs not providing gateways (both for satellite & submarine
cables);
(ii) Infrastructure Providers providing dark fiber (IP Category I);
(iii) Electronic Mail;
(iv) Voice Mail.

FDI up to 74% is permitted for the following telecom services subject to
licensing and security requirements (proposals with beyond 49% shall
require prior Government approval): (i) internet services providers with
gateways; (ii) Radio Paging; and (iii) End-to-end bandwidth.

Payment of royalty up to 2% on exports and 1% on domestic sales is
allowed under automatic route on use of trademarks and brand name of
the foreign collaborator without technology transfer. Payment of royalty
up to 8% on exports and 5% on domestic sales by wholly owned
subsidiaries to offshore parent companies is allowed under the automatic
route without any restriction on the duration of royalty payments.

Offshore Venture Capital Funds / Companies are allowed to invest in
domestic venture capital undertakings as well as other companies
through automatic route, subject only to SEBI regulations and sector
specific caps on FDI.
180

FDI up to 26% is eligible under Automatic Route in the Insurance sector,
as prescribed in the Insurance Act, 1999, subject to their obtaining
licence from Insurance Regulatory & Development Authority.

FDI up to 100% is permitted in airports, with FDI above 74% requiring
prior approval of the Government.

FDI up to 100% is permitted with prior approval of the Government in
courier services subject to existing laws and exclusion of activities
relating to distribution of letters. FDI up to 100% is permitted with prior
approval of the Government, for development of integrated township,
including housing, commercial premises, hotels, resorts, city and
regional level urban infrastructure facilities such as roads and bridges,
mass rapid transit systems, and manufacture of building material in all
metros, including associated commercial development of real estate.
Development of land and providing allied infrastructure will form an
integral part of township's development.


FDI up to 100% is permitted on the automatic route in hotel and tourism
sector and for Mass Rapid Transit Systems in all metropolitan cities,
including associated commercial development of real estate. FDI up to
100% in drugs and Pharmaceuticals (excluding those, which attract
compulsory licensing or produced by recombinant DNA technology and
specific cell/tissue targeted formulations) placed on the automatic route.

The defence industry sector is opened up to 100 per cent for Indian
private sector participation with FDI permitted up to 26 per cent, both
subject to licensing.

International Financial Institutions like Asian Development Bank,
International Financial Corporation, Commonwealth Development
Corporation, German Investment and Development Company (DEG) etc.,
181
are allowed to invest in domestic companies through the automatic
route, subject to Securities and Exchange Board of India / Reserve Bank
of India Guidelines and sector specific caps on FDI (10).

FDI policies for the year 1998 -1999
Financial turmoil in the world economy, imposition of economic sanctions and
sluggishness in domestic activity had some bearings on foreign investment
during the year. The Union Budget, 1999 - 2000 announced the establishment
of Foreign Investment Implementation Authority [FIIA] in order to rationalize
and simplify approval and implementation procedures of foreign investment
proposals. With a view to further facilitating inflows of foreign direct investment,
expansion of automatic list of approvals and a more dynamic role for Foreign
Investment Promotion Board were also announced.

FDl policies for the year 1999 - 2000

Foreign investment recovered during 1999 - 2000 reflecting the stability of the
domestic currency, broad-based industrial revival, easing of economic sanctions
and return of orderliness in the financial markets coupled with strong stock
market performance.
A number of policy initiatives were taken during the year to further facilitate
inflows of foreign investment. In August 1999, a Foreign Investment
Implementation Authority (FIIA) was established for speedy conversion of
approvals to actual flows. The Insurance Regulatory and Development Act
(IRDA) was passed in December 1999 permitting foreign equity participation in
domestic private insurance companies up to 26% of the paid up capital.
Moreover, investments in all sectors, except for a small negative list, were
placed, in February 2000, under automatic route for direct investments. Indian
companies were allowed, subject to specified norms, to raise funds for
investments through issue of ADRs / GDRs without prior government approval
and up to 50% of these proceeds were allowed for acquisition of companies in
overseas markets. Indian companies could acquire companies engaged in
information technology and entertainment software, pharmaceuticals and bio-
technology in the overseas market through stock - swap options up to $ 100 m
182
on automatic basis or ten times the export earnings during the preceding
financial year as reflected in the audited, balance sheet, whichever is lower.

FDI Policies For The Year 2000 - 2001

FDI is seen as a means to supplement domestic investment for achieving a
higher level of economic growth and development FDI benefits domestic
industry as well as the Indian consumers by providing opportunities for
technological up-gradation, access to global managerial skills and practices,
optimal utilization of human and natural resources, making Indian industry
internationally competitive, opening up export markets, providing backward
and forward linkages and access to international quality goods and services.
Towards this end, the FDI policy has been constantly reviewed, and necessary
steps have been taken to make India a most favourable destination for FDI. The
major initiative taken to attract FDI during 2000 -2001 & 2001 - 2002 are as
follows:

In pursuance of Government's commitment to further facilitate Indian
industry to engage unhindered in various activities, Government has
permitted, except for a small negative list, access to the automatic route
for FDI, whereby, foreign investors only need to inform the Reserve Bank
of India within 30 days of bringing in their investment, and again within
30 days of issuing any shares.

Non-Banking Financial Companies (NBFCs) may hold foreign equity up u
100% if these are holding companies.

Foreign investors can set up 100% operating subsidiaries (without any
restriction on number of subsidiaries) without the condition to disinvest
a minimum of 25% of its equity to Indian entities, subject to bringing in
US $50 m out of which US $ 7.5 m to be brought upfront and the
balance in 24 months. Joint venture operating NBFCs that have 75% or
less than 75% foreign investment will also be allowed to set up
subsidiaries for undertaking other Non Banking Financial: Company
183
activities, subject to the subsidiaries also complying with the 3,
applicable minimum capital inflow.

FDI up to 49% from all sources is permitted in the private banking sector
on the automatic route subject to conformity with RBI guidelines.

In the process of liberalization of FDI policy, the following policy changes
have, been made:
(v) 100% FDI permitted for B to B e-commerce
(vi) Condition of dividend balancing on 22 consumer items
removed forthwith
(vii) Removal of cap on foreign investment in the Power Sector
(viii) 100% FD permitted in oil-refining.

Automatic Route is available to proposals in the Information and
Technology Sector, even when the applicant company has a previous
joint venture or technology transfer agreement in the same field.
Automatic Route of FDI up to 100% is allowed in all manufacturing
activities in Special Economic Zones (SEZs), except for the following
activities:
(vi) Arms and ammunition, explosives and allied items of defence
equipment, defence aircraft and warships;
(vii) Atomic substances; mi
(viii) Narcotics and Psychotropic substances and hazardous chemicals;
(ix) Distillation and brewing of alcoholic drinks;
(x) Cigarettes/cigars and manufactured tobacco substitutes.

FDI up to 100% is allowed with some conditions for the following
activities in Telecom Sector:
(v) ISPs not providing gateways (both for satellite& submarine cables);
(vi) Infrastructure Providers providing dark fiber (IP Category I);
(vii) Electronic Mail;
(ix) Voice Mail.

184
FDI up to 74% is permitted for the following telecom services subject to
licensing and security requirements (proposals with beyond 49% shall
require prior Government approval): (i) internet services providers with
gateways; (ii) Radio Paging; and (iii) End-to-end bandwidth.

Payment of royalty up to 2% on exports and 1% on domestic sales is
allowed under automatic route on use of trademarks and brand name of
the foreign collaborator without technology transfer. Payment of royalty
up to 8% on exports and 5% on domestic sales by wholly owned
subsidiaries lo offshore parent companies is allowed under the automatic
route without any restriction on the duration of royalty payments.

Offshore Venture Capital Funds / Companies are allowed to invest in
domestic venture capital undertakings as well as other companies
through automatic route, subject only to SEBI regulations and sector
specific caps on FDI.

FDI up to 26% is eligible under Automatic Route in the Insurance sector,
as prescribed, in the Insurance Act, 1999, subject to their obtaining
licence from Insurance Regulatory & Development Authority.

FDI up to 100% is permitted in airports, with FDI above 74% requiring
prior approval of the Government.


FDI up to 100% is permitted with prior approval of the Government in
courier services subject to existing -laws and exclusion of activities
relating to distribution of letters, FDI up to 100% is permitted with prior
approval of the Government, for development of integrated township,
including housing, commercial premises, hotels, resorts, city and
regional level urban infrastructure facilities such as roads and bridges,
mass rapid transit systems, and manufacture of building material in all
metres, including associated commercial development of real estate.
185
Development of land and providing allied infrastructure will form an
integral part of township's development.

FDI up to 100% is permitted on the automatic route in hotel and tourism
sector and for Mass Rapid Transit Systems in all metropolitan cities,
including associated commercial development of real estate. FDI up to
100% in drugs and Pharmaceuticals (excluding those, which attract
compulsory licensing or produced by recombinant DNA technology and
specific cell/tissue targeted formulations) placed on the automatic route.
The defence industry sector is opened up to 100 per cent for Indian
private sector participation with FDI permitted up to 26 per cent, both
subject to licensing.
International Financial Institutions like Asian Development Bank,
International Financial Corporation, Commonwealth Development
Corporation, German Investment and Development Company (DEG) etc.,
are allowed to invest in I domestic companies through the automatic
route, subject to Securities and Exchange Board of India / Reserve Bank
of India Guidelines and sector specified caps on FDI.

Industrial policy resolutions of 1948,1956 and 1980.

Industrial policy comprises of the procedures, principles, rules, policies and
regulations which together govern the industrial sector to guide the industrial
development or the country in conformity with the objectives of five year plans
and the needs of the economy. As the economy develops, the government has to
closely study the process of economic development and make necessary
changes and modifications in the policies so as to make the policies relevant for
the situation or the environment prevailing in the country at different points of
time. A Sometimes the changes in policies are so drastic that a new approach at
the industrial development or the development of any other sector is arrived at.
When these changes are announced the reactions from the sector concerned are
studied closely by the government and necessary amendments are made to the
policies already announced. In Indian scene, the situation prevailed
immediately after independence was completely different from what is being
186
witnessed today. Hence, if we study the industrial policies announced in the
later 40's and early and middle 50s we would get a background with which we
will be able to understand and appreciate the changes that have been
announced in 1991. This would also help us to understand the justifications for
the drastic changes announced at periodical intervals. Hence, we would discuss
now in brief, the features of 1948, 1956 and 1980 Industrial Policy Resolutions.

INDUSTRIAL POLICY 1948

Immediately after independence, the government had to give a guideline for the
industries in India and so it announced its policies for industries. The political
freedom attained in 1947, posed a challenge to the government, to devise its
own policies. With the production at low levels, population increasing, partition
impacts, rising price level, industries to be developed to accelerate economic
development, etc., the 1948 Industrial policy resolution was announced.
Through that the government clearly accepted its responsibility of ensuring
planned development of industries of various types. The 1948 policy laid the
foundation for a new experience as would be clear from the following features of
the policy. The industries were classified into the following four categories:

1. The strategic industries to be completely owned by the government
included manufacture of arms and ammunition, production and
control of atomic energy, ownership and management of railway
transport, etc. No private sector participation or existence will be
permitted in this category of industries.

2. The second group included the basic and key industries. Private
sector existence in this group would be tolerated for a period of 10
years after which their performance would be evaluated. New units in
this category' will be established only by the government and the
existing ones would be taken over by the government if their
performance is found to be not satisfactory after the review. The
industries included in this category include: aircraft manufacture,
coal, iron and steel, ship building, radio sets and mineral oils, etc.
187

3. In this category government included the basic industries like salt,
automobiles, tractors, prime movers, electrical engineering, heavy
machinery, machine tools, heavy chemicals, fertilzsers, electro-
chemical industries, non-ferrous metals, rubber manufacture, power
and industrial alcohol, cotton and woollen textiles, cement, sugar,
paper and newsprint, air and sea transport, minerals and industries
relating to defence. Private sector will be given complete freedom to
enter into this category, but the government can intervene and
regulate any of them, if found necessary.

4. All the other industries formed the fourth category. Mainly left for
private sector, the government pointed out that progressively it may
participate but not eliminate the private sector. Both individual as
well as co-operative undertakings will be permitted in this sphere.

This policy also gave importance to small scale industries and suggested that
both the central and state governments should join together in solving the
problems faced by the small scale industries. As these industries would offer
good scope for absorbing the displaced labourers, and agricultural workers and
wee also ideal for co-operative type of organisation, the government felt that
they must be developed. As regards the foreign capital, the government clearly
pointed out that there is need for free flow of capital as well as technology. At
the same time the government also said that it should regulate; no
discrimination will be made between the Indian and foreign undertakings with
regard to the applications of the provisions of the policy resolutions. Profits and
repatriation of capital would be permitted subject to the provisions of the -
foreign exchange control. Further if any undertaking is nationalised, then fair
and equitable compensation would be paid.



Evaluation:

188
The main aspect of this policy is that it laid the foundation for the introduction
of MIXED ECONOMY in India. Under this the government will encourage co-
existence of both private and public sector units in industries according to the
provisions of the policy. This paved the way-for the participation of government
and the corporate sector in the industrial building process of the country. This
also facilitated a direct comparison between the performance of both the
sectors, in terms of various indicators. Being the first policy resolution the
government had made a good beginning. But this policy was criticised for being
classificatory. It gave an impression that the private sector, even in spite of
possessing the potential was not allowed to play its due role in the industrial
development. Secondly, there was a threat of nationalisation, specifically, in the
case of industries under the second category. Thirdly, the government
intervention was present even in the case of third category of industries. Hence,
on the whole, being the first policy, the government could not make the policy
more imaginative, except, of course, introducing the principle of mixed
economy.

INDUSTRIAL POLICY 1956
A new policy was necessitated after 1951, because, India adopted a socialistic
pattern of society, the Constitution guaranteed Fundamental Rights and
Directive Principles of State policy and the First five year plan was completed by
1956. After reviewing the developments and achievements, the government
came out with the Industrial Policy Resolution of 1956. For all the later policies,
this became the basis and until 1980, the provisions of this policy remained
more or less in force.

The following are the important features of this Policy:
The industries were classified into three categories. This was indicated in terms
of Schedule A, Schedule B and Schedule C industries.
The Schedule A industries are completely slate owned and the state is
responsible for the development and growth of them.

189
The Schedule B included industries which were under the control of
government, especially new units. The private sector is also permitted to
enter into this category, but it will be given only a supplementary role.

The Schedule C industries included all the remaining industries, the
future of which would be completely in the hands of private sector. Of
course, government regulation in general would be formulated and made
applicable to them as any other industries. The first classification
(Schedule A) included 17 industries, the Schedule B included 12
industries and Schedule C included all the rest.

The government clearly indicated that the above classification is not very rigid,
and private participation and presence even in the first category in the nature of
allied units, user of by-products, etc., would be permitted, similarly the
government may enters the Schedule C industries if the planning and
development warrants it. The private sector is expected to work in close unison
with the state. The government assured fair and free treatment to private sector
units and non-discriminatory treatment was also promised. The government
continued to encourage the growth and development of small scale and village
industries by extending subsidies, tax concessions, protection from large and
medium industries, and assisting them in modernisation to improve their
competitive strength. The Resolution also aimed at reducing the regional
disparities in the growth and development of industry so as to achieve balanced
industrial development throughout the country. The Resolution also highlighted
the need to protect and improve the conditions of industrial workers in the
country. Mainly several machineries for settling industrial disputes were
thought of. The government continued with its policy regarding foreign capital
without much change.

Evaluation:

This resolution assigned a major role to the public sector. It created a condition
in which the public sector units could be established and developed well. This
was fell necessary to achieve the desired rate and pattern of development of
190
industries in India. The government made it clear that it had no intention to
wipe out the private sector, instead it wanted the private sector to emerge as the
supplementary sector for the public sector and join the latter to achieve rapid
industrial and economic development. After the resolution came into force, over
a period it was found that the private sector developed faster by taking
advantage of loopholes and exceptions in the Resolution. There were cases
where licenses were issued to private sector while public sector should have
been given the license. Hence, it was found that this Resolution in fact, led to
the rapid growth of private sector.

INDUSTRIAL POLICY OF 1980

As already pointed out the Industrial policy of 1956 formed the basis of this
policy in 1980. This new policy had the following objectives:
(i) to achieve the optimum utilisation of the installed edacity
(ii) to achieve maximum production and through that achieve
higher productivity and employment generation
(iii) to rectify the regional imbalance by focusing on the backward areas
(iv) giving priority treatment for agro-based industries
(v) to promote inter-sectoral relationship
(vi) to encourage the growth of export oriented and import substitution
industries
(vii) to speed up the growth of small scale units, etc.

With these objectives in view, the new policy laid down the following provisions:

1. After reviewing the performance of the public sector units the
government has decided to introduce measures for improving the
efficiency of these units so as to make them contribute more towards the
economy.

2. In order to promote economic federalism, the policy provided
for integration of industrial development in the private sector. The
government also decided to eliminate the artificial division between small
191
and large scale industrial units. In each district a few nucleus plants
will be set up which would generate opportunities for a number of small,
cottage and ancillary units. This would ultimately create the scope for
faster industrial development in the industrially backward districts.

192
3. To provide the scope for more and more small and cottage industries, the
government redefined these units as below:
a. the limit of investment for tiny units was to be raised from Rs. 1
lakh to Rs.2 lakhs
b. the limit of investment for small scale units was to be raised from
Rs. 10 lakhs to Rs. 20 lakhs and
c. increase the limit of investment for ancillaries from Rs. 15 lakhs to
Rs. 25 lakhs.

4. to promote industrial growth in rural areas and also to improve the
employment opportunities there and raise their percapita income, the
policy provided for promoting industries in the rural areas. This was also
expected to maintain the ecological balance in the country. Greater
attention would be given to the growth of handlooms, handicrafts and
khadi and other village industries.

5. Another important provision was that the government decided to
regularise the unauthorized excess capacity with the industrial units,
especially the FERA & MRTP units by allowing them automatic
expansion by 25% of the existing licensed capacity on a selective basis.

6. To prevent spread of industrial sickness, the government indicated that
very stringent steps would be taken against those units which are
deliberately mismanaged and indulging in financial improprieties. As
regards the existing sick units, arrangements would be explored to revive
them or to encourage their mergers with healthy units by introducing
suitable tax concessions to encourage such actions. When other methods
of revival of sick units are not found feasible, then the management of
such sick units would be taken over.

EVALUATION

This policy has several lapses. Its claim to eliminate the division between small
scale and large scale units is something contradicting the basis of such
193
divisions. There was a need to treat the small scale with liberal treatment so
that in a labour intensive economy, these units can create employment
opportunities. There is nothing wrong with such specific preferential treatment
of small scale units. But this policy aimed at removing such differences.
Secondly, this policy created a precedence by regularising the unauthorized
excess capacity created by large units, instead of taking action against such
erring big units. While the big units welcomed this move of the government, yet
this has resulted in the expectation that the government would continue to have
such liberal treatment in future also. This indirectly has also affected the
growth prospects of new industries and the existing medium and small scale
units. Though the government justified its move by stating that such a move
would facilitate fuller utilisation and higher output, yet the consequence of such
a move was not thought about. However, it may be pointed out that the seeds of
liberalization were sown through this policy and the government's intention to
select capital intensive path of development.

The features of 1991 Industrial policy

The government announced its new Industrial policy in July 1991. The new
policy has outlined several changes which have together opened a new era to
the growth and development of industrial sector in India, The conventional
regulations and restrictions have been replaced with liberalization and reliefs.
Consequent to the announcement of the new policy, there has been all round
jubilation in the industrial sector. The following are the salient features of the
new industrial policy.

Even by 1985-86, the government realised the need to encourage the industrial
sector to stand on its own legs and towards achieving this a number of policies
and procedural changes have been announced. This was expected to increase
productivity, reduce costs and improve the quality with which the domestic
industries are expected to face competition with strength. There was an honest
attempt to release the public sector from a number of constraints and it was
given a large measure of autonomy. Technological and managerial
modernization programs were taking place in large scale. All these measures
194
together contributed to the achievement of an impressive annual growth rate of
8.5% during the VII Five year plan. Having understood the effectiveness of all
the policy changes in the past, the new industrial policy will continue to pursue
a sound policy to encourage entrepreneurs, develop the indigenous technology
through intensive research and development activities, dismantle the regulatory
system, improve the capital market, etc. Small scale sector would get a special
attention and the government promised to come out with a new policy towards
the small scale industries. Foreign technology and investment would be
welcomed to improve the domestic production base and increase the exports.
The MRTP Act would be suitably modified to encourage competition. Public
sector will be made to run on commercial lines and play a vital role in economic
development. The essence of this new policy will be discussed under the
following heads: 1. Industrial licensing, 2. Foreign investment, 3. Foreign
technology agreement, 4. Public sector, 5. MRTP Act and 6. Small scale and tiny
sector policy.

INDUSTRIAL LICENSING POLICY

To achieve the objectives of the strategy of the industrial sector in the 90's a
number of changes in the system of industrial approvals have been brought
about. The domestic producers will be able to withstand the competition in the
country as well as abroad only through procedural reforms. Hence, the role of
government will be changed from that of exercising control to one of providing
help and guidance. Changes in the policy towards public sector in the last few
years have clearly indicated that private sector enterprises will be allowed to
compete in many areas hitherto earmarked for public sector. Consequently, the
new policy has completely reclassified the Indian industries as below:

a) Eight industries have been completely reserved for the public sector.
They are: i. Arms and ammunition and allied items of defence equipment,
defence aircraft and warships, ii. atomic energy, iii. coal and lignite, iv. mineral
oils; v. mining of iron ore, manganese ore, chrome ore, gypsum, sulphur, gold
and diamond, vi. mining of copper, lead, zinc, tm, molybdenum and wolfram,
195
vii. mineral specified in Schedule to the Atomic Energy Order, 1953 and viii.
railway transport.

b) Eighteen industries have been listed as industries which require
compulsory licensing. However, this provision would not apply in respect of the
small scale units taking up the manufacture of any of the items reserved for
exclusive manufacturing in small scale sector. Compulsory licensing would be
required in the following industries;

i. coal and lignite, ii. petroleum other than crude and its distillation
products, iii. distillation and brewing of alcoholic drinks, iv. sugar, v. animal
fats and oils, vi., cigars and cigarettes of tobacco and manufactured tobacco
substitutes, vii. Asbestos and asbestos based products, viii. plywood, decorative
veneers and other wood based products such as particle board, medium density
fiber board, block board, ix. raw hides and skins, leather, chamois leather and
patent leather, x. tanned or dressed fur skins, xi. motor cars, xii. paper and
newsprint except bagasse based units, xiii. electronic aerospace and defence
equipment of all types, xiv. industrial explosives, xv. hazardous chemicals, xvi.
drags and pharmaceutical xvii. entertainment electronics and xviii. white goods
like domestic refrigerators.

As regards the provisions of the industrial licensing policy,
(i) Industrial licensing has been completely abolished for all projects
except for the industries classified above, i.e., the area reserved for
public sector and the list of 18 industries and the areas reserved for
small scale industries will continue.

(ii) Public sector will continue to maintain monopoly in industries
coming under the areas of security and strategic considerations.

(iii) In projects where imported capital goods are required, automatic
clearance will be given provided the foreign exchange availability is
ensured through foreign equity. Or alternatively if the value of
imported, goods does not exceed 25% of the total value of plant and
196
equipment subject to the ceiling of Rs. 2 crores, automatic clearance
will be given. However, this would come into effect only from April,
1992 in view of the current balance of payments position. In all the
other cases, the prior approval and clearance from the Secretariat of
Industrial approvals in the Department of Industrial development
will be required.

(iv) Except the list of industries requiring compulsory licensing, the other
industries will not require any approval from the Central government
for their location in ares other than cities of more than one million
population. In cities with more than one million population, non-
polluting industries like electronics, computer software and printing
will be permitted outside 25 kms. of the periphery. If such cities
require industrial re-generation policies will be made more flexible.
However, the existing zoning and land use regulation and
environmental legislation will continue to regulate industrial
locations. All efforts will be made through incentives and other
methods like infrastructural development, to disperse the industry to
rural and backward areas.

(v) New Broad-banding facility will be provided to the existing units so
as to enable them to produce any article without additional
investment. The exemption from licensing will be applicable to all
substantial expansion of existing units.

(vi) The mandatory convertibility clause will no longer be applicable for
term loans from the financial institutions for new projects,

(vii) A very significant step is to abolish all the existing registration
schemes.


(viii) In case of substantial expansions and new projects, it is enough if
the entrepreneurs file the information memorandum.
197

(ix) The list of industries requiring compulsory licensing and industries
for automatic approval of foreign technology agreements will be
notified in the Indian Trade Classification (Harmonized system),

FOREIGN INVESTMENT
Foreign investment carries with it the benefits of technology transfer, marketing
expertise, modem managerial techniques and new possibilities for promotion of
exports. As this requirement is felt in this world of industrial change and co-
operation, the new policy has clearly contained the following provisions related
to foreign investment:
(i) In high priority industries approval will be given for direct foreign
investment upto 51% foreign equity and all the bottlenecks in this
process will be removed- Clearance in such cases will be given if the
foreign equity covers the foreign exchange requirements for imported
capital goods. The necessary amendments will be made in the FERA.

(ii) The general policies governing the domestic units in regard to import
of components, raw materials and intermediate good and payment of
know-how fees and royalties will also be applicable to the high
priority industries in which foreign investment is limited to 51%
However, the payment of royalty will be routed through the RBI to
enable it to monitor the outflow of foreign exchange on account of
dividend payment also to ensure that such payments are balanced by
export earnings over a period of time.

(iii) All the other foreign investments not included in the Category I slated
above will require prior clearance.

(iv) Trading companies primarily export oriented will also be permitted
under the foreign equity proposals as indicated in (i) above. However,
the provisions of the Export-Import policy applicable to the domestic
units will also be applicable to such trading companies.

198
(v) To encourage substantial inflow .of foreign investment, a Special
empowered board would be constituted. This Board would negotiate
with the large international firms and approve direct foreign
investment in select areas. This is expected to fetch foreign
technology and open the industries in India to wider world market.
Such investments will be subjected to favourable treatment based on
the merits irrespective of the rules, regulations and procedures in
practice.

FOREIGN TECHNOLOGY AGREEMENT

A welcome change in the outlook of the government as evidenced by the new
policy is the realization that the sophisticated technology, from abroad can be
brought in only through liberal and less restrictive procedure and policies. The
interference of the government in this regard is to be reduced so as to enable
the domestic industries in achieving a high rate of industrialization. As a result
of this liberalization, automatic approval for technology agreements related to
high priority industries will be made with respect to certain specific parameter.
Other industries which can enter into such agreements without incurring the
expenditure of foreign exchange will also be extended liberal treatment. The
industrialists are left to themselves to decide and enter into foreign technology
agreements depending upon the commercial viability of their enterprises. In due
course this measure is expected to pave the way for exchange of superior
technology from India with other countries. With the overall liberalization, the
competition will be high and it is expected that industries will invest much more
in research and development activities. Keeping in view all these expectations,
the government has announced the following changes in regulations governing
foreign technology agreement:

(i) No prior permission is needed for hiring foreign technicians, foreign
testing of indigenously developed technologies. Such activities
involving payments will be governed by the guidelines of the RBI and
such payments can be made through the blanket permits.

199
(ii) Automatic permission will be given for foreign technology agreements
relating to the high priority industries. The royalty payments through
such agreements will be subjected to certain provision. Upto the
payment of Rs.1 crore, royally will be @ 5% for domestic sales and 8%
for foreign sales or exports. However, the total royalty payment should
not exceed 8% of sales over a 10 year period from the date of
agreement or 7 year period from the dale of commencement of
production.

(iii) In the case of industries not covered in the high priority list automatic
permission will be given for technology agreement provided it does riot
entail any foreign exchange payment commitment.

(iv) In all the other cases, the general procedures in practice will be
adhered to and such industries will require approval.

PUBLIC SECTOR

The public sector was given the predominance in the industrial development
over the last four decades and the amount of investment made in this sector,
though justified from the point of view of socialistic democracy, it has been
struggling with so many problems like poor productivity, excess staffing, lack of
continuous technological up-gradation, inadequate attention to research and
development, etc. The rate of return on investment in public sector has been so
low that it has prevented the automatic growth of these assets to the
government. The main reason for this poor performance of the public sector has
been the taking over of the sick units from the private sector and the number of
units which are in the consumer goods and service sector. Hence, in the new
policy the government has rightly given the emphasis to the development of
public sector in the field of essential infrastructure goods and services,
technology development and building of manufacturing capabilities,
manufacture of products such as defence equipment. The public sector will also
enter the other areas not strengthened if they generate good profits and the
management will be granted more autonomy through a system of memorandum
200
of understanding. Private sector will be invited to induce competition in these
areas. In selected industries in public sector, the government would disinvest a
part of the equity share holding to provide market discipline to the performance
of the public sector. Based on these views the new policy has the following
provisions regarding the public sector:

(i) A review of the public sector portfolio investment will be made to give
the emphasis on the role of public sector in the strategies, high tech
and infrastructure. Public sector units will be allowed entry into
areas not strictly reserved for it.

(ii) The Board for Industrial and Financial Reconstruction will be
approached to help the sick units to rehabilitate them. To protect the
interest of workers who are likely to be affected due to rehabilitation
of public sector sick units, a social security system is proposed to be
devised.

(iii) A significant policy aimed at raising the resources and encouraging
public participation in the growth of public sector units is that the
government will offer a part of its share holding in the public sector
to the mutual funds financial institutions, genera! public and
workers.

(iv) In the direction of strengthening the management of public sector
units the Board of public sector management will be made more
professional and given more powers. Further to make the
management of such units more autonomous and accountable a
system of memorandum of understanding will be adopted. Apart from
improving the expertise of the government in implementing the MOU,
the government also would place in the Parliament the MOU to
facilitate detailed discussion.


MRTP ACT
201

A major deviant of the new policy is in respect of the MRTP Act. The new policy
aims at removing the unnecessary bureaucratic controls and allow the
industries to breathe in an atmosphere of freedom. The efforts of the
government in the past intervening in the investment decisions of the MRTP
companies have been proved to be counter-productive. Hence, the newly
empowered MRTP Commission will enquire into complaints received from
individual consumers or classes of consumers. The following is the essence of
the provisions in the new policy regarding MRTP Act:

(i) The limits of assets in respect of the MRTP companies and dominant
undertakings have been removed and suitable amendment in the
MRTP Act will be made in due course.
(ii) The need to obtain the prior approval of the central government for
establishing new units, expansion of existing units, merger,
amalgamation and take over as well as appointment of Directors have
all been removed.
(iii) The MRTP Act will be used only for controlling and regulating
monopolistic, restrictive and unfair trade practices. As a follow-up the
MRTP Commission will be authorized to inquire suo moto or
complaints lodged by individual consumers or classes of consumers
regarding monopolistic, restrictive and unfair trade practices.
(iv) All the necessary amendments will be made in the MRTP Act to give
more punitive and compensatory powers of the MRTP Commission.



Industrial pattern in India on the eve of planning and growth since the I
Five Year Plan

By 1950, the industrial pattern in India was completely under the shackles of
the British policy. Till independence, India was used as a market for the
finished goods of Briton and so nothing spectacular could be explained about
202
the industrial pattern in India at that time. The main features of the industrial
pattern on the eve of planning (1950) were:

1. There was a conspicuous lop-sided pattern of industry found by 1950.
On the one side large industries owned by British businessmen was
existing and the other extreme the indigenous industries of small size
but in large numbers was found. There was no medium scale
industries at all. Obviously the employment pattern was concentrated
in these two extreme types of industries.

2. The capital intensity in Indian industries was very low compared to
several other Western countries. This was because of low wage level
and very small market size for the products. So there was no scope for
large scale production.

3. The composition of industrial output was such that the ratio between
consumer goods and capital goods was 62: 38. This amply explains the
under developed nature of the capital goods sector.

On the eve of the I Plan the government studied the prevailing situation and
then decided to launch the process of industrialization in India in order to
achieve a higher rate of growth. For this purpose steps were taken to design the
industrial development to accelerate growth. The plan-wise steps for achieving a
higher rate of industrial development is given below:

I Plan: During this Plan the emphasis was more on the development of
agricultural sector than the industrial sector. However, the effort was to
improve the power and irrigation facilities so as to facilitate rapid
industrialization. The target for the growth was to achieve 7% But in reality this
called for huge investment which did not come forth. Out of the total investment
planned for the industrial sector (Rs. 797 crores), Rs. 94 crores was the outlay
fixed for the public sector. The Plan also aimed at fuller utilization of the
existing capacity. However several important industries like Sindiri Fertilizer
203
factory, Chittaranjan Locomotive factory, Indian Telephone industries, etc were
set up during this Plan.

II Plan: The seeds of industrialization were sown during this Plan. During this
Plan period several important changes took place and the most notable one
being the government declared its Industrial policy resolution 1956. Heavy
industries and large scale industries were to be set up. The total investment by
the private and public sector was Rs. 1575 crores. The following priorities were
set up to achieve a desirable pattern of industrial development during this Plan.
(i) To give top priority to heavy engineering and machine building
industries.
(ii) Expanding the capacity of some of the industries producing
aluminium, cement, chemical pulp, fertilizers, etc.
(iii) To undertake modernization and re-equipment of the major national
industries like cotton textile and jute.
(v) To achieve fuller utilization of available capacity and
(vi) To expand the capacity of the consumer goods industries.

With these priorities, major iron and steel plans were set up in public sector in
collaboration with other countries. Apart from these the industrial development
also included the development of several other medium scale and small scale
units in large scale. The combined effect of all these industrial development was
during this Plan period the index of industrial production shot up to 194 in
1960-61 from a mere 139 in 1955-56.

III Plan: This Plan provided for a big leap in industrial development by raising
the rate of investment to a new peak to strengthen the industry, power and
transport and also to achieve a rapid rate of industrial progress. With this view,
the total investment ear-marked for industrial development was Rs. 3000 crores
in which public sector contribution alone amounted to Rs. 1700 crores. In fact
in this Plan the public sector was given predominant role. Apart from this the
village and small scale industries received a great impetus in the form of Rs.
425 crores of investment by private and public sector. Added to this was to set
up 300 new industrial estates throughout the country. The target for industrial
204
development was" fixed at 14%, though the actual achievement was only 7.6%
per annum. There was overall industrial development and it was thought that
the country could receive the stage of self-reliance.

IV Plan: With a good agricultural output on the eve of this Plan (which coincided
with the start of Green revolution), the industrial development started picking
up. This Plan had specific objectives for industrial development as indicated
below:

1. To fulfill the commitments made for investments
2. To expand the production capacity as required by the future
3. To bring down the level of dependence on import for supplies
4. To exploit the existing internal development to lay the base for new
industries.

With a total investment of Rs. 5300 crores by the private and public sectors, the
Plan provided for the development of large, medium and small scale and village
industries. But during this Plan the achievement was well below the target due
to several factors. Specifically, operational problems in some of the basic
industries, lack of integrated planning, deficiency in design, loss of man-days
due to strikes and lock-outs, decline in demand for industrial machinery,
inadequacy of investment, stagnation in the production of commercial crops,
etc.

V Plan: This Plan started with the emphasis on the following with the objective
of achieving self-reliance and growth with social justice: i. Rapid growth of the
core sector, ii. Encourage development of industries which accelerate rapid
diversification and growth of exports, iii. Increasing the production of industries
which supply for mass consumption, iv. To curtail the production of non-
essential commodities except for export purposes.

With this emphasis the total investment by the public private sectors worked
out to Rs. 10135 crores. The Village and small scale industries received
tremendous encouragement during this Plan and the government reserved
205
production of 124 items for small scale industries. Inspite of all these, the
actual achievement of industrial development was just 5.3% per annum against
a target of S.1% This was mainly because of the capacity constraints in
industries like cement, paper and fertilizer, lack of transport facilities, shortage
of fuel, electricity, low administered price, strained industrial relations,
inefficient management, etc.

VI Plan: This Plan started with a strategy to achieve structural diversification,
modernization and self-reliance. Towards this, the Plan formulated policies on
the following lines:

i. Enhancing the manufacturing capacity in a substantial way covering a
wide range of industries, ii. Giving special attention to the capital goods
industry and electronics industry in particular, iii. In order to meet the foreign
exchange requirements, the exports of the engineering goods and industrial
products would be stepped up, iv. Providing for a combination of the import of
contemporary technology and also development of indigenous technology
through intensive research and development and v. Developing a strategy for
backward regions.

The Plan provided for an overall of investment of Rs. 22187 crores, though the
actual expenditure was of the order of Rs. 30000 crores. However, the industrial
growth did not exceed the target determined due to various reasons, the
important of which are: Power shortage, poor industrial relations and continued
labour unrest, poor demand conditions, lack of concern for improvement of
efficiency failure to give greater emphasis on the technology up-gradation, etc.

VII Plan: This Plan provided for a total investment of Rs. 19708 crores by the
Public sector and Rs. 2752 crores for the development of the village and small
scale industries. Over and above this the private sector investment of a very
huge size was also forthcoming. The Plan developed an industrial strategy with
the following elements:
206
(i) to completely remove the infrastructural deficiencies like power
shortage, by providing for more efficient use of the existing capacity
and also establishing new power plants.
(ii) to encourage modernization of industries especially sugar and
textile industries through up-gradation of technology.
(iii) to determine specific targets for productivity for major industries like
steel fertilizer, paper, cement etc.
(iv) to identify the industries which possess competitive advantage and
then encourage them more to improve their export by making the
export production an integral part of the domestic production.
(v) to encourage the sunrise industries which carry enormous potential
for improving productivity and quality
(vi) to reduce regional disparities in industrial development and also
ensure dispersal of industries by locating new industries in
industrially backward states and districts,
(vii) to extend the coverage of pollution control system in more industries.

An encouraging note during this Plan was that the actual achievement of
growth was very much better than what it was in other plans, against a target
of 8.5% This better growth rate was achieved mainly because of i. better
performance of infrastructural sector, changes in the area of licensing, higher
import of capital goods, higher utilization of the existing capacity, extending of
broadbanding policy to more industries, etc. The overall outlay during this Plan
was Rs. 22148 crores.

VIII Plan: At the start of this plan, the government had taken a crucial decision
to change its fiscal, monetary, trade, industrial and foreign investment policies.
In one word, the liberalization policy was announced. The continued emphasis
on public sector was dropped as it had provided the necessary momentum for
growth and so the private sector initiatives have to be encouraged. The overall
efficiency of the private sector proved that it has come off age and play a greater
role in the economic development. The competitive advantage of Indian
industries should be made full use of and so the private sector is vested with
the responsibility for improving the efficiency and productivity. An open door
207
policy is adopted to facilitate the growth of private sector and also to integrate
the domestic production with the rest of the world. External collaboration, joint
ventures, etc will all be viewed with a main focus on the flow of benefits. The
overall outlay in this Plan was set at Rs. 40673 crores. The Plan has fixed 8.9%
as the annual average growth rate and with the prevailing conditions, this
target appears to be reasonable and achievable.

EXIM Bank and the functions of EXIM Bank The schemes of financing of
the Bank

The Export-Import Bank of India (EXIM Bank) established on 1st January,
1982 is a wholly owned financial institution of the government. It was
established, by an Act of Parliament, for the purpose of financing, facilitating,
promoting foreign trade of India. It is a principal financial institution for co-
ordinating the working of institutions engaged in financing exports and imports.

Chapter IV of the EXIM Bank Act provides: The EXIM Bank may grant, in or
outside India, loans and advances, by itself or in participation with any bank of
financial institution whether in or outside India, for the purpose of export or
import and shall also function as the principal institution for co-ordinating the
working of institutions engaged in financing of the export in such manner as it
may deem appropriate." The Chapter provides further: "The EXIM Bank may
also carry on and transact all or any of the following kinds of the following
business, namely:

(a) granting loans and advances to a scheduled bank or any other bank
or financial institution notified in. the Official Gazette by the
Central Government in this behalf by way of refinance of loans and
advances granted by it for purpose of export or import.

(b) underwriting the issue of stocks, shares, bonds or debentures of
any company engaged in export or import, the Export-Import Bank
of India Act, 1981.

208
(c) issuing bid bonds or guarantees in or outside India by itself or in
participation with any government bank or financial institution in
or outside India.

(d) accepting, collecting, discounting, re-discounting purchasing,
selling or negotiating in or outside India bills of exchange or
promissory notes arising out of transactions relating to export or
import and granting of loans and advances in or outside India
against such bills or promissory notes.

(e) granting, opening, issuing, confirming or endorsing letters of credit
and negotiating or collecting bills and other document drawn there
under.

(f) undertaking any transaction involving a combination of government
to government and commercial credit for purpose of export or
import.

(g) granting loans and advances outside India for any Indian joint
venture.

(h) granting lines of credit to the government of any foreign state or any
financial institution or person outside India for purpose of export
and import.

(i) granting loans and advances to any person in India in connection
with his equity contribution in any joint venture in any country
outside India.

(j) financing export or import of machinery and equipment on lease
basis.

(k) subscribing to or entering into such other dealings in foreign
exchange, as may be necessary for the discharge of its functions.
209

(l) subscribing to, or investing in, or purchasing of, stock, shares,
bonds, or debentures of any country outside India.

(m) opening of any account in any bank in or outside India or the
making of any agency arrangement with, or acting as agent or
correspondent of, any bank or other institution in or outside India.

(n) transferring for consideration, any instrument relating to loans and
advances granted by it.

(o) issuing participating certificate.

(p) subscribing to, or investing in, or purchasing of stock, shares,
bonds, or debentures to the extent necessary for the enforcement of
a line, pledge or other contractual right

(q) undertaking and financing of research, surveys, techno-economic or
any other study in connection with the promoting and development
of international trade.

(r) providing technical, administrative and financial assistance of any
kind for export or import.

(s) planning, promoting, developing and financing export-oriented
concerns.

(t) forming or conducting subsidiaries for carrying out its functions.

(u) acting as agent of the Central Government, any State Government,
the RBI, the Development bank or any other person as the Central
Government may authorize.

210
(v) collecting, compiling and disseminating market and credit
information in respect of international trade,

(w) doing any other kind of business which the Central

(x) government may authorize.

(y) generally doing such other acts and things as may be incidental to
or consequential upon, the exercise of its powers or to discharge of
its duties under this Act or any other law of the time being in force,
including sale or transfer of any of its assets.

Financing schemes of the EXIM Bank:

The present focus of the Bank is on medium term and long term credits.
Whenever a buyer of goods or services exported from India is allowed to defer
payment, an export credit, arises. Deferred export credit is available for the sale
of machinery, manufactured goods and related services. Such credit may be in
the form of Supplier's credit or Buyers credit - Supplier's credit arises when
an Indian exporter extends credit to the overseas buyer and finances himself
through the EXIM Bank. Deferred export credit takes the form of Buyer's credit
when the EXIM Bank extends credit directly to the buyer.
The EXIM Bank operates three broad programs of financing viz. Loans,
Rediscounting and Guarantees. At present the Bank operates nine lending
schemes which are briefly described below

1. Loans to Indian companies:

Direct financial assistance to export: Funds are provided, on deferred payment
terms, to Indian exporters of plant, equipments and related services, which
enable the exporter to extend deferred credit to the overseas buyer. This
programme covers project exports, which could be turn-key
projects/construction projects. Such project exports arise when an Indian
company contracts either to set up on a turnkey basis any textile mill, sugar
211
plant or contracts a construction project overseas. Financing export of eligible
goods is covered under this programme.

Consultancy and technology services: Indian companies can borrow funds from
EXIM Bank and provide deferred credit overseas buyers of Indian consultancy
of technology services.

Overseas investment financing: The bank provides financing, where an Indian
company establishes a joint venture overseas, and requires funds towards
equity participation.

Pre-shipment credit: This programme is available for companies, that have won
an export contract for the eligible goods and are seeking finance to produce the
goods which entails a production period exceeding six months.

Loans to foreign government companies and finance institutions:

This is offered directly to foreign importers for the import of eligible Indian
goods and related services with repayment terms spread over a period of years.

Lines of credit to foreign governments:
Besides Foreign Government, such lines of credit are available to foreign
financial institution. Such lines provide long term finance for import of Indian
capital goods related services.

Relending facility to banks overseas: Relending facility to banks overseas is
made available to enable them finance to importers, for import of Indian capital
goods. Banks overseas would intermediate between foreign buyer and EXIM
Bank, and the latter would intermediate with the supplier.

Rediscounting facility: Under this type of assistance, specific mention may be
made about the following schemes:

212
Export Bills Rediscounting: This lending programme is available to commercial
banks, in India, who are authorized to deal in foreign exchange. Such banks
can re-discount their short term usance export bills portfolio with EXIM Bank.
EXIM Bank provides funds, under this programme, for a period of 90 days
against export bills that have equal period to run, before realization.

Refinance of export credit: Under this programme, commercial banks, in India,
who are authorized to deal in foreign exchange, can obtain from EXIM Bank
100% refinance of term loans extended for export of eligible Indian goods. Such
credit enables Indian Exporters to offer credit terms to foreign Importers. For an
export contract upto Rs. 10 million, commercial banks can obtain financing
participation under EXIM Bank's other programme, including syndication
facility.

Guaranteeing of obligation: The Guarantee programme is available in the case
of construction and turnkey contracts. Construction contracts involve erection,
civil works and commissioning.

In such contracts, an Indian exporter usually requires bid bond, advance
payment guarantee, performance guarantee, guarantee for retention money and
guarantee for borrowings abroad. EXIM Bank participates with Commercial
banks in India in the issue of guarantee.

Various facilities offered by the EXIM Bank to the exporters of different
categories

i) Facility to exporters of engineering goods and turnkey project
exporters:

Deferred payment exports arise when the export proceeds are to be received
beyond six months from the date of shipment (in case of exports to Afghanistan
and Pakistan beyond three months). Turnkey projects arc those which involve
rendering of services like design, civil construction, erection and commissioning
of plant along with supply of equipment. Typical projects include supply,
213
erection and commissioning of equipment for generation, transmission and
distribution of power and plants for manufacture of cement, sugar, textiles,
chemicals, etc.

When an Indian' exporter extends deferred credit directly to the overseas buyer,
the export contract falls under the category of Suppliers Credit. On the other
hand, if a foreign buyer is offered credit by a financial institution or a
consortium of financial institutions in India and the Indian exporter is paid the
export value by the institution(s) concerned, the relative export contract falls
under the category of Buyer's credit.

Supplier's credit: Credit is provided by the EXIM Bank on deferred payment
basis, in participation with commercial banks, to Indian exporters, of
engineering goods and turnkey projects to enable them to extend credit to
importers overseas.

Where individual contract value is not more than Rs. 1 crore banks may provide
the credit and avail 100 per cent refinance from the EXIM Bank.

Overseas buyer's credit: As an alternative to Supplier's credit availed by the
exporters, credit extended by the EXIM bank to buyers abroad with a view to
enable the latter to import engineering goods and projects from India, on
deferred credit terms. Credit to overseas buyers is also available from the EXIM
Bank in the form of Lines of Credit to overseas financial institutions, foreign
governments and agencies, and relending facility to overseas banks.

Pre-shipment credit: Credit is available to eligible exporters to buy raw
materials and inputs required to produce capital equipment that has to be
exported. EXIM bank participates in the credit if the requirement is for a period
of more than 180 days.

Foreign currency loans: Foreign currency loans can be availed of from the EXIM
Bank at market rates to cover purchase/procurement of machinery from third
countries.
214

Technology and consultancy services finance:
Credit is also available to eligible Indian exporters of technology and
consultancy services to enable them to extend term credit to importers
overseas.

Non-funded facilities: Exporters of engineering goods and turnkey projects
abroad arc also provided the following facilities: i) issue of Bid Bonds ii) issue of
advance payment guarantees, iii) issue of performance guarantees, iv) issue of
guarantees for release of Retention Money's and v) issue of guarantees for
raising Borrowing overseas.

ii) Facility to overseas construction project exporters:
Construction projects involve civil work, Steel structural works, as well as
design, equipment supply, erection and commissioning. Typical projects include
electrification and utility, power transmission, pipelines, water resource
management systems, airports, roads, bridges, hotels, housing and erection of
industrial plants. The EXIM Bank offers funded, non-funded and advisory
services to Indian construction project exporters.

Pre-shipment credit:
The Bank finances the exports from India and the preliminary expenses in
rupees relating to the execution of the project. Commercial banks also extend
this facility for definite periods at confessional rates of interest.

Post-shipment rupee credit:
The EXIM Bank enables financing of exports until progress payments are
received commercial banks extend this facility at confessional rates of interest.

Foreign currency loan:
The Foreign currency loan can be availed of from the EXIM Bank, at market
rates, to cover purchase/procurement of machinery from third countries.

Deferred credit:
215
The EXIM Bank provides deferred credit facilities against security for a portion
of the contract covering export of selected items and technical services from
India.




Non-funded facilities:
Exporters of construction projects overseas are also provided several facilities as
explained already.

iii) Consultancy and technology service finance:
Indian companies executing overseas contracts, involving consultancy and
technology services, can avail of EXIM Bank's financing programme with a view
to offer deferred payment terms of their clients. This enlarges the market for
export of Indian consultancy services. The consultancy and technology services
for this purpose include:
a) providing personnel including skilled and unskilled workmen are persons for
rendering technical or other services;
b) Transfer of technology, know how expertise or other skills;
c) furnishing any information, blue prints, plans or advice; and
d) any other activity considered acceptable by the EXIM Bank.

Indian consultants, having corporate status or otherwise who-have secured a
contract for export of services wherein deferred payment term need to be offered
to the client, can utilize the facility.

iv) Lines of credit:
EXIM Bank extends lines of credit to overseas Government of Agencies
nominated by them to enable buyers in those countries to import capital
engineering goods from India on deferred payment terms. This facilities enables
Indian exporters to offer deferred credit terms to customers in those countries
as per terms and conditions already negotiated between the EXIM Bank and the
216
overseas governments. The exporters can obtain payment from the EXIM bank
against negotiation of shipping documents, without recourse to the exporters.


v) Facility for syndication of Export credit risks:
Commercial banks, in participation with EXIM Bank provide long term credit, at
competitive rate of interest, to Indian exporter of capital goods, turnkey projects
and consultancy services, thereby enabling Indian exporters to compete
effectively in the international markets.

The facility for syndication of term export risks lends flexibility to. the export
credit mechanism by allowing banks to assume risks, without blocking their
funds -for long terms, at fixed interest rates, commercial banks can now
support export proposals without impairing their liquidity.

Commercial banks seeking enhancement in their export portfolio can avail of
this facility end participate in the syndication arrangement.

vi) Facilities for deemed exports: .
"Deemed export

occur in case of specified transaction within India which result


in foreign exchange earnings or foreign exchange savings.

Deemed exports involving supply of capital goods and other eligible goods have
access to the EXIM bank's deferred credit facility .at internationally competitive
interest rates. EXIM bank extends credit through the supplier or directly to the
buyer. Intermediating banks/institutions can also avail of refinance facility
from the EXIM bank covering the full value .of the term credit. EXIM bank may,
in addition, provide pre-shipment (working capital) facility, normally for large
transactions involving long manufacturing cycle time.

Other facilities available from the EXIM bank relating to 'deemed exports'
include issue of guarantees and bridge financing in foreign currency. These
facilities are normally availed by project exporters.
vii) Advisory services:
217
Through its International Merchant Banking division, the EXIM Bank offers the
following advisory services:
(a) work closely with Indian companies in designing financing packages for
joint ventures in third countries;
(b) advise Indian companies executing contracts abroad, on sources of
favourable financing overseas;
(c) providing access to Euro-financing sources and global credit sources to
Indian companies engaged in exports;
(d) advise on exchange control practices globally and
(e) advise and design financial packages for export oriented industries in
India

These services are being added to in order that tailor-made financing packages
for high value export contracts are available.

Ministry of Commerce, Government of India, determines the eligibility of
transactions which are to be treated as 'deemed exports. These are published,
from time to time, in the Imports and Export Policy Book.

New export-import policy 1992 - 1997.
The balance of payments position, which had reached a point of near collapse in
June, 1991, slowly stabilized during the course of 1991-92. Although new
policies to deal with the situation were quickly formulated by the new
government and implemented within a few months the external payments
situation took time to stabilize primarily because it had been allowed to
deteriorate to a state o/ near bankruptcy in June 1991. Foreign currency
reserves had declined to $ I.I. billion despite heavy borrowing from the IMF in
1990-91 and a substantial part of this was held in illiquid deposits which could
not have been easily mobilized if needed.
International confidence had all but collapsed, commercial borrowings had
dried up and even letters of credit opened by Indian banks were being generally
rejected unless accompanied by confirmation by foreign banks.

218
The strategy for the management of the balance of payments outlined in the
Budget for 1991-92 which was presented in July, 1991 relied upon a
combination of macro economic stabilization and structural reforms i industrial
and trade policy. It was recognized that in the medium term, the solution to
the balance of payments problem would have to come from a much stronger
export performance, but in the shorter run the strategy had to be underpinned
by mobilization of external financing from the multilateral agencies and from
bilateral donors. Restoration of
access to imports through liberalization had to depend initially upon additional
financing since the export efforts would take time to show results. Since access
to external commercial borrowing was constrained the only other sources of
funds were the bilateral and multilateral agencies. Visible support from the
multilateral agencies was important for restoring international confidence.

Accordingly, the government negotiated a standby arrangement with the IMF in
October, 1991 for 5 2.3 billion over a 20-month period, a Structural Adjustment
Loan with the IBRD of $ 500 million and a Hydrocarbon Sector Loan with the
ADB for $ 250 million. Parallel with the effort to draw on multilateral sources,
the government also launched the India Development Bonds aimed at
mobilizing NRI sources of funds.

With the assurance of external support through these efforts, there was a
gradual stabilization of the balance of payments position in the course of 1991-
92. Foreign exchange reserves were restored to more normal levels increasing
from $ 1.1 billion in June, 1991 to $ 5.6 billion at the end of March, 1992. The
entire amount of drawls from the IMF in 1991-92 with the accretion from India
Development Bonds together amounted to an inflow of S 2.87 billion. This was
less than the increase in reserves of $ 4.51 billion from June 1991 to end
March, 1992. In effect, the exceptional financing mobilized in 1991-92 was used
primarily to build up reserves.

Import restrictions were gradually lifted in the course of 1991-92 as the balance
of payments stabilized. By the end of 1991-92 the new Liberalized Exchange
Rate Management System introduced in the Budget for 1992-93 eliminated
219
import licensing in most capital goods, raw materials, intermediates and
components and introduced a dual exchange rate system with one rate
effectively floated in the market. The Budget for 1992-93 also reduced the
customs duties in line with declared Government policy in order to make the
Indian economy more competitive and gradually exposing Indian industry to
external competitive pressure. The trade and exchange rate policy regime for
1992-93 was therefore characterized by major progress in eliminating
unnecessary administrative and discretionary controls over foreign trade which
were contributing to making our economy uncompetitive.

The year 1992-93 saw a revival of imports to more normal levels. The total value
of imports in US $ in the period April-December 1992 increased by 16.5% over
the level in the corresponding period of 1991-92. The increase appears large
only in comparison with a highly depressed level prevailing in 1991-92. In fact
the level of imports in 1992-93 as a whole is expected to be around $ 25 billion
which is somewhat lower than the level in 1990-91.

Exports in 1992-93 performed far better than in 1991-92. Total export growth
in the period April-December was 3.4% in dollar terms compared with an
observed decline of 1.5% in 1991-92. The performance of total exports is
depressed by the decline of more than 60% in exports to Russia and other
States of the former Soviet Union in 1992-93. The growth of exports to the
general currency area in the period April-December was 11.4%. The average
growth rate in April-December, 1992 has been adversely affected by a decline in
exports of 12.5% in December, reflecting the disturbed conditions prevailing in
that month, figures for January are also likely to be depressed by the riots US $
19 billion. But it is hoped that the export performance in subsequent months
will return to the high growth rates of 15 - 16 per cent observed during
September-November.

The current account deficit in 1992-93 is expected to be around $ 7 billion,
reflecting the revival of imports to more normal levels. This deficit is being
financed through a combination of traditional financing sources and exceptional
financing.
220

However, there are important uncertainties in the balance of payments. The full
impact of the disturbances in December, 1992 and January, 1993 on exports
and imports is difficult to assess at this stage. Clearly, the receipts on account
of tourism would be less than anticipated. The inflow of NRI deposits has in any
case been small this year. The inflow of external assistance is also subject to
some uncertainties consequent upon constraints that affect the rate of
utilization. A step-up in commercial borrowings was, in any case, not envisaged.
Finally, there is the uncertainty arising from leads and lags. Interest rates
and exchange rate expectations do affect the timing of receipt of export proceeds
and payment of import costs. However, while these uncertainties justify a
measure of caution in assessing prospects, the balance of payments in 1991-92
has performed more or less as expected,

New export-import policy 1992 - 1997
On March 31, 1992, the Government announced a new export-import policy for
the period J 992-1997, This policy has the following objectives:
1. To institute the required framework for globalization of the India's
foreign trade.
2. To improve the export capabilities of our industry, the policy aims at
promoting the productivity, modernization and competitiveness.
3. To facilitate improvement of image of our products in foreign markets,
the policy encourages the attainment of high quality in the export
products,
4. By allowing liberal access to raw' materials, intermediates,
components, consumable and capital goods etc., in the international
market, the policy wants to achieve higher exports.
5. The policy provides for deregulation to achieve self-reliance so "that
(he domestic producers can improve then- efficiency and become
competitive internationally.
6. The policy also lays emphasis on research and development as well as
technological advancements so that the domestic producers will
benefit from globalization.
221
7. A significant object is to simplify the procedure for exports and
imports.

Subsequently, the government announced further modification to the above
policy by April 1, 1993. The important features, of this modified policy are:
(a) The duty-free export benefit given to the Export oriented units
and the units in Export Processing Zones is extended to
units engaged in agriculture and allied activities provided
they export 50% of their total production.
(b) The government removed 144 items from the negative fist of
exports leaving only prohibited items, items requiring license
and canalized items.
(c) As a step to tap the potential of farm sector, professionals,
hotels, travel agents and diagnostic centers, the government
extended the Export promotion capital goods scheme to them.
(d) For more than 2200 items, standard input-output norms is
fixed to enable the issue of license under the duty exemption
scheme.
(e) The criterion for recognizing export houses is now based on the
foreign exchange earning to FOB values of physical exports.
(f) The procedure relating to export and import has been further
simplified.
(g) Compensation would be given for unutilized import licenses for
duty free license scheme and EXIM scrip holders.

These provisions in the latest export-import policy would certainly enable India
to improve her exports and bring down imports." This has been experienced
during the first half of 1994 itself.

Public Distribution
1. Meaning and objectives of Public Distribution System [PDSJ
The countries like India with more population commensurate with production of
minimum needs especially food grains, are necessarily in a position to have a
streamlined system of distributing the essential commodities to the population
222
living with lesser purchasing capacity to fulfill the objectives of democratic
government.

As a fundamental Constitutional right, in India the producers and traders of
food grain have the right to do business freely and can earn profit as much as
possible. They were given every right to influence the market by means of
pricing, supply, distribution, etc. At the same time the consumers are also given
rights to protect themselves from greedy traders, who are indulged in
malpractices in trade. It becomes the duty of the government to protect the
rights of both producers, traders and consumers. In our country the
government is liable (o protect consumers and that too consumers who are
living below the poverty level. Consumers who are living below the poverty line
are to be provided their minimum needs. "Poverty is concerned with the
relationship between the minimum needs of people and their ability to satisfy
their needs. "Minimum needs" and the amount of money required to satisfy
their needs" - first its minimum food budget. [Economic and Social Issues -
Leftwich & Sharp]

Gradually out government took steps to safeguard the interest of the population
who are under poverty line and also to improve the growth rate of productivity
in agriculture and industry and trade. These steps led to the dual price
mechanism in market, legislation in pricing and marketing and introduction of
PDS.

PDS is at present functioning for the cause of middle income and poor income
group with consumer orientation. Consumerism has been explained as follows:
"Measures are intended to protect consumers from unscrupulous 'sellers who
presumably charge more for goods and services. Then they are worth to buyers.
The price^ controls on various items fall into this category. These consumers
who can get as much at the controlled price as they would purchase at an
uncontrolled price clearly gains.

The market mechanism may be able to bring about an "equilibrium" between
demand and supply. Even in this sphere, but it will not be able to bring about a
223
balance between need and supply. Planning is necessary to take care of the
poor and down trodden who are for the most part, outside the market system
and have little asset endowment to benefit from the natural growth of economic
activity.

"The market alone cannot ensure employment and a living wage to all our rural
poor" [Prime Minister's statement on 8
th
Plan]

TABLE: 1.1 Net availability of foodgrains in India
Year Population in
Mn.
Net availability of
foodgrain in m.t.
Per capita
availability in gms
1956 397 63 431
1961 442 76 469
1972 562 96 467
1979 659 114 474
1984 738 128 478
1988 799 132 448
1989 816 147 494
1990 833 144 474
1991 849 158 510

[Source: Govt. of India, Economic Survey, quoted by Ruddar Dutt & KPM
Sundaram in Indian Economy, 1993)

The net availability of food production has increased from 63 m to 158 m
between 1956 and 1991, whereas the population has increased from 397 m to
849 m during the same period. To be more specific the greater growth of
population was in the rural areas. It also signified that the share of family
consumption in total food production will increase and much less will be left
over as marketable surplus. This type of deviation, indicated the government to
enter into equitable distribution system of food supply.

TABLE: 1.2 The growth of population and growth of food supply
Year Population in .m. Food Production in m.t.
224
1979-80 659 110
1983-84 738 152
1987-88 799 140
1990-91 833 177
1991-92 849 175

(Source: Indian Economy, Ruddar Dutt & KPM Sundaram)

During the past planning years our country has faced heavy inflationary
pressure. The vulnerable section of the community was very much affected by
the heavy raise in prices. During unproductive seasons the daily bread winners
in urban areas and the rural agricultural landless laborers are the ones very
much affected by the steep rise in prices of essential commodities.

Hence it is the duty of our government to protect the vulnerable class from this
crisis. Thus the government entered into this PDS.

The crop yield in India is very low when compared to other countries. The crop
yield in India is quite disproportionate to the abnormal growth rate of
population needs, Even after Green revolution, which took up the food
production spectacularly, the international, comparison brings a low position of
India. Hence it is the sole responsibility of our government to streamline the
food supply to protect the weaker sections of the society.

TABLE: 1.3 Average yield per hectare [in Qtls.]
Commodity Country 1951-56 1961-66 1987-88
Rice India 8 10 17
China 17 18 35
Japan 26 33 40
Wheat India 7 8 20
China 9 9 30
France 21 29 30
Germany 28 33 68
225
Source: Economic Survey 1990, P ..

The seasonal fluctuations create disparity in the quantum of production. The
growing regional disparity in food production creates an artificial food scarcity.
The amount of food supply and other demand are taken into consideration by
the Central government to fix up the prices. So it becomes important to
distribute the food grains on the basis of population, supply and demand.
Hence it is inevitable on the part of the government to bring a streamlined
system in food production, management for equal distribution.

Food problem and its management become complex and multifarious due to
black marketing and hoarding. These practices create artificial demand for food
supply and reflects as the high prices, the worst sufferers would be the poorer
and middle class people. This paved the way for PDS.

Famine were frequent in the past but rare in the present. Bihar [1965-66],
Maharashtra [1972-73], West Bengal [1974-75], etc., Through PDS government
shall augment food supply to tackle the food crisis. There are certain other
factors which affect the free open market system such as social and political
revolutions. So the government is liable to lay its hand and supply food grains
and other essentials at the cost of affected people.

Fluctuations in prices of food grains affect producers and consumers as well.
The negative effect of price rise will be more severely felt by the weaker sections
of the society. The distribution system should aim at equal and fair distribution
of commodities to the general public.

Quality food is the other criteria taken into consideration by the government.

More than 75% of the Indians cannot afford to pay for quality diet which results
in malnutrition. Adulteration is one of the reasons for poor quality of food
grains. Mass and mushroom growth of slums in Indian cities and their belt
areas also necessitated the PDS. Hence PDS is becoming an essential system in
urban areas.
226

Over crowding and the consequent pressure of population on land hence led to
subdivision and fragmentation on land, decline in per capita area, disguised
unemployment and thus marginal productivity of labour is zero or negative. The
unemployed or under employed gets only seasonal employment only. They are
not getting any personal income. This needs effective PDS.

2. Evolution of PDS in India
Before II World War the deficiency in food production was met out by importing
food grains from Burma, Japan and other countries. During this time the
import of food grain was highly affected. In 1941 the Central government fixed
the statutory wheat price and in 1942 statutory price was fixed for rice also.
The administration of controls was vested initially in the state government. The
3
rd
Price control conference in 1941 led to the interference of the central
government The conference held in 1942 recommended an All India Plan for
distribution of wheat and rice. For further streamlining, a Food grain Policy
committee was appointed in July 1943 under the Chairmanship of TN Gregory
[Food Policy and Economic Development in India, Jospeh, S.C., Madras 1961]

The recommendations of the Committee to bring all major food grains under
statutory price control, calling for Central supervision to supply of food grains
to deficit areas, introducing rationing system in the larger cities with over one
lakh population initially and extendable to other gradually, to all food grains
and all sections of society. Based on the scheme, the distribution of rice was
introduced first in Madras in rationing and then in Bombay.

In 1950 government of India appointed a committee to review the situation
known as Food grains procurement committee. The following were
recommended by that Committee: Effective co-ordination and fo\d production,
distribution system of essential commodities and a good control over the
distribution of the same.

227
In 1950 due to bad crop and steep rise in food grain prices, due to Korean war,
India had to face a slump period. This was overcome by getting a loan of 2 m t
of wheat from USA.
During the First five year plan the government of India had the objective of
reducing the dependence on foreign food and food and was to attain self
sufficiency in domestic production. The series of good harvests in the country
and the consequent decline in food grain prices during I Plan period made the
government to relax the control and later remove it altogether. Food prices
during this period were reduced by 23%


In 1955, the problem of food shortage and rise in prices again emerged. But
soon it was rapid. In 1956 the government of India entered into an agreement
with USA under PL480. USA agreed to supply 3.1 m t of wheat and 0.19 m t of
rice for the next three years. This gave the opportunity for the government of
India to stabilize the price structure.

In 1958-59, the crisis was acute. There was severe food crisis in Bihar, Bombay,
Rajasthan, Tamilnadu, Orissa, etc. In 1959, food grains prices rose to 41% in
the first three years of II Plan. In 1957, the government of India appointed a
Committee to review the food problem called as "Food grains Enquiry
committee" The recommendations were as follows:

1. compulsory procurement of food grains from foreign countries till
a successful policy is framed by the central government of India.
2. it recommended for an organized PDS through a network of fair price
shops and also to maintain buffer stock.

[Dandekar committee report] - about the fair price shop during 1961 -64 the
prices of domestic grains in general continued to rule considerably above the
price at which the imported grains were being issued through the fair price
shops. So the government has set up in 1964-65 FCI to build up buffer stock of
5 m t every year. But it has failed due to two consecutive drought years.

228
During 1967-68, the name of the Fair Price Shop Scheme was corrected into
PDS without arty change in the system of organization. However the PDS came
in full swing during 4
th
and 5
th
Plan. This Plan has recommended the following:
1. It is needed on a regular basis 2. To have an adequate buffer stock system.
Moreover the requirements of the PDS should be met mostly through internal
procurement. Due to shortage of stock in 1973-74, the government had to
import food grains and there was a high rise in price due to this the PDS could
not fulfill its objectives.

In 1975 the government of India appointed the National commission on
Agriculture. The recommendations were: 1. Al! towns and cities with a
population of over one lakh should have a full fledged system of PDS. 2. All
chronically drought prone areas should be covered under PDS. 3. All industrial
town workers covered under all India Consumer Price Index numbers should
have PDS. 4. Areas affected by flood, are to be covered under PDS.

All these recommendations were at a later stage fully implemented and
executed by the government of India. Fifth five year plan was with the aim of
removing poverty and growth of social justice and equality and also attainment
of self-sufficiency' in all areas. Since 1974, the PDS has handled efficiently the
distribution of food grains with FCI. In 1974 the government created a full
fledged system of civil supplies and co-operation to ensure orderly production
and distribution of commodities.

The Central government has developed support organization such as National
Agricultural Co-operative Marketing Federation [NAFED] and National
Consumers Co-operative Federation [NCCF] to undertake wholesale trading.
Sixth and Seventh Plan took steps to minimize the problems of the society to get
basic amenities like education, health care, sanitation, and safe drinking water
food grains. The Seventh plan pays special attention in increasing the
production of food grains, edible oils, sugar, textile and other items of mass
consumption.

229
The Eighth plan aims at the growth of diversification of agriculture to achieve
self- sufficiency in food production and to generate surplus for exports. The
estimated agricultural production during the Eighth Plan is given below.

TABLE: 1.4 ESTIMATED AGRICULTURAL PRODUCTION DURING 8
th
PLAN
91-92 m t 96-97 Annual growth output
Rice 72.5 88 3.95
Wheat 56 66 3.34
Course cereal 30 39 5.4
Pulses 14 17 3.96
All food grains 172.3 210 4.01
Sugar cane 235 275 3.19


8
th
Plan proposed to raise the production of rice, pulses, oilseeds. It Aimed at
self sufficiency and to prevent exports of food grain. The main objective of this
Plan w-s the extension of PDS to in accessible rural, tribal areas, etc.

Evaluation of consumer co-op. Fair price shops
Before 1912, co-ops. Was started in India as Agricultural co-ops. During the I
World War period, a number of consumer stores came up in few important
cities and towns. In 1928-29 there were in a) 323 primary stores in India.
Before H World War period there were 396 stores with 43000 members. During
II World war the dimension of (he objectives of these stores changed. The acute
shortage of food supply during and after the II World War forced the government
to intervene into the functions of consumer co-ops. Then the co-op stores
acted as agencies for the government in the distribution of controlled
commodities to prevent black marketing to ensure equitable distribution. In the
first five year plan the importance of consumer societies was emphasized but it
was not properly implemented. The Second five year plan reiterated the scope
of the development of a network of the co-op societies in urban areas also. A
committee was appointed by the Government to review the functions of these
societies. They have recommended a good organizational set up an" effective
230
structural pattern of consumer co-ops, their size, viability and whole sale stores
promoters, etc.

The Committee differentiated the primary, wholesale and district wholesale
societies and norms specified is given below. (Co-op sector in India - Sami
Uddin, Mafazur Rahman,..............
Share Capital Turnover Members
Primary co-op. Stores 5000 1 lakh 250
Wholesale stores 50000 2 lakh 100 Primary stores are
members
Wholesale stores 100000 300 lakh 200 Primary members

In the 3
rd
five year plan it was observed that 'conditions for the development of
consumer co-ops are generally favourable and if the special efforts are made
rapid progress can be achieved. This will be of greatest help not only on in the
stabilization of retail prices but also in preventing the evils of adulteration in
food stuffs.' After Chinese aggression the government of India felt the need of
co-op. Consumer societies to ensure the supply of food grains at controlled rate
to the home needs. Hence the government provided financial and also
establishment assistance to all co-op consumer stores.
Share Capital Primary Stores Apex wholesale stores
Contribution Rs. 2500 Rs. 50000
Management expenses Rs. 1800 Rs. 6000
Godown contribution Rs. 125000
Rent subsidy Rs. 9000
(Maximum)

(Ref: S. P. Jain President Indian Chamber of Commerce and Industry,
Hindustan Times, Nov. 1962, P 6)

During III Plan period the number of stores promoted were as follows:

More than 1 lakh populated city 113
In towns with more than 50000 population 137
231
District primary stores 4000

During 4
th
5 year plan it was extended to urban areas with population of 1 lakh
and more and stores opened to cover population of over 20% of urban and to
capture at least 20% of retail trade. Co-op fair price shops in rural areas were
also promoted during 5
th
and 6
th
plan periods. 2.12 lakh villages with 15000
societies undertook supply of daily essential goods of life. It rose up to 80000
during 1964-65. During 1973-74 Indian economy has witnessed an
unprecedented inflation of essential goods.

In 1975 the emergency was declared in India and the then Prime Minister
announced the 20 point programme. As per this programme the government
envisaged to provide economic and social justice to common man. Drastic
financial and fiscal measures were taken up against smugglers, hoarders, black
marketers, etc., by the government.

In order to manage that situation, the government of India set up two new
departments of Civil supplies and co-operative section is to coordinate and
harmonize the activities at various levels of the state government and ministry
of the central government for an effective PDS. These new departments have
evolved a broad strategy for an effective PDS.

The strategy evolved with multi dimensional approach, and the vital points are
identification of essential goods for different areas, effective monitoring of
function and of retail prices of consumer goods and essential goods selection of
vulnerable areas for introducing the scheme of public distribution, ear marking
of manufactured goods in the organized sector for distribution through co-
operatives, forging closer links between co-op. Marketing and public
distribution, induction of representatives of consumers, including housewives
in keeping a watch on the PDS, making administrative arrangements to ensure
smooth functioning of the system and a more effective enforcement of various
legislative measures designed to protect the interest of the consumers.

232
Thus co-ops have been given an important place in the PDS. Further essential
items were being supplied to students hostels, universities and colleges on
preferential terms. Accordingly, it has become the policy of the state
government to the possible extent, new fair price shops should be allotted to the
co-ops. And the co-op. Fair price shops. In due course, the central government
advised the state governments that (hey should not deal directly with the
manufactured essential commodities and should use the consumer co-ops as
an agency to distribute the commodities.

The 6
th
and 7
th
five year plans of government of India had followed an integrated
approach and paid attention not only to production and procurement but also
to storage and transportation of selected commodities. Further the plan insisted
to expand PDS quickly to cover all areas of the country, particularly backward,
remote and inaccessible areas. Hence the government of India instructed all
state governments to extend PD points inmost difficult inaccessible areas. The
government of Tamilnadu took steps to open additional fir price shops in the
said areas and also took steps to develop the infrastructure needed to open fair
price shops in those areas.

From 1992, an additional quantity of 830 t of rice per month were issued in
these areas under special subsidy scheme. Government of India reduced the
issue price by Rs. 50 per quintal to these areas. Government India also bears
Rs. 25. per quintal as incidental cost for effective distribution to tribal areas.

The price per quintal charged by Tamilnadu Civil Supplies Corporation ltd.,
after adjusting central contribution is given below:
Rice Central pool price Tamilnadu PDS price
(per quintal in Rs.)
Common 337 512
Fine 617 592
Super fine 648 623

The price in PDS is comparatively lower than the price under central pool. Four-
; Kgs. Extra quantity of rice were given to card holders in tribal area in addition
233
to general quota prescribed in other areas. According to integrated
Tribal development. Programme, the issue price of rice is as follows in Tribal
areas in Tamilnadu
Rice Before 1.2.94 (per
kg.)
After 1.2.1994 (per
kg.)
Common 2.25 3.25
Fine and Superfine 3.50 4.75
Wheat 3.05 3.80

In order to protect the weaker sections of the society the government has
further reduced the issue price of food grains by Rs. 50 per quintal by July
1994. The government of Tamilnadu consequently ensures minimum
availability of 20 kg. Per person per month and per family in those areas, which
are predominantly tribal and remote.

According to the report of the Ministry of Civil supplies, the government of India
between April, 1993, to March 1994 over 4000 tonnes were lifted by states in
the revamped PDS. With an off take of 85% After 1995 April, the position
improved to 100% State governments are advised to integrate the schemes such
as Jawahar Rozgar Yojana employment assurance scheme, wage employment
programme, etc., along with issues under PDS. This indicates that the PDS has
given very little to the poor. 'The responsibility of the revamping system will be,
if there is true targetting. Targetting in terms of keeping high income group
away from PDS." The poorer class should be taken care of by the PDS fully.
[RamManohar Reddy's article in The Hindu, 12.7.194]

Further Chief Minister of Tamil Nadu said "It is not enough to associate women
in the vigilance panels alone, the shops should be made to be entirely manned
by women." [The Hindu dt. 12.7.1994] She appealed to women to adopt the PDS
as a people's movement since it was an essential movement.
The structure of Organization: It has the following components: Central
government, FCI, State government and Tamil Nadu Civil supplies corporation
ltd., Co-operative societies, Link co-operative societies, Fair price shops, Village
primary co-operative societies.
234

After the famine in 1962 the Central government took pains to tackle the
problem of food supply. Thus according to the 5 year plan, the government had
proposed to streamline the ration supply of essential commodities. One of the
main objective of the central government was to maintain a sufficient amount of
buffer stock. With this view the government of India promoted a separate
company known as food corporation. FCI is procuring food grains during heavy
harvest seasons and supplies to all over the country. Later during shortage of
food supply civil supplies was

The food supply was fairly maintained by the FCI though PDS. FCI is
maintaining their own purchase points, hulling and processing points, etc., all
over the country. The government of India has appointed a Commission for the
analysis of Agricultural Prices. This commission fixes the price considering the
cost of production, cost of fertilizer, labour cost, cost of seeds, cost of scientific
implements, transportation cost, etc.

The role of Civil supplies and consumer protection
The government of Tamil Nadu has a separate department and a ministry of
Civil supplies. If is under the control of a minister of food and civil supplies. The
policies and other objectives are effectively implemented through the ministry.

Policy and aim of Civil supplies department: To ensure that food articles and
essential commodities 'are supplied in adequate quantity: To ensure that
essential commodities are available at fair price. To supply adequate quantity of
essential goods at an affordable price to all low and middle income group people
m the country and to protect them from black marketers, hoarders, etc.

Main function of civil supplies department:
Consumer education is the main aim of the Government of India. By publishing
pamphlets, dialogue and visual media through TV, movies new papers,
government bulletins; etc., Civil supplies department co-ordinate the activities
of officials so that the essential "commodities will be available at fair price. It
has taken steps to maintain uniformity in the price allover the state, equitable
235
distribution of commodities. Procurement and distribution of commodities are
entirely at their disposal. Civil supplies department is empowered to issue
licenses to traders, who are dealing in commodities: They regulate their market
dealings and has the right to take steps against the black marketers, hoarders,
etc., thus maintaining a strong and good PDS. In TN there is a Commissioner
for Civil supplies controlling al districts. Below the rank of Commissioner there
is one Joint commissioner. A district is divided into several zones, which are
under the control of Deputy Commissioners. There are Assist Commissioners,
in the rank of Deputy collectors. These officials are controlling the issue 2nd
use of family cards and supply of essential commodities through family cards.

They play the role of inspecting authorities in the free flow of public
distribution. Commissioners of civil supplies in Tamil Nadu is apex enforcing
authority of government policies and laws in the state regarding food supply.
Out of the total 1150 shops, 318 are managed and owned by TNSC ltd., and
832 run by co-ops. In Madras



4. Problems of PDS
Problems experienced under PDS in Chennai city reported by the sample
respondents are classified source-wise and presented below.

Problems at the PDS shop levei
1. The allotment order for issue of commodities from the godown is
issued regularly in the case of TNCSC ltd., while it is delayed in the
case of Co-operatives because the TNCSC ltd., the allotment is directly
made by the Food Corporation of India while for the Co-operatives it is
done through the Civil Supplies department. Allotment to Co-
operatives is made only when the payment is made before the' liftment
of commodities. In the absence of regular allotment and supply of
essential commodities, consumers suffer and they have to make
several trips to the respective: shops: to draw their requirement.

236
2. In the absence of sizable quantity of commodities are lost through
pilferage, damage by white ants, rats, rodents, etc While TNCSC ltd.,
shops experienced this problem to a limited extent, the shops in the
co-operative segment reported this as a serious. problem. Poor storage
facilities affect the quality of commodities, which drives the public
from the PDS shops. As a result the objective of the PDS is defeated.

3. One of the important problems stated at the shop level was the non-
issue of the essential commodities. But the surveys revealed that 72
per cent of the non-issue was due to the failure of the card holders to
draw their requirement.

4. Under weighment is one of the standing complaints against the PDS
shops. But most of these complaints are not properly registered in the
complaint book. This is because the consumers are illiterate and not
aware of the existence of such complaint book. This is because the
consumers are illiterate and not aware of the existence of such
complaint book. Another reason for not registering the complaint is the
consumers do not want to incur the displeasure of the shop employees
and face consequences of complaining.

5. Though the rules governing the administrating of the PDS shops
provided for punishment of erring staff and actions against any
malpractice, in more than 80 per cent of the cases no punishment was
added. This is because of the Trade union interference, political
pressure, inconvenience which will be caused to the customer due to
the closure of shops, corruptive practices etc. The examination of the
reasons for the prevalence of such malpractice among the staff in PDS
shops revealed that the salary for the staff is very low and the several
of them are not regularized in their services.

6. An important problem at the shop level is the security risk faced by the
shops located in slum areas and other violence prone areas. They are
under, constant threat from anti-social elements.
237

Problems of consumers
1. As no credit facility is extend by PDS, poor people, who are the target
segment never get the benefits of PDS. Illiteracy coupled with poverty
make them pledge their ration cards with the pawn brokers or other
shop keepers, who in turn draw essential commodities from PDS shops
using these ration cards, and sell the essential commodities at open
market prices.

2. A serious problem reported by the consumers is the underwieghment.
Nearly 40 per cent of the consumers of TNCSC ltd., shops and 90 per
cent of the consumers of shops in Cooperative segment reported this
problem. This brings to light the poor performance pf the PDS shops,
which has a great impact on the overall performance of the PDS.

3. Indirectly, the consumers of the PDS shops are themselves responsible
for the ills of the PDS. The failure of these consumers to draw their
allotted quota of essential commodities facilitate all malpractices. The
consumers cite poor quality of commodities, underweighment,
inconvenient location of shops, absence of credit facility and non-
availability of commodities in times of need as the reasons. But this
leads to several other problems like, deterioration of quality of
commodities, forced diversion of commodities to unauthorized persons
through duplicate cards or cards on which only sugar and kerosene
alone are bought.

4. To control the malpractices at the shop level, government has provided
for a complaint register in each PDS shop. But the study, revealed that
more than 40 per cent of the consumers are not aware of the existence
of complaint register with the PDS shops. Even though the other
consumers are aware of this facility, only four per cent of the complaints
are registered. The reasons stated for this are: fear of consequences like
protracted disputes with the staff concerned at the PDS shops, need .to
establish the basis of complaint, time taken for enquiry, etc.
238

Problems of Officials of PDS
1. Issuing of cards is reported as a very difficult work as it involves a multi-
stage operation involving issue of application, receipt of
application, verification through enquiry and spot inspection,
preparation of cards and issue of cards. Deliberate concealment of
vital information like income details, size of family, correct address, etc.
pose severe hurdles in the issue of cards. Added to these, the
upcoming of new residential colonies and slum area pose a challenge to
the officials in the verification of genuineness of the applicants.

2. Delay in the allotment to co-operative shops cause a serious of other
problems. Delay in allotment, and liftment add, to the woes of the
officials of PDS. This results, in delay in distribution infuriating the
consumers of these shops.

3. Malpractices at the-shop level is another serious problem reported. In
the absence of registered complaints no concrete and corrective actions
could be taken. Whenever such actions are initiated, the political
intervention and union threats make, them inactive.

4. Funds management is another problem of the officials of PDS. The
source of income for these shops is the commission earned on quantity
sold. With this the salary payable to staff, improvement of facilities at
the shops like storage, issue counters, security for goods, etc., have to
be managed. The necessity to make advance remittance to lift the
controlled commodities from the godowns add to the financial
difficulties.

5. Labour problems of different types at the PDS shops are experienced.
For instance, aggressive unions stand in the way of any disciplinary
action against erring staff; adoption of pressure tactics to get the
regularization of service of laborers, demand for higher pay and
allowances, etc.
239

Policy options
The evaluation of PDS with reference to the objectives set for the study revealed
the need for formulating policies on various aspects. These are suggested
hereunder.

Suggestions for shop level problems: '
1. One of the primary need of PDS is the objective evaluation at regular
intervals by an external body. Such an evaluation would bring to light
the problems crippling the PDS, and once the problems are identified,
they could be eliminated at the root itself, instead of allowing them to
assume unmanageable proportions. This evaluation process could be
handled by a Committee consisting of representatives of all interests -
card holders, shop officials, policy makers, academicians, finance
professionals and lawyers: The membership 'in the Committee should be
strictly based on the credentials and exposure in such tasks. The
Committee shall be constituted fresh once in two years, to avoid any
scope for influence or interference. The policies formulated by the
Committee shall be publicized and public are implemented, the follow
up action shall be called for a monthly basis.

2. One of the basic problems of the shops in the Co-operative segment is
the delay in the allotment. Efforts should be taken to study the system
of allotment and eliminate unnecessary bureaucratic delays. The Food
Corporation; of India (FCI] could be made, to supply directly to all shops
thereby avoiding the delay. The allotment to shops for a month may
continue to be on the basis of closing stock of the previous month, but
the closing statements from each shop should be collected within
first/two days of a month and consolidated area-wise. This would
facilitate pooled shifting of commodities from the FCI godowns thereby
economizing on transportation and avoiding delay. As regards the
verification of closing stock, staff could be deputed from shops in
another area to avoid any manipulations.

240
3. A major hurdle in. the successful functioning of Co-operative shops is
the availability, of funds. This could be solved by implementing the
following suggestions:
a) Shops in an area could be grouped and the shop in-charge of each
shop could be made to undergo a training in funds management.
This training could be on a regular basis involving Finance
professionals.

b) State government may consider granting financial assistance for
the shops in the Co-operative segment on concessional terms
through the Regional office of these Co-operative shops. A
proposal for development plans shop-wise may be obtained and
evaluated by the Regional office. Then the required funds may be
obtained and allotted to each shop. As regards the repayment the
shops could be allowed to sell controlled items to generate
revenue. Priority in this regard, should be given for improvement
of; storage facilities at the shop level.

c) The advance remittance to be made for allotment of commodities
by FCI could be determined in advance on the basis of three
monthly average allotment, instead of waiting for the closing stock
statement each month. Any excess, advance remitted may be
adjusted against the subsequent remittance and any deficit may,
also be collected once the amount of, deficit is intimated. This
would help to avoid delay in allotment and liftment of
commodities. Consequently; the diversion of commodities to
generate required funds, could be reduce to large extent. Further
the quality of commodities, would also be maintained as with
government funding the storage facilities could be improved.

4. Wide publicity should be given among the public, especially among
people dwelling in slum areas to make them conscious of their right to
complaint against any malpractice at the; PDS, shops achieved by
printing in, bold letters, the information on the availability of complaint
241
book in all the PDS shops. This could very easily be achieved by printing
in bold letters, the information on the availability of complaint book in
all the PDS shops, on the e ration card itself.

5. A frequently reported problem at the shop level is the labour, problem.
This needs an integrated effort to solve. Apart from involving the & staff
union in labour related matters, the reasons for the problems should be
studied seriously. This may even be entrusted to the Committee
constituted for evaluation of PDS shops. As the main reason for labour
problem is related to service conditions and the salary structure and
other allowances, the government must recommend the salary structure
making it flexible to provide for modifications as and when the need
arises. At the Regional level, establishment of a separate cell to address
the labour problems would go a long way to improve the working
relationship.

Suggestions for card holder related problems:
1. As regards the problem of under weighment, a multi-level approach is
necessary to solve this. A flying squad with necessary powers and
authority may be constituted which would check the weighment at the
shops periodically and submit a report to the authority concerned. Any
punitive action taken on erring staff should be, strictly in accordance
with the procedure laid down by the government. In the case of
complaints from card holders, their identity should be kept
confidential. This would encourage, the card holders to come without
any apprehension, whenever any manipulative practices are noticed.

2. Any unauthorized issue of controlled commodities should be viewed
very seriously. The shop level workers should be made familiar with the
series of actions that would be initiated in the event of such
unauthorized issues. Preferably an undertaking from the shop level
staff could be obtained at the & time of recruitment itself, explicitly
empowering the organization to prosecute them for any such violation
of rules and regulations. Publicizing the manipulative actions resorted
242
to by shops would also serve as a deterrent -apart from educating the
customers.

Suggestion for problems of Officials of PDS
1. The effectiveness of the PDS depends on the fool proof system of issue of
cards. In this regard, the existing system of verification and cross
checking are found to be operating well and these could be reviewed from
time to rime. It would also be better to get an undertaking from the
employers to the correctness of salary details in the application for cards
renewed or new cards issued.

2. Issue of new cards or renewals to applicants in new residential localities
or slum areas should be strictly under the supervision of a field
inspection team headed by a person at the Assistant Commissioner level.

3. Wide publicity about the malpractices at the shop level should be given
to educate the public and encourage them to register complaints.

4. Recruitment of staff at every level should be structured and preferably
handled by an independent government body to eliminate any favoritism
in recruitment,

Other suggestions
1. It would be a healthy practice to encourage independent study of
functioning of PDS in different states so as to improve the existing
system in any state. Interaction with the academic bodies on this would
be much rewarding to strengthen the system.

2. Publication of the functions and performance of PDS in the state would
help to invite suggestions for improvement from the common public.

3. While the policies are formulated, involvement of all interests like card
holders, shop level workers and officials should be called for. This would
help in drafting viable policies.
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4. Incentive schemes could be announced at zonal level for shops which
function efficiently. The criteria for determining the performance could be
generated by involving the people concerned.

5. Similarly incentives and promotion could be announced for flying squads
which are effective in detection and elimination of malpractices at the
shop level.

6. There is an urgent need to constitute Card holder's council in each area
which would help to resolve the disputes of various nature among the
public and shops in that area Disputes beyond the powers of the Card
holders council could be referred to higher level authorities for disposal.

7. Professionals from different fields may be invited to function as the
Honorary Consultants to improve the efficient functioning of the PDS.

8. Card holder contact week could be organized every quarter to provide a
forum for ventilating their grievances and making suggestions for
improvement. These meetings should be held in the presence of Deputy
Commissioners and the suggestions given should be examined and
implemented.

Price controls
Price control refers to the policy of the government to monitor and regulate the
price changes in an economy. This is attempted by the government with the
following objectives:
1. To ensure that there is social and distributive justice. The fruits of
planning and development should reach all the people so that the
benefits of development is equally distributed. While the rich people in a
community have the wherewithal to protect themselves under any
eventuality, the poor and down trodden always get exposed. To protect
such people price control is essential.

244
2. To ensure that people get quality goods at a reasonable price. This is
achieved by controlling the price as well as the quality of the
commodities produced.

3. To protect the community from the exploitative tendency of the
monopolies who resort to restrictive trade practices.

4. To achieve supply control and management the government should
control price.

5. As the price of inputs would ultimately get reflected on the output, [here
is a need to control both the input price and output price.

6. To ensure that the available resources are properly allocated and directed
and also to eliminate the misuse of resources, price control is necessary.

7. Unless there is price stability, the value of money is bound to; fluctuate
which in turn, affect the exchange, rate. This results serious balance of
payments problems.

8. To insulate the economy from wide fluctuations, inflation and deflation -
price controls are necessary.

Agricultural price policy of the government:
Terms of trade refers to the relative changes in prices in two sectors, and the I
corresponding effect of these on the respective sector. For example, suppose the
agricultural prices increase at a slower rate than the prices in the
manufacturing sector and industrial sector. Then the agriculturists have to pay
a higher price for manufactured goods and sell their own goods at a lower price.
This is certainly unfavorable to the agriculturists. On the other hand suppose
the agricultural prices increase at a higher rate than that of the industrial
prices, then the situation is favourable to agriculturists. Usually in developing
countries the terms of trade is unfavorable to agriculturists and India is not an
exception to this. To change this trend, government has been announcing its
245
agricultural price policy so as to ensure that the terms of trade does not
deteriorate. Thanks to the steps taken by the government that today to some
extent the terms of trade is better than what it was in the past. The logic behind
the government trying to design a policy in favour of agricultural sector is that
when the agricultural sector is benefited by the terms of trade, then the
agriculturists get better prices and this makes their occupation profitable. This
would encourage them to demand, more of industrial goods. Automatically the
industrial sector will be able to develop based on this ever increasing demand
and market prospects It is always said that demand is a more potential factor
in accelerating growth of industrial sector than the supply. Hence, the
government is formulating the agricultural price policy to make me terms of
trade better and favourable for agricultural sector.

The price policy for agricultural sector in India could be discussed in two
distinct phases. One before 1965 and the other after 1965. Before 1965, our
agricultural price policy was more consumer based. As the percapita income
was low, the government felt the prices of agricultural goods should be
controlled and when they have to be distributed through fair price shops, the
consumer price was very much less than the open market price. This directly
affected the interest of the agriculturists. Hence, the government decided to set
up in 1965 the Commission on Agricultural Costs and Prices (CACP). This
CACP has the following major functions to perform:


1. To function as the advisory body to government in matter- relating to
price policy for major food crops and commercial crops to formulate a
balanced and integrated price structure taking due care of the
producer's and consumer's interest.

2. To review periodically the price policy already determining and then
make necessary adjustments and revisions to make the price policy
effective.

246
3. To examine the existing method* of determining cost of marketing and

marketing margins for different crops in different regions, so as to make
suggestions for reducing marketing costs and margins to ensure that
the" producers get a fair return on their investment.

4. To make regular review of the studies on agricultural prices and collect,
information and data relating to agricultural prices and to suggest
methods of improvement.

5. To study and advise the government on all matters relating to
agricultural production and prices referred to it by the government.

With the setting up of the CACP, India is able to follow a consistent price policy,
for agriculture. This has helped to narrow the gap in agricultural prices
prevailing in surplus and deficit states and stabilize the price of food grains.
The CACR

follows a specific procedure before giving shape to the price policy for
crops. First it collects the opinions and information from various State
Governments, the producers organization, marketing organization and other
agro-based industries, consumer organizations, research institutions and
others through a detailed, questionnaire. Once the reply is received from the
State governments, the CACP hold discussions with other agencies for each
commodity. Then it finalises its findings and recommendations and sends its
report to the government. This report, is circulated among the concerned
ministries and departments as well as Planning" Commission. After getting the
views of these institutions and organizations, the final report is submitted to the
Parliament for its approval and final decision. The agricultural price policy has
the following constituents:

1. Minimum support price:
This is the price announced by the government for various crops well in
advance of the harvest. If the actual market price falls below this level, then the
government has the commitment to buy the quantity available for sale
irrespective of the ruling price in the market. This is basically to ensure that the
fanners are not affected due to fall in price in the market. The CACP arrives at
247
this minimum price for each crop after taking into account the cost of
production, input prices, the prices for competing crops and the need to
maintain the economic stability. Once the price is announced well before the
harvest, the expectation is that the farmers are certain atleast to get the
minimum assured by the government. But a major problem in arriving at the
price is that sufficient data are not available on a continuous basis. To
overcome this the data relating to cost of production and input prices are being
collected regularly by the research institutions throughout the country from
whom the CACP is collecting the data.

2. Procurement prices:
These are prices at which the government buys the agricultural produce from
the farmers mainly for the purpose of public distribution. It is easy to
understand that the procurement prices should be higher than the minimum
support price, so that the government can encourage the fanners to sell the
produce to the government. The CACP arrives at the procurement prices for all
crops on the basis of input prices, price of related crops, inter-state disparities
in prices of the produce, fair return to the farmers, etc.

3. Public distribution:
This is in fact the back bone of the pricing policy in that through this
arrangement the government ensures availability of produce to the common
man at a reasonable price. Through statutory rationing as well as the informal
rationing the government achieves the object of stabilizing the prices of
agricultural commodities. At the same time the government also allows the open
market in all these commodities so that any one who can afford to pay the open
market price can buy these goods and those who cannot afford can get these
from the ration shops or fair price shops.

4. Minimum buffer stocks:
This is yet another important constituent of the price policy. Through this the
government maintains sufficient stocks to prevent any violent price fluctuations
in the market for agricultural produce. For example, suppose the price in the
open market soars up, then the government would release the produce from its
248
stock and brings down the price while when the price in the open market goes
down, the government makes the purchase to add to its buffer stock, thereby
prevents further fall in price.
All efforts to maintain the agricultural price have not been successful due to the
following reasons:
(i) Procurement policy of the government has not been very successful and it is
found that hardly 15% of the total food grain produced is covered by the
procurement of the government. This shows clearly the inadequate,
effectiveness of the procurement policy.

(ii) The prices fixed for the various crops do not have any link with the rising
cost-of cultivation. As a result the farmers incur loss. This they avoid or
minimize either by curtailing the output or switching on to some other crop.

(iii) The public distribution is found to have several loop holes. Right from the
stage of procurement, storage, till the stage of sale through fair price shops'
several malpractices are noticed. The result, the public distribution fails to
bring the benefits expected of it.

(iv) Consumers often complain that the price they pay is much higher than the

price paid to the farmers by the government. This price differential is due to
various taxes and costs incurred apart from the margins claimed by the;
intermediaries. As a result the government plans for price stabilization taking
the price it pays to the fanners, while the actual price at which the consumers
pay is much in variation. Hence, the price policy objective is not accomplished.

(v) The objective of price policy is to obtain an integrated price by taking into
account various components before arriving at the final price. But such an
integration is not found in practice and more frequently, the farmers use
political pressure to get a higher price for the produce. This defeats the
principles on which the price policy is formulated.

In order to rectify the defects in the price policy, the following suggestions are
made:
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1. The minimum support price fixed by the government should protect only
the efficient producer and not just every producer.

2. The price policy should only help the farmers to prevent the losses and
not to make profits.

3. The minimum support price should be arrived at on the basis of the cost
of cultivation of efficient farmers.

4. The support price announced by the government should enable the
farmers to make necessary adjustments to minimize their loss.

5. The price fixed by the government should not be inflationary in nature.

6. The price policy should help to discourage and eliminate oligopolistic
practices in the market.

The government on its part, having realized the need to revise the basis of
arriving at the cost of cultivation figures, set up a committee under the
chairmanship of Hanumantha Rao in 1990 to suggest an alternative
methodology for computing the cost of cultivation. This committee suggested
the following revised methodology which was accepted by the government:
I. The wages paid to the laborers included in the valuation of labour
could be based on either the statutory minimum wages or actual
wages whichever is higher.
II. Managerial element is valued at the rate 10% of the total cost.
III. The procurement price and the minimum support price announced
in advance could be adjusted according to the actual in the market.

With all the above development, we are slowly coming closer to the
determination of a realistic price for agricultural produce. But a very recent
development is now posing a new challenge. The Dunkel's draft has suggested
that the government should slowly withdrew all the subsidies extended to the
agricultural sector that the farmers should be made to compete with each other
250
and also the international farmers purely on the basis of the quality of the
produce. The protection given to the agricultural sector should slowly be
withdrawn that only the efficient farmers; can continue in the fold and that way
the country would be benefited. Though there is some truth in this argument,
yet, in our country liberalization is catching up, in the industrial sector and the
agricultural sector is not matured enough to react positively to liberalization
policies and there is a school of thought that the acceptance of Dunkel's draft
may make the situation difficult for the Indian farmers, in spite of the
government's assertions to the contrary.

Foreign exchange regulations
Foreign exchange refers to the earnings and payments made by a country on its
exports and imports of goods and services over a year. The more the country
earns, the better it is. There are several sources through which the foreign
exchange flows into a country. Apart from the exports of goods and services,
there are remittances made by the non - residents Indians living abroad, other
countries making payments to their consulates and embassies, gifts and grants
from other governments to Indian government, loans and advances received by
Indian government, other adhoc receipts under various heads, etc. Similarly,
the if outflow of foreign exchange would include the corresponding payments
made by any source in India to countries abroad. Over and above all these
official sources of inflows and outflows, there are several other unofficial
resources, of inflows and outflows. In fact, the government can control
effectively the official sources but the unofficial sources remain outside the
government control and so 4-they cause havoc to the economy. There is a need
to control and regulate the foreign exchange resources, as otherwise, they might
have a direct impact on the exchange rate and the balance of payments
position, which, in turn would affect the internal price stability. Hence after
independence, the government passed a Foreign exchange regulation Act in
1947 which was subsequently modified in 1973.

The following are the objectives of regulating foreign exchange:
To conserve the foreign exchange resources.
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To account for all inflows and outflows of foreign exchange to eliminate
any negative impact on balance of payments and exchange rate.
To monitor, control and channelising the utilization of foreign exchange
resources and through that to accelerate the economic development

As per the regulations, RBI is the institution vested with all powers to deal with
all aspects of foreign exchange. Normally, the RBI empowers travel agencies and
the commercial banks to deal with foreign exchange. They are required to
submit returns on a daily basis so that the extent of foreign exchange received
and issued is closely monitored. The 1991 Industrial policy resolutions had
specific provisions relating to foreign exchange regulations. These are briefly
summed up below.

Foreign investments:
Foreign investments carry with it the benefit of technology transfer, marketing
expertise, modern managerial techniques and new possibilities for promotion of
exports. As this requirement is felt in this world of industrial change and co-
operation, the New Industrial Policy (NIP) has clearly contained the following
provisions relating to foreign investments:
1. In high priority industries approval will be given for direct foreign
investment upto 51% foreign equity and all the bottlenecks in this
process will be removed. Clearance in such cases will be given if the
foreign equity covers the foreign exchange requirements for imported
capital goods. The necessary amendments to the FERA will be made.

2. The general policies governing the domestic units in regard to import of
components, raw materials and intermediate goods and payment of
know-how fees and royalties will also be applicable to the high priority
industries in which foreign investment is limited to 51% However, the
payment of royalty will be routed through the RBI to enable it to monitor
the outflow of foreign exchange on payments are balanced by export
earnings over period of time.

252
3. All the other foreign investments not included in the category 1 stated
above will require prior clearance.

4. Trading companies primarily export oriented will also be permitted under
the foreign equity proposals as indicated in 1 above. However, the
provisions of he export-import policy applicable to the domestic units will
also be applicable to such trading companies.

5. To encourage substantial inflow of foreign investment, a Special
Empowered Board would be constituted. This Board would negotiate with
the large international firms and approve direct foreign investment in
select areas. This is expected to fetch foreign technology and open the
industries in India to wider world market Such investments will be
subjected to favourable treatment based on the merits irrespective of the
rules, regulations and procedures in practice.

As regards foreign technology agreement, a welcome change in the outlook of
the government is the realization that the sophisticated technology from abroad
can be brought in only through liberal and less restrictive procedures and
policies. The interference of the government in this regard is to be reduced so as
to enable the domestic industries in achieving a high rate of industrialization.
As a result of this liberalization, automatic approval for technology agreements
related to high priority industries will be made with respect to certain specific
parameters. Other industries which can enter into such agreements without
incurring the expenditure of foreign exchange will also be extended liberal
treatment. The industrialists are left to themselves to decide and enter into
foreign technology agreements depending upon the commercial viability of their
enterprises. In due course this measure is expected to pave the way for
exchange of superior technology from India with other countries. With the
overall liberalization, the competition will be high and it is expected that
industries will invest much more in research and development activities.
Keeping in view all these expectations, the government has announced he
following changes in regulation governing foreign technology agreement:

253
1. No prior permission is needed for hiring foreign technicians, foreign
testing of indigenously developed technologies. Such activities involving
payments will be governed by the guidelines of the RBI and such
payments can be made through blanket permits.

2. Automatic permission will be given for foreign technology agreements
relating to the high priority industries. The royalty payments through
such agreements will be subjected to certain provisions. Upto the
payment of Rs. 1 crore royalty will be at the rate of 5% for domestic
sales and 8% for foreign sales or exports. However, the total royalty
payment should not exceed 8% of the sales over a 10 year period from
the date of agreement or 7 year period from the date of commencement
of production.

3. In case of industries not covered in the high priority list automatic
permission will be given for technology agreement provided it does not
entail any foreign exchange payment commitment.

4. In all the other cases, the general procedures in practice will be adhered
to and such industries will require specific approval.

In 1999, some more modifications were brought in the Foreign Exchange
Management Act [FEMA]. These modifications are to come into effect from May
31, 2000 and until then the Enforcement Directorate was given time to probe
and investigate all cases of FERA violations. The basic difference between FERA
and FEMA is stated by the RBI as ; the object of FERA was to conserve foreign
exchange resources, whereas the object of FEMA is to facilitate external trade
and payments and to promote orderly maintenance of foreign exchange market
in India. FEMA has the following important features:
FEMA substantially liberalized various provisions to make the
external trade and payment very simple, which, specifically
benefited .the residents traveling for business / professional
reasons.
254
The Exchange Earners' Foreign Currency account holders and the
Residents' Foreign Exchange account holders are now permitted to
freely use the funds held in both the categories of accounts for any
permissible current account transactions.
The rules relating to foreign investment have been made more
transparent.
FEMA provided for civil procedure in cases of violation and
contained elaborate redressal machinery for total justice and
fairness to the aggrieved persons.
The FEMA also prohibited seven categories of current account
transactions in lotteries, banned magazines, football pools,
narcotics, etc,

Technology Transfer
Jawaharlal Nehru was responsible for the improvement of Science and
Technology in India. Under his leadership several research institutions like The
Council of Scientific and Industrial Research [CSIR], Department of Atomic
Energy, The Indian Council of Agricultural Research were all established. These
were followed by Department of Electronics, Department of Space Technology,
the Indian Space Research organization, etc. In 1958 the Science Policy
Resolution was passed with the objectives to:
Foster, promote the sustain by appropriate means the cultivation in
science and scientific research in all its aspects - pure, applied and
educational.
Ensure an adequate supply within the country of research scientists of
higher quality and recognize their work as an important component of
the strength of the nation.
Encourage and initiate with all possible speed programs for the training
of scientific and technical personnel on a scale adequate to fulfill the
country's needs in regard to science and, education, agriculture, industry
and defense.
Ensure for the people of the country all the benefits that can accrue from
the acquisition and application of scientific knowledge

255
Following this policy, on the agricultural front, the country witnessed Green
Revolution, which made the entire world turn to India for its experience and
experiments in agriculture. The success achieved was phenomenal that
production and productivity increased manifold. But correspondingly the
irrigation and other infrastructure facilities like storage facility, transport,
communication, etc., developed slowly. For a long time, there was absence of
effective linkage between the scientific laboratories and the fanners. But this
was overcome by early 1970's and since then Indian agriculture has been on
the forward march.

On the industry front, though there was wide talk about self-reliance, yet in
reality the industries spent precious little on Science and
technology. Modernization was given low priority. Research and development
activity and investment was found only in a very few industrial units. Another
aspect was the improvement in Science and Technology never crossed the
urban frontiers. Though India ranked second in the world in terms of technical
manpower, this was never utilized to our advantage. Only government
organization gave some serious considerations to research and development
activities. Further the attempt was to develop and apply technology to meet
the requirements of the rich community in India. Whatever technology that
was imported never suited our domestic requirements and attempts to adopt
them for Indian environment did not succeed. After the declaration of
Liberalization in 1991, the government has given very serious consideration to
Technology and development. The summary of the Technology policy of 1991
is given below.

A welcome change in the outlook of the government as evidenced by the new
policy is the realization that the sophisticated technology from abroad can be
brought in only through liberal and less restrictive procedure and policies. The
interference of the government in this regards to be reduced so as to enable the
domestic industries in achieving a high rate of industrialization. As a result of
this liberalization, automatic approval for technology agreements related to high
priority industries will be made with respect to certain specific parameter. Other
industries which can enter into such agreements without incurring the
256
expenditure of foreign exchange will also be extended liberal treatment. The
industrialists are left to themselves to decide and enter into foreign technology
agreements depending upon the commercial viability of their enterprises. In
due course this measure is expected to pave the way for exchange of superior
technology from India* with other countries. With the overall liberalization, the
competition will be high and it is expected that industries will invest much more
in research and development activities. Keeping in view all these expectations,
the government has announced the following changes in regulations governing
foreign technology agreement:

(i) No prior permission is needed for hiring foreign technicians, foreign testing of
indigenously developed technologies. Such activities involving payments will be
governed by the guidelines of the RBI and such payments can be made through
the blanket permits.

(ii) Automatic permission will be given for foreign technology agreements
relating to the high priority industries. The royalty payments through such
agreements will be subjected to certain provision. Upto the payment of Rs. I
crore, royalty will be @ 5% for domestic sales and 8% for foreign sales or
exports. However, the total royalty payment should not exceed 8% of sales over
a 10 year period from the date of agreement or 7 year period from the date of
commencement of production.

(iii) In the case of industries not covered in the high priority list automatic
permission will be given for technology agreement provided it does not entail
any foreign exchange payment commitment.

(iv) In all the other cases, the general procedures in practice will be adhered to
and such industries will require approval.

REVIEW QUESTIONS
1. Discuss the objectives of licensing policy in India.
2. List the findings and recommendations of Dutt committee report.
257
3. Discuss the features of Indian licensing policy. How far the current
policy is a deviation from the old ones ?
4. Explain the circumstances under which MRTP Act was brought.
Why was it given up on the eve of Liberalization?
5. What do you understand by control of capital issues ?
List the recommendations of Narasimham committee II in this
context.
6. Discuss the forms of foreign capital.
7. Why is foreign capital required?
8. Discuss the role of foreign capital in economic development.
9. Analyze the problems of foreign capital. Discuss in this context the
policy of the government towards foreign capital since
independence.
10. Explain the government policy on Foreign Direct Investment.
11. Critically evaluate the Industrial policy resolutions of 1948, 1956
and 1980.
12. Explain briefly the provisions of the Industrial policy 1991 which laid the
foundation for liberalization.
13. What is an EXIM bank ? What are its functions?
14. What is meant by public distribution system? Discuss the
justifications for it continuance.
15. Comment on the working of public distribution system in India.
16. Critically examine the functioning of public distribution system from
the view point of institutions, people and government. Suggest
suitable remedies.
17. Outline the contours of agricultural price policy in India.
18. What is meant by foreign exchange? What are the justifications for
regulating it? Comment on the policy of the government in relation
to foreign exchange.

Discuss the need for technology transfer. Analyse the policy of the government
in this regard.

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CHAPTER IV
Monetary and fiscal system - Banking and credit structure in India - Financial
institution - Fiscal system - theory and practice

INDIAN FINANCIAL SYSTEM AND COMMERCIAL BANKING
The shape and status of an economy to a large extent depend on the
development it had achieved, which in turn depends on the strength of financial
sector. A country with a strong financial sector is bound to progress faster and
steadier than any other country. Financial sector refers to all the categories of
financial institutions which provide as a conduit between those who are in need
of funds and those who are supplying funds. Such institutions are usually
referred to as financial intermediaries. While these intermediaries do function at
a profit, not all of them are profit centered. In other words, the financial
intermediaries can be broadly classified as organized sector institutions and
unorganized sector institutions. Those in the former category function in the
interest of the society and so not very much profit centered. The way in which
all these institutions are integrated is understood through a study of financial
system. The structural positioning of these intermediaries determine the flow of
funds in an economy. That is, how these institutions mobilize funds and how
they distribute or channelise the funds mobilized depend on how they are
organized. For instance, in the olden days, only money lenders provided the
needed funds either from their own savings or that of their close relatives.
Obviously they confined their operations only to a limited locality and purposes.
Depending upon the borrower and the security offered, they charged varying
rate of interest and there was absolutely no regulation of their business
practices. But once public institutions like commercial banks came into the
scene, there was a need to organize their operations strictly in relation to the
national priorities. Thus came the institutions in the organized sector, which
are governed by a set of rules and regulations. Hence, if in a country the size of
operation of the institutions in the organized sector is large, then the flow of
funds from the savers to investors will be smooth and would contribute towards
the economic development. Even the mere presence of unorganized sector
institutions will countervail the contributions of the organized sector
institutions.
259

In the Indian context, the financial system includes a number of institutions in
the organized sector and unorganized sector.. Under the organized sector we
could include: the State bank of India and its associates, all the nationalized
commercial banks, the Regional Rural banks, private sector Indian and foreign
banks, non-scheduled hanks, all the levels of co-operative banks, Government
institutions like National Savings Corporation, Post office savings banks,
Provident fund, all the corporations created by legislature like LIC, UTI, etc. In
the unorganized sector, the institutions are of several types ranging between
money lenders, chit funds, nidhis, finance companies, etc.

The constituents of Indian Financial system changed over a period of time, as
the nature of demand for funds changed and so institutions had to come up to
meet the specific needs of a demand segment. For instance, while the
rationalized commercial banks and co-operative banks are focussed more
towards the priority sector and rural segment, the chit funds and nidhis came
into the scene to cater to the needs of businessmen and small firms. Finance
companies entered the scene mainly to meet the funds requirements of hire
purchase and leasing firms. While specialised institutions add to the maturity
of the financial system, the difficulty in regulating them exposes the gullible
small savers and investors to a great risk. The regular failure of finance
companies, nidhis, etc., have rudely -shaken the confidence of the common
public and discouraged them from investing activities.

Growth of NBFCs:
Non banking financial companies have emerged as a single most important
constituent of our Financial system. These institutions have originally started
functioning as hire purchase agencies, but introduced in due course a host of
innovative services, that their number has swelled to nearly 50000 by 1998.
They have been very popular in the Indian scene mainly because they could
mobilize huge funds by offering attractive high rate of interest, adopting a
simple procedure for processing and lending, improving customer relations
and introducing new customer oriented funding schemes. To understand their
extent of coverage, there are hire purchase finance companies, housing
260
finance companies, investment companies, mutual benefit financial
companies, etc. Though their growth was actually adding to the financial
products in the market,

the operation of a number of them raised questions about their stability. and
genuineness of intentions. When a number of such NBFCs failed, in response;
public outcry, regulatory guidelines were brought by the RBI. A number, of
committees were set up to examine the nature and content of the regulatory
mechanism. Particularly, the recommendations of the Shah committee of 1992
and Khanna committee of 1996 assume significance. Their recommendations
included:

Abolition of categorywise classification of finance companies.
Application of uniform regulation for all finance companies.
Focussing regulatory attention on large size companies.
Compulsory registration of all deposit accepting companies.
Determining capital adequacy standards and prudential norms.
Prescription of provision for bad and doubtful debts.
Compulsory annual credit rating.
Following this, a number of provisions in the Regulations Act were amended
and the RBI [Amendment] Act 1997 has brought forth the following regulations:
NBFCs are more clearly defined and their minimum net owned
funds was, fixed at Rs. 25 lakhs.
Registration with RBI at the time of entry is made compulsory.
Existing units were given time of three years to reach the
minimum level of), net owned funds.
NBFCs should transfer not less than 20% of their profits to the
reserve fund every year.

In case of any violation of any of the regulations by the NBFCs, the RBI will
prevent them from accepting deposits and also sell, transfer, etc. their
properties.

261
Several other regulatory measures were announced in January, 1998 which
include:
NBFCs with credit rating below 'A' are not allowed to accept deposits.
For any violation of norms, the repayment of deposits will be ordered by
RBI.
Interest rate and brokerage fixed.
Regular tax returns should be filed.
No lending is permitted against the own security.

But the NBFCs appealed to the RBI to relax the provisions, as otherwise their
business would be at stake. Accordingly RBI some of the regulations, providing
for the growth of these NBFCs at the am protecting the interest of investing
public.

Housing Schemes
Housing emerged as one of the important priority sector lending schemes. This
so because of both increase in the demand for houses in both the urban and
rural areas. With considerable number of people settling down in urban slums,
housing problem has assumed a tremendous proportion. As a sequel to this,
the government has established National Housing Bank in 1988 with a number
of programmes to address the housing needs of various sections of the
population.

Specifically a Home Loan Account is devised to promote the savings habit
among the public for acquiring houses. With a minimum periodicity of 5 years,
any one can open a Home loan account with any scheduled bank. The amount
deposited into the account is also exempted from income ax. The balance in the
account earns interest at 10%. Once the specified period of deposit is over, the
account holder is eligible for housing loan. The loan amount is determined as a
multiple of accumulated savings in Housing Loan Account.

Loans granted under this category will be refinanced by the National Housing
Bank. The Commercial banks are advised to provide 1.5% of their incremental
deposit over the previous year for direct or indirect loans or investments.
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Schemes funded by HUDCO, like Nehru Rojgar Yojani have gone a large extent
in easing the housing problems of the rural masses. Apart from this under
Priority Sector allocations the following housing loans are provided :

A] Direct advance : Loans upto Rs. 5 lakh are granted for construction of
houses and upto Rs. 50,000 towards repairs of houses for all categories of
borrowers.

B] Indirect advance : Under refinancing scheme, non governmental agencies are
also eligible when they lend for house construction. Advances are also given for
the clearance of the slum and rehabilitation of the slum dwellers.

Subscribing to the bonds issued by the National Housing Bi.nk and HUDCQiis
also extended.

As regards the margin on loans, the percentage of margin is determined based
on the loan amount. As a security, mortgage of the property and
Government guarantee are acceptable. Maximum repayment period is-fixed at
15 years, and

the repayment holiday is also granted to the borrower. The
eligibility condition for getting loan is fixed in relation to the income of the
borrower. Interest rate on loan is again linked to the amount borrowed.

Through Indira Ayas Yojana scheme free dwelling units are given to the persons
living below poverty line in the rural areas, belonging to SC and ST community
and bonded labourers. The scheme is, also extended to families of servicemen of
the armed forces and paramilitary forces killed in action irrespective of their
income limit.- This scheme is implemented through the District Rural
Development Agency. Beneficiaries are identified through Gram Panchayat or
Block Development Officer. The beneficiary has to under take the construction
of the house and the money is released in stages.

THE FUNCTIONS OF COMMERCIAL BANKS
The functions performed by the commercial banks may be listed 2.5 follows :
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1) Accepting deposits, 2) Lending loans and advances,
3) In vestment of funds, 4) Promote the use of cheques,
5) Agency functions, 6) Purchase and sale of foreign exchange,
7) Financing of internal and international trade,
8) Creation of credit, 9) Other functions and
10) Fulfillment of socio-economic objectives.

1. Accepting deposits:
This is one of the primary functions of commercial banks. The commercial
banks accept different types of deposits, the deposits may be broadly classified
as a) demand deposits and b) time deposits. The former refer to the deposits
which are repayable by the banks on demand by the depositors, while the time
deposits are accepted by the banks for a fixed period of time before the expiry of
which they don't return the deposit. The demand deposits include the current
account deposits and savings bank account deposits. These two types of
deposits earn very low rate of interest as they can be withdrawn any time. In
the case of savings deposit, the depositor is not allowed to withdraw more than
a fixed number of times or amount over a period of time. The time or term
deposits include the fixed deposit and recurring deposits. In the former a sum
is deposited for a fixed period of time determined at the time of deposit and is
never allowed to be withdrawn before the expiry of period of deposit. Any such
foreclosures will invite penalty apart from forfeiting the interest. Recurring
deposits are the type of deposits in which a depositor agrees to deposit a fixed
sum of amount every month for a number of months as determined in advance,
and at the end of which the depositor will be repaid his deposit amount along
with interest. Every bank will be interested in mobilising as much deposit as
possible as it would improve its liquidity with which the bank can meet is
liabilities and expand its business.


2. Advancing of loans :
Commercial banks accept deposits and use them for expansion of their
business. The banks never keep the deposits mobilized idle. After keeping some
cash reserve, they invest the funds and earn. They also lend loans and
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advances to the common men after satisfying themselves about the credit
worthiness of the borrowers. They grant different types of loans like ordinary
loans in which the banks lend money against collateral security. Cash credit is
another type of loan in which the entire amount sanctioned is credited into the
borrower's account and he is permitted to withdraw only a specified sum at a
time. Overdraft is yet another facility under which the customer is allowed to
withdraw an amount subject to the ceiling fixed, from his account and he pays
interest on the amount of overdrawn. Discounting bills of exchange is another
type of advance granted by the commercial banks in which a genuine trade bill
is discounted by the banks and the holder of the bill is given the amount and
the banks arrange to collect the due from die drawer of the bill on the date of
maturity.

3. Investment of funds :
One of the main functions of the commercial banks is to invest their funds so as
learn interest and returns apart from utilizing their funds in a productive
manner. India as per the statutes, they must invest a part of their total
investments government securities and other approved securities so as to
impart liquidity. Banks apart from enabling them to earn out of their
investment Banks now. days have set up mutual funds through which they
mobilize funds from the people invest them in very attractive projects which is a
help rendered to the investors who otherwise will not have the benefit of
participating in the project. Banks administer these mutual funds through
specialists and experts whose services are not available to the common men.

4. Promote use of cheques:
By the spread of banking habit, banks have achieved a remarkable successi-pil
promoting and encouraging the use of cheques by people in the settlement of
their-claims. Cheques are not only safe but are die cheapest medium of
exchange in me place of cash, apart from being fully negotiable instrument

5. Agency functions of commercial banks :
Commercial banks function as he agent of their customers and help them
several ways. For these agency services, the banks charge a nominal amount
265
The agency services include, transfer of customer's funds, collection of funds on
behalf of the customers, transactions in the shares and securities for their
customers, collection of dividends on shares and interest on debentures for
their customers, payments of subscriptions, dues, bills, premia on behalf of the
customers, acting as the Trustees and Executor of the customers, offering
financial and other consultancy services, acting as correspondents of the
customers, etc.

6. Purchase and sale of foreign exchange :
The banks also undertake to help their customers in dealing or transacting in
foreign exchange. Though only banks with license to deal in foreign exchange
along can act on behalf of their customers, yet in India several commercial
banks by virtue of their relationship help the customers in this connection.

7. Financing internal and international trade :
This is a major function of the commercial banks. The international trade
depends to a large extent on the financial and other support given by the banks.
Apart from encouraging bills transactions, the banks also issue letter of credit
facilitating the importers to conduct their trade smoothly. The banks also
process all the documents through consultancy services and reduce the
botheration of the traders. They also lend on the basis of commercial bills
warehouse receipts, etc., which help the traders to expand their business.

8. Creation of credit:
It is worth noting the credit created by the commercial banks. In the process of
their lending operations they create credit The process involves the following
mechanism: whenever the banks lend loans, they do not pay cash to the be
Towers; instead they credit the accounts of the borrowers and allow them to
withdraw from their accounts. This means every loan given will create a deposit
for the banks. Since every deposit is equal to money, banks are said to be
creating money in the form of credit As a result the volume of funds required by
the trade, government and the country is met by the banks without any
necessity to use actual cash.

266
9. Other functions:
Other functions of the commercial banks include providing safety vault facility
for the customers, issuing traveller's cheques acting as referees of their
customers in times of need, compiling statistics and other valuable information,
underwriting the issue of shares and debentures, honouring the bills drawn on
them by their customers, providing consultancy services on financial and
investment matters to customers, etc.

10. Fulfillment of socio-economic objectives :
In the process of performing all the afore-mentioned services, the banks do play

key role in the economic development and nation building. They help the
country^ in achieving its socio-economic objectives. With the nationalization of
banks, the priority sector and the needy people are provided with sufficient
funds which helm them in establishing themselves. In this way the commercial
banks provide a firm and durable foundation for the economic development of
every country.

CREDIT CREATION BY BANKS
Commercial banks accept deposits and lend loans and advances. In this
process* they create two types of deposits, namely primary deposits and
derivative or deposits. The form refers to the cash deposited by a customer in a
bank or deposit a cheque with the bank for collection. The banker merely
accepts cash am converts it into a deposit. Hence, this is merely a passive role
performed by the banks. These primary deposits do not add to the money stock
in the economy From their experience and observation the banks know that not
all the customs will withdraw their deposits on any single day. Hence, after
providing for some reserve to meet the cash requirement of the depositors, the
banks lend the balance to the borrow. The amount of reserve to be maintained
by the banks is Cash Reserve Ratio which is determined by the central bank.

The derivative or active deposits refer to the deposits which are created out of
the %x loans and advances granted by the banks. Suppose an individual is
sanctioned loan of Rs. 10000 by a bank A. The bank does not give him cash
while sanctioning the loan. Instead the bank merely opens an account in the
267
name of individual and credits his account with Rs. 10000. He is then allowed
to withdraw this amount whenever he wants. When the bank credits his
account with Rs. 10000, it is treated as a new deposit received by the bank.
Hence, the bank derives this new deposit from the loan given and the bank has
actively created this new deposit. This is the reason why it is always said that
loans create deposit'. The new deposit created in this manner will add to the
money stock of the economy. Whenever the loan is returned by the borrower to
the bank, then there is no further possibility of creating new deposit. This
results in net decrease in money stock.

Therefore creation of credit or granting of loan adds to money supply to in the
economy and the return of loan results in reduction in money supply.

It should also be noted that the banks create active deposits while they
purchase assets or securities from others or discounting the bills of exchange or
any other negotiable instruments. But the majority of credit is created only out
of the loans given.

The multiple credit creation process can be explained with a single bank or
more than one bank. The former is called single bank credit creation and the
latter multiple bank credit creation model. To explain both these models, let us
assume i) there are three banks A, B, and C ii) the cash reserve ratio is 10%
and iii) an initial deposit (primary deposit) of Rs. 10000 is made into bank A.

When bank A receives the new deposit its balance sheet will appear as below :

BALANCE SHEET OF BANK A
LIABILITIES ASSETS

New deposit
Rs.
10000

New Cash
Rs.
10000
10000 10000

Out of this new deposit of Rs. 10000 the bank has to maintain a reserve of 10%
which works out to Rs. 1000. The balance of Rs. 9000, can be lent by the
268
banker. Suppose Bank A lends Rs. 9000 to P, a borrower, who uses this fund to
pay off his creditors. On giving the loan to P, the balance sheet of Bank a will be
:
BALANCE SHEET OF BANK A
LIABILITIES ASSETS

Deposit
Rs.
10000

Cash (Reserve)
Loan to Mr. P
Rs.
1000
9000
10000 10000

The creditors of P may have an account with bank B" and so they may deposit
Rs. 9000 received from P in bank B. This is the primary deposit of fresh deposit
bank B. Of this the bank will maintain a reserve of Rs. 900 and it may give a
loan, of Rs. 8100 to Q. Then the balance sheet of bank B will appear thus :

BALANCE SHEET OF BANK B
LIABILITIES ASSETS

New deposit
Rs.
9000

Cash (Reserve)
Loan to Mr. Q
Rs.
900
8100
9000 9000

Suppose Q uses this loan of Rs. 8100 to pay off his creditor who has an account
with Bank C. Bank C will, then, get a fresh deposit of Rs. 8100 and it would
lend^ Rs. 7290 after keeping a cash reserve of Rs. 810 The balance sheet of
bank appear as below :
BALANCE SHEET OF BANK C
LIABILITIES ASSETS

New deposit
Rs.
8100

Cash (reserve)
Loan to Mr. R
Rs.
810
7290
8100 8100

269
R may use this loan to repay his creditor who may have an account with Bank
D and it would create loan out of the new deposit received. Hence, in the above
example, a fresh deposit of Rs. 10000 in Bank A has resulted in the creation of
loans to the tune of Rs. 24390 (9000 + 8100 + 7290). If this process continues
more amount of credit will be created.

In the above example, we have assumed that each borrower has enabled fresh
deposits in different banks. Suppose the amount lent by Bank A is retained by
it (because the creditors of P deposit the money in bank A itself). Hence, the
example given above explain the multi-bank credit creation model and if it is
altered sightly, assume the existence of bank A alone, then it becomes an
example for single bank credit creation model.

It is of interest to know the total amount of credit created by the commercial
banks in the above example. This could be found out that die following formula
K = 1/r. In the formula K is the deposit multiplier and r is the cash reserve
ratio. In the above example r = 10%, ie., 1/0.10 which is equal to 10. This
means that original deposit will multiply by 10 times if the cash reserve ratio is
10% Suppose we increase the cash reserve ratio to 20% then the multiplier will
be 5 and the cash reserve ratio is 5%, the multiplier will be 20. Hence a rise in
cash reserve ratio will reduce the volume of credit created and a fall in cash
reserve ratio will increase the volume of credit created. We find the total amount
of credit created we can use the deposit multiplier calculated above multiply it
with the initial deposit In otherwords,

Addition aggregate deposits - Fresh deposit x K
In the above example, fresh deposit is Rs. 10000 and the multiplier is 10. Hence
the total credit created is 10000 x 10 = 100000.

So far we have explained the credit creation process by the commercial banks.
We can also explain the credit contraction process which means, that whenever
the depositors withdraw their deposits then the banks will be left with lesser
cash to create only lesser credit. Both the credit creation and contraction are
subjected to the following limitations:
270

1. The volume of cash in circulation determines the extent of credit
created. With larger volume of cash, the primary deposits will be more
thereby the credit created will also be more. Any reduction in the
volume of cash will reduce primary deposits and so the credit created.

2. Cash reserve ratio, in fact, is a primary determinant of credit created. It
has been already shown that higher the cash reserve ratio lesser will be
credit created and lower the ratio greater will be the credit created.

3. The external drain or the extent of withdrawal of cash by the depositors
also determine the volume of credit created. When there is heavy
withdrawal of cash by depositors there will be reduction in credit
crated and lesser withdrawal will encourage a larger volume of credit
created.

4. Banking habit of the people is one of the factors influencing the credit
created; If people conduct most of their businesses using cheques
rather than cash, then the banks will have more cash (primary deposits)
to create more credit when people use more of cash rather than
cheques, bills, etc.

5. The central bank is the leader of the monetary system and its decision
to follow a liberal credit policy will encourage more of credit creation
and a stringent credit policy will bring down the credit created.

6. The availability of a large volume of collateral securities will facilitate
larger volume of credit creation and with lesser volume of collateral
securities only, lesser credit will be created.

7. The business condition prevailing in the country will be one more
factor; determining the extent of credit creation activity. With
prosperity and boom conditions prevailing there is greater opportunity
for additional investment and'
:
so the credit creation will take place in
271
large scale. During the period of depression and. adversity, as the
investment opportunities are very limited, there is no scope for credit
creation.

PERFORMANCE OF THE COMMERCIAL BANKS IN INDIA, THEIR
PROBLEMS AND SOLUTIONS TO IMPROVE THEIR FUNCTIONING

The trends in performance of commercial banks in India can be explained in
terms of various indicators given below.

I. Deposit mobilization : A phenomenal success in deposit mobilization is
achieved by the commercial banks since nationalization. In 1950-51 the total
deposit with the commercial banks was Rs. 880.6 crores which rose Rs. 102127
crores in 1986-87. This was mainly due to raid branch expansion after
nationalization, the increase in money supply in the economy, the improved
banking habits among the public, etc, however, the rate of increase in deposit
has not been commensurate with the rapid rate of increase in branch
expansion.

This is easily understood from the low per capital deposit of Rs. 723. further
even in 1986 the total deposit with the commercial banks amounted to only
34% of the national income. However, encouraging signs and indicators are
being observed which may herald a sizeable increase in deposit mobilization in
the years to come. The main indicators are the increasing fixed deposit and
declining current deposits. With better interest on deposits, the banks should
be able to improve their deposit mobilization.

2. This objective has been certainly achieved as is clearly indicated by the
following facts. From a mere Rs. 546.93 crores in 1950-52 the total
advances by the commercial banks stood at Rs. 57518 crores in 1986-
87. This is more than 100% increase in advances compared to 1950-51.
In 1950-51, the banks were lending only 62.1% of their total deposit in
the form of advances which has increased to 65.7% in 1986-87. Since
the nationalization, the advance to priority sector by the commercial
272
banks has infact enabled this sector to grow without any financial
constraint. In 1986-87, the advances to the priority sector out of the total
bank credit rose to 43.6% achieving a significant objective of
nationalization in providing the scarce resources to the priority purposes.
An important feature of this sizeable advances is that the share of the
public sector banks is the maximum and the commercial banks have
also started concentrating on the priority sector.

3. Substantial increase in investments : One of the important reasons for
maintaining: the profitability in the commercial banks is their pattern of
investments. The investments by thebanks went up from about Rs. 360
crores in ,1955-56 to more than Rs. 38563 crores in 1986-87. Of this
about 37.8% of the investments are in government securities.

4. Branch expansion : One of the significant achievements of the
government is the rapid branch expansion achieved over these 36 years.
From a few thousand branches in 1050-51, the number of branches
stood at 8321 in 1969 which increased to 53567 branches by June,
1987. This was also due to the merger of smaller banks into bigger
banks. The voluminous banking operations^ in the country today is
mainly due to the fact that almost every third village has a branch 6f a
bank. Though initially such a branch expansion activity led to
competition among them, yet over a period with the measures taken by
the banks, the competition among the banks have come down.

5. Sizeable increase in the advance towards the priority sector : Banks
have played a commendable role in the provision of advance to the
priority section Apart from the quantum of assistance, the coverage of
banks in terms of assistance to various segments also increased. By
December, 1979 the priority sector advances constituted 34.4% of the
total bank credit as against 25.8% un June 1977. The government fixed
a target of 40% which was achieved by the banks as already indicated
under the advances given by the banks. The banks;" have been strictly
instructed that they should extend 60% of the deposit mobilized in the
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rural and semi-urban areas to the priority segments in those areas. By
June 1987, the commercial banks' advance was 43.6% of their total
deposits which was extended to the priority sector.

6. Declining profitability of banks : A very serious matter of concern about
the operation of the commercial banks in India is that their profitability
is fast' declining. There are several reasons for this. Firstly, the banks
have to mobilize; their deposits among the increasing competition among
themselves and also, among the various schemes of savings announced
by the government. As a result the banks have to bear a higher cost of
deposit mobilization which directly, affect their profitability. Secondly,
the interest paid on the reserves maintained by the commercial banks
with the central bank is very low and this considerably reduces their
profitability. Thirdly, with the expansion of branches throughout the
country, the operational cost of the banks have gone-Up, thereby
bringing down their profitability. Fourthly, the outgo in terms of staff
salary and other allowances also take away a sizeable amount of income
from the banks bringing down their profitability. Fifthly, the priority
sector lending by the banks at concessional rates is yet another reason
for poor profitability. Sixthly, the banks have been lending large amounts
to the sick units due to the compulsion from the government.
Consequently their profit is affected.

Problems of the commercial banks :
1. Commercial banks, though very large in number have not effectively
mobilized the deposits in the country. This is very clear from the fact
that a large number of non-banking financial institutions mobilize
considerable deposits from the public.

2. The banking habits among the public is not yet at an encouraging level.
Especially in the rural areas people prefer to keep their money at home
at great risk man depositing with the banks.

274
3. Government is also responsible to some extent for the slow
development of banks in India. There is no compulsion from any
government institution that the funds available with the government
agencies should be kept as deposits with commercial banks only.

4. Competition from foreign banks, non-banking financial intermediaries, a
score of government aided institutions have also made the business of
the banks difficult.

5. A sizeable amount of funds of the commercial banks are locked with the
sick units. The investments in these units are made.only on the
government insistence.

6. The frequent loan melas organized and disbursal of unproductive loans
have also created a big problem to the banks. Further the cancellation of
loans from banks, waiver of these loans for specified period, etc., also
add to the problems of banks.

To overcome the above problems in an effective manner the following
suggestions can be considered:

1. The competition between the commercial banks and the other non-
scheduled banks as well as foreign banks should be eliminated. This is
being done by various provisions relating to opening of a new branch,
working hours, investment of funds, allotment of area for each bank, etc.
But in terms of working it is better that the competitive spirit is
maintained so that the banks will be constrained to maintain and
improve their efficiency.

2. The existing banking structure should be modified to match the
requirements and changes. For instance, instead of allowing the
existence of a number of small banks, attempts should be made to
amalgamate the small and inefficient ones with the big and efficient ones.
Especially in the case of branch expansion a more critical study is called
275
for so that establishment of uneconomic and] unviable branches can be
avoided. The areas really in need of banking facilities should be carefully
identified with long term perspective and then the branches! should be
opened. A close monitoring of the working performance of each] such
new branch should be made so as to determine the justification allowing
their existence.

3. The banking functions should be thoroughly overhauled so as to
introduce; modern methods of functioning. For instance, the age-old
method of maintaining a large number of ledgers should be done away
with and; computers should be used in large way. Apart from this,
possibility, of extending banking services throughout the day (24 I/ours
banking) should be; thought of. Some of the branches of foreign banks
have started offering this 1 facility and Indian counterparts can also
think of such methods.

4. Streamlining the banking procedure is a long felt need in India.
Surprisingly, even among the nationalized banks there is no uniform
procedure for several functions. Uniformity will not only help the people
to understand; the procedure but also the banks to economic their
operations, for instance, if there is a uniform account opening for
prescribed for all the banks, then possibly large scale printing of this
form will bring down the cost of printing. Like this; uniformity in every
procedure wherever possible should be identified and-implemented. This
will be identified an effort to economize the use of resources.

5. Periodical and stringent review of the competency and efficiency of the
staff is' also a must By devising a healthy procedure for staff evaluation,
every bank can attempt to maximize the output and minimize the strain.
Mere-strengthening of the staff without arrangement for improving the
staff performance through rigorous training, updating of knowledge,
evaluation, etc., ' will only weaken the functioning efficiency of the bank.

276
6. Innovative methods of deposit mobilization should be thought of, apart
from the conventional methods. The banks could call for opinion from
the public regarding the methods of deposit mobilization and may even
consider giving rewards and prizes for the best suggestions.

7. Extending the area of operation of the banks should take up new areas
like leasing, hire purchase, etc., to mop up the additional deposits and
also to extend the banking coverage.

8. Investment of funds should be very carefully planned and every attempt
should be made to maximize the return on various types of investments.
As far as possible the loan recovery should be maximized. Any attempt to
waive the loans or cancel the loans will only encourage defaulters.

9. Government should also be sympathetic towards these banks by allowing
their funds to flow towards the banking sector. The surplus funds
available with the government could be placed at the disposal of the
banks which will strengthen their operation and in fact the economy
would be benefited more in terms of new loans and advances.

10. Efforts should also be made to solve the customer problems by involving
them in the decision making process. The service charges imposed on
various services should be rationalized and restructured and as far as
possible the uniformity in this regard must be achieved. It is often seen
that the private sector banks give concessions or even waive the service
charges to some of the major customers, while the nationalized banks
have no such provision. As a result, private sector banks are able to
attract a sizeable volume of funds through deposits.

11. Educating the common public about the manipulative activities of the
non-balance financial institutions like chit funds, nidhis, mutual funds,
etc., so as to make them understand that the same type of services can
be availed of from the banking system but with lesser risks. The
regulation in this regard should be made more rigid so as to discourage
277
any blade companies from resorting to any shady dealing and
manipulative activities.

12. Considering the pivotal position occupied by the banking sector in the
country, it is high time that politicians are prevented from pressurizing
the banking sector to yield to their unhealthy practices with ulterior
motives. A country where banking sector is completely free from political
interference alone reaps the expected benefits from that sector and
encourage health banking practices.

LEAD BANK SCHEME

A milestone in the history of banking in India is the nationalization of the 14
major commercial banks in 1969. This process was undertaken with the main
objective of involving the banking sector in a big way in the nation building and
economic development. To help to achieve this commendable objective, two
committees were set up viz., National Credit Council Study Group with D.R.
Gadgil as the Chairman and the Committee of Bankers under the chairmanship
of Nariman. These committees independently went into their terms of
reference and recommended an 'area approach' for involving the banks in
economic development. This paved the way for giving a concrete shape to the,
lead bank of scheme'. As nationalization of banks took place to extend and
expand the banking services to all the un-banked areas especially the rural
areas, the RBI decided to implement its Lead Bank scheme through the
nationalized banks. But this did not discourage the private sector banks from
playing their role in economic development. Infact the Lead bank scheme
involved all the nationalized banks, State bank of India and its associates and
three private sector banks. Hence, the era of bank-propelled economic
development started.

The Lead bank scheme has the following features :
1. All the districts in the country except the Metropolitan area were
allotted among the banks selected for this purpose.

278
2. Each bank was expected to take all the initiative to develop the district
allotted to it. The initiative includes conducting a detailed survey to
identify the resources and the potential of the district concerned and
then to devise suitable schemes for utilizing these resources.

3. The identification of unbanked centers is also included in this regard
and such centers will be examined thoroughly to determine whether
bank should be established in such places or not.

4. The districts were allotted to the different banks depending upon the
size of the bank, the resources with which they operated, the ability to
handle additional volume of work, regional orientation of the bank
concerned, etc.

5. The district allotted to a bank should not be considered as the area
wherein only the bank concerned alone should initiate or carry out the
developmental works. In otherwords, the lead bank should not become
a monopoly in the district allotted, but it should also invite participation
from other agencies in the district. In that manner the lead bank will
function as a leader of a consortium.

6. To co-ordinate all the development activities taking place in the allotted
district and other potential projects for the district, the lead bank is
expected to set up a district level consultative committee of banks and
other financial institutions. This committee was vested with the powers
to review the performance in various schemes periodically.

Working of the Lead bank scheme
To start with the 25 banks selected a, lead banks have completed the survey of
the district allotted, to each of them. The district consultative committee in each
district has also been formed. The lead bank scheme also designed and
monitored the branch expansion activities in all the unbanked areas and with
nationalization in 1969, the branch expansion took place simultaneously in
about 336 district of the country. The lead banks also started co-ordinating the
279
activities of various agencies in the rural areas like co-operative banks,
commercial banks, other financial agencies and other development agencies.
The lead banks also started identifying the potential of each district and studied
critically the existing line of business and other activities. It also could identify
the credit gap in each district. Credit gap refers to the difference between the
credit needs of the rural areas and the credit supplied by all the agencies, to
bridge this credit gap the lead bank took several steps. Firstly, it decided to
improve the deposit mobilization in the area concerned. Secondly, the quantum
of funds required for the development activities in the district was estimated.
Thirdly, the various agencies in the district were, approached to participate in
the scheme. Fourthly, with the district consultative committee the performance
of each scheme would be reviewed periodically and corrective steps if any
required, would be taken up. I this manner the lead bank scheme aimed at
removing the credit gap in each district.

The lead bank scheme was expected to generate the following benefits:
1. The entire country would inherit a sound banking system.
2. there will be perfect and effective supervision and expansion of the credit
facilities.
3. The various agencies connected with the developmental activities in each
district would be able to achieve a high degree of co-ordination and
operation.
4. The available scarce resources in each district would be mobilized and
used for the development of the district concerned.
5. The banks will start playing a significant role in the economic rebuilding!
and development.
6. A systematic attempt will be made to identify the credit gaps in each
district' and appropriate action will be taken to fill up these gaps.
7. There is absolutely no scope for achieving development in ont- district at
tile's cost of other district. In otherwords, the lead bank scheme would
also." contribute in its own way towards the balanced regional
development.

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But the lead bank scheme failed in certain respects encouraging the critics of
this scheme to argue against this scheme on the following grounds:
1. While it is true that lead bank would take up the role of initiating-the
development in the district allotted, but it cannot assume the role of the
Planning commission.

2. A lot of confusion prevailed among the lead banks regarding their exact
function and objectives. However this confusion was removed later on
when the lead banks started sharing their survey findings with other
interested agencies in the district and also started opening branches
themselves in the areas identified by them.

3. Critics also pointed out that a financial and commercial institution like
bank cannot be best suited to analyse and solve the task of techno-
economic work. r Further the banks can be taken as professional
institutions in the field of finance and not in the area of development. It
was pointed out that banking function is completely different from the
development function. In the absence of trained and skilled staff the lead
banks could not accomplish the objectives for which they were created.

4. There were several other practical difficulties in executing this scheme.
For instance, the allotment of districts to the banks was not done
strictly, on the basis of regional orientation of the banks. As a result the
banks could not effectively attend to the initial spade work in the district
allotted to them. Operational difficulties like language barrier, difficulty
in controlling the work from long distance, difficulty in finding staff for
the newly opened rural branches, reluctance of the staff to move to rural
areas, absence of trained and skilled people, etc., together raised serious
doubts about the success of this Scheme.

5. A major criticism of the scheme was that the authors of this scheme
thought that once the banks are established in the rural or unbanked
areas, the other problems in those areas would automatically be solved.
Development of any region or area depends on the availability of
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infrastructural facilities, in that area. Hence, without the other facilities
basically required for developmental efforts, banks alone cannot
transform the area or region.

Considering these problems of the lead bank schemes, steps have been taken to
improve the scheme. For instance, the Banking commission itself has
recommended the regrouping of the banking system so as to make; the
allocation of districts more meaningful and purposeful. A detailed training
programme was charted to be implemented by every bank among the existing
and the newly recruited staff. The detailed requirement of each region including
finance, was assessed so as to make the appropriate agencies to come up with
necessary assistance to the bank to implement the scheme. Another effort taken
up was-to arrange for multi-level discussion among the participating banks the
scheme so as to share the available information and other details of the scheme
to find out solutions for various problems. A close co-ordination and cordial
relationship was maintained with the state government concerned to strengthen
the scheme.

FUNCTIONS OF CENTRAL BANK
According to De Kock, modem central bank performs six important primary
functions. They are:
1. Central bank has the monopoly of note-issue.
2. Central bank acts as-the banker, agent and adviser to the government.
3. Central bank acts as bankers' bank.
4. Central bank acts as the custodian of the nation's gold and foreign
exchange reserve.
5. The Central bank collects and publishes economic statements and other
useful information.
6. The Central bank acts as the controller of credit.

Apart from the above functions, Central bank also performs the following two
functions:
a) it is the custodian of the cash reserves of commercial banks and -
b) it acts as the bank of central clearance, settlement and transfer.
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Let us now discuss each one of these eights functions in detail.

Central bank has the monopoly of note issue :
In olden days when the paper currency was introduced, each king issued his
own currency or in each province a paper currency was used. When commercial
banks were established, each one issued its own currency. Under both these
situations, % there was lack of uniformity in the notes issued. There was also
lack of recognition of the notes issued, further there was a maximum limit up to
which the commercial bank could issue notes as they had been maintaining
limited cash

reserve and sometimes commercial banks failed to convert their
notes into other forms of assets which shook the confidence of the common
public. Therefore, the government itself undertook the issue of currency in its
own hand. Even this was not satisfactory as it lacked elasticity and flexibility,
hence, finally central bank was made in charge of issue of currency.

This centralized system of note issue has the following advantages

1. It facilitated uniformity and absolute control over the monetary system.
2. It built up public confidence on banks.
3. It offered complete flexibility to the monetary system.
4. It enabled perfect control over the credit created by the commercial
banks.
5. It also helped to maintain the internal and external value of money.

Hence, in these days every country has vested the Central bank with the
responsibility of issuing currency and it started with Bank of England in 1884.
In India the Reserve Bank of India is issuing currencies. Every currency issued
is backed up by suitable asset of value, like foreign currencies, government
securities, other securities and other metallic reserves. As a result of this back
up, the public confidence on the banks and the currency issued has gone up.


ii. Central bank acts as the banker, agent and adviser to the government:

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As the banker of the central government, the central bank performs several
functions. Some of the important functions are:
1. It keeps the account of the government and so accepts receipts to the
government and payments by the government.
2. It acts as the collecting banker of the cheques, drafts, etc., payable to the
government.
3. It also transfers funds from one place to another on behalf of the central
government.
4. It also provides short term loans to the government to tide over the
temporary crisis.
5. It also conducts all the international financial transactions on behalf of
the government. Any payment for imports or receipts from exports are all
accepted by it on behalf of the government.
6. It manages the public debt on behalf of the government, spent from
receiving tax payments from the common public.

By virtue of the information that it possesses, the central bank functions as the
adviser of the government It helps the government to monitor the economy. It
formulates the monetary policy and helps in the implementation of the policy. It
suggests to the government the type of foreign policy, tax policy, commercial
policy, exchange rate policy, etc., depending on the economic conditions
prevailing in the country. It also maintains the foreign exchange reserves of the
government.

iii. Central bank acts as the bankers' bank:
This function of the central bank can be classified into two sub-functions. They
are:
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1. It is the custodian of the cash reserve of the commercial banks and
2. It is the lender of the last resort.

Let us discuss each one these sub-functions.

As regards the first sub-function, it is mandatory in the case of commercial
banks in every country to keep a part of their total liabilities in the form of cash
reserves. The quantum of cash reserves which the banks have to maintain
depends on the policy of the central bank. Usually the commercial banks
maintain two types of cash reserve. One type of reserve is maintained with the
central bank and the other is maintained by the commercial banks with
themselves. This type of centralization of reserve of commercial banks confer
the following advantages :
1. It improves the public confidence.
2. It facilitates effective and fuller utilization of cash reserve of the country.
3. It enables the central bank to go to the rescue of the commercial bank
which is in need of funds.
4. On the basis of the serve, the commercial banks are able to create credit.
5. It also conducts all the international financial transactions on behalf of
the government Any payment for imports or receipts from exports are all
accepted by it on behalf of the government.
6. It manages the public debt on behalf of the government, apart from
receiving tax payments from the common public.
7. The central bank is able to exercise absolute control over the activities of
the commercial banks.

We have already stated that the central bank acts as the lender of the last
resort. This means whenever the commercial banks, in times of need, are not
able to get financial accommodation from any other source, they can get it from
the central bank. This is done in several ways. One popular way is that the
commercial banks sell their securities and rediscount valid trade bills with the
central bank and in turn get financial resources. The financial support by the
central bank enables the commercial banks to improve their liquidity apart from
carrying on their functions with limited funds. While this strengthens the public
285
confidence, this also empowers the central bank to impose and exercise
absolute control over the commercial banks. A significant merits of this
function is that it has enabled the central banks over the globe to direct and
regulate the flow of credit. They could ensure the availability of adequate funds
for the priority sectors.

iv. The Central bank is the custodian of the nation's gold and foreign
exchange reserves:
Central bank performs this very important function to protect the country from
the consequences of foreign, trade. It issues the export and import permits to
the traders and others. Through this, it ensures that all the international
transactions are performed only through the central bank and the payments
and receipts are routed through it. This prevents misuse and speculation in
foreign exchange. With the centralized system, the central bank is able to
maintain the exchange rate and resort to selling or buying of foreign currencies
to minimize the fluctuations in the exchange rate. It is also able to encourage all
the productive export oriented activities and discourage the unnecessary and
wasteful import activities. It also formulates and executes exchange regulation
policies, punishing and penalizing the erring individuals and institutions. It
strengthens the county's trade relations with other countries.



v. The Central bank collects and publishes economic statistics and other
useful information:
In every country, it is the central bank which is given the powers to collect all
the economic data related to the country and publish them as authoritative
information. This helps the government to understand the actual economic
condition prevailing in the country and take suitable policies. For instance,
through the collection and analysis of price data the government is able to
understand and formulate the necessary price policies to maintain internal
price stability. Similarly, credit policy, agricultural policy, industrial policy and
other policies are all formulated on the basis of the economic data and useful
information provided by the central bank.
286

vi. Central bank acts as the bank of central clearance, settlement and
transfer:
With the expansion of branch of banks and increasing use of banking services,
the transmission of funds from one place to another place has become
essential. The volume of funds transmission has gone up by several times these
days that any delay is causing irreparable damage to the economy. The transfer
of funds takes place efficiently and quickly only with the help of central bank.
Central bank is the /centre of clearing house operations. Every bank having
an account with central bank is able to easily settle its payments receipts
without any need to go through cumbersome cash movement. Further the
credit base in an economy can expand only when the negotiable instruments
can be freely transferred and honored with minimum delay possible. In this
respect the clearing house operation of the central^' bank in every country
assumes special importance. The value of this service of thereof central bank
can be understood only when this service is affected in times of banker strikes.
Huge amounts of cash transactions remain immobile causing immense of
difficulties and paralyzing the economy.
vii. Central bank acts as the controller of credit:
Of all the functions of the central bank, this function of the central bank is very
important. Indiscriminate and uncontrollable creation of credit will result in
serious implications. Hence, the central bank performs this function. It helps
in first limiting the quantum of credit created through its quantitative credit
control policies and second it also ensures that the available funds are
channelized properly; so that the funds will be used productively. The central
bank achieves this through its qualitative credit control policies or selective
credit control policies. Through the credit control policies, the central bank
strives to maintain domestic price stability, exchange rate stability, high level of
employment, etc. Central bank has several weapons to discharge this function
which are interlinked and help to achieve the objectives of credit control
policies.

287
OBJECTIVES OF CREDIT CONTROL POLICY OF THE CENTRAL BANK
VARIOUS INSTRUMENTS OF QUANTITATIVE CREDIT CONTROL ALONG
WITH THE LIMITATIONS OF EACH ONE OF THE INSTRUMENTS.

The following are the objectives of the credit control policy of the central bank :
1. Maintaining the internal price stability.
2. Controlling the economic fluctuations, i.e., business cycle.
3. Achieving the stability in exchange rate.
4. Maintaining the stability in the money market.
5. Promotion of economic growth through well planned and coordinated
efforts and
6. Preparing the country to meet any eventuality like wars.

Broadly, the various methods of credit control can be classified

i) Quantitative credit control and ii) Qualitative credit control.

The former aims at controlling the volume of credit and money supply in the
economy, while the latter aims at channelising the available credit in the
desired direction. The quantitative credit control policy makes use of three
important methods of controlling the volume of credit and money supply in a
country. The three methods are:
1. Bank rate or discount rate policy.
2. Open market operations and
3. Variable cash reserve ratio.

1. Bank rate or discount rate policy :
It is one of the earliest methods of general credit control developed by the Bank
of England and it was considered an effective method till the outbreak of I
World war. After the war, Bank of England developed other methods as it found
the bank rate policy to be not so effective. The essence of this policy that
commercial banks approach the central bank whenever they are in need of
financial accommodation. They get the necessary assistance by re-discounting
the eligible bills and other securities. The Central bank would re-discount these
288
instruments at a rate which directly determines the volume of funds which the
commercial banks can get through this method of financial accommodation. A
revision of this re-discounting rate by the central bank will necessitate the
commercial banks to change their rate of discounting of eligible bills and
securities.

As a result the businessmen will be encouraged or discouraged in approaching
the commercial banks to get financial accommodation. Hence, it could be
understood that the re-discounting rate is very much linked with all the other
market rates and; discounting rate. In order to understand the process let us
take an example. Suppose a commercial bank has a discounted trade bill worth
Rs. 2 lakhs at 15% and given holder of he bill Rs. 1.70 lakhs. Suppose the
commercial bank is in need of funds it can approach the Central bank and get
the same bill re-discounted. Suppose the re-discounting rate 10%, then the
commercial bank will get after re-discounting the bill Rs. 1.8 lakhs. Now it
should be noted that the rate at which the Central bank discounts the eligible
bills already discounted by the commercial banks is called re-discount rate or
bank rate. The discount rate refers to the rate at which the commercial bank
discounts the bills of the businessmen. The bank rate or the re-discount rate
and the discount rate are very closely related. Suppose there" is inflationary
situation prevailing in the economy and the Central bank wants to> reduce the
purchasing power. It will then raise the bank rate. Suppose the bank rate is
raised from 10% to 15% correspondingly the commercial banks will also raise
their discounting rate from 15% to say 22% As a result the commercial bank/
will get only Rs. 1.7 lakhs after re-discounting the bill and the businessman will
get only Rs. 1.56 lakhs after discounting the bill. Since the rate of discount is
very high or the cost of borrowing in the market becomes high, the business
men will start borrowing less and so volume of credit will come down. This will
lead to decline in economic activity and the price level will fall down. Similarly
during deflationary situation, the downward revision of bank rate will bring
down the discount rate and encourage more borrowing and expand the
economic activity and allow the price level to go up helping the economy to
recover. At a lower bank rate and discount rate the bank credit is made
cheaper and borrowing is attractive-There are two interpretations available in
289
explaining the process of the bank rate policy. One was developed by Hawtrey
and the other by J.M. Kemes.
According to Hawtrey, the interest changes constitute major part of the cost of
holding and that businessmen are very much sensitive to changes in interest
rate. He explained that any change in bank rate will bring about corresponding
changes in short term interest rates. Suppose the bank rate is raised, the short
term rate of interest will go up making the bank credit costly and discouraging
the business men from borrowing and investing. This will lead to shrinking of
business activity affecting employment and income. When the employment goes
down, the income goes down, bringing down the purchasing power, thereby the
demand for goods will fall causing price to fall. Similarly a rise in bank rate will
have opposite effect.

Keynes, on the other hand, was of the opinion that any change i bank rate will
affect the short term interest rates and bring down the capital value of old long
term securities as the new short term securities carry higher return. So there
will be diversion of investment from long period to short period securities. To
avoid this diversion, the long term rates should be revised upwards which will
make borrowing costly. As there will be no corresponding upward revision in
the marginal efficiency of capital of long term investment the businessmen will
be forced to reduce their investment which will mean fall in output, employment
and income. As a result the aggregate demand will fall down and the
inflationary tendency will be arrested. Both these interpretations are correct as
one approaches the problem of inflation through short period securities and the
other through long term securities.

The effectiveness of the bank rate policy in controlling the credit depends on the
following conditions:
1. The bank rate and the other interest rates should be very closely inter-
connected, as otherwise the desired effect through manipulation of bank
rate cannot be achieved.
2. The economic structure of the country should be elastic. This means
that wages, costs and' prices should be flexible so that they cart change
depending upon the changes in bank rate.
290
3. The existence of well developed and well Organized short term funds
market is the next requirement.

Limitations of the bank rate policy:
The bank rate policy in practice has not been very effective because of the
following reasons:
1. The conditions for the success of the bank rate policy are rarely met in
practice, making it ineffective.
2. Businessmen and industrialists are found to be less sensitive to changes
in interest rate as they change their policies depending upon the
business prospects and adversities.
3. Bank rate has been found to be non-effective in controlling deflation, as
mere reduction in bank rate and through that making credit cheaper
does not enthuse the investors to increase their investment.
4. There exists conflict between the internal and external effects of the bank
r policy. For instance, when domestic borrowing becomes costly,
international borrowing may become cheaper defeating the purpose
changing the bank rate.
5. Commercial banks are found to be increasingly less dependent on the
central bank and so any change in bank rate fails to bring the necessary
effect.
6. Rank rate policy affects both the productive as well as unproductive
activities in the same way; so it is not advisable.
7. The increasing importance given to the fiscal policy, especially after
Keynes has made the bank rate less useful.
8. The changing pattern of business finance with over emphasis on
ploughing back of profits, building up reserve funds, etc have made
investors relying less on commercial bank credit and as a result bank
rate policy has become ineffective.
9. The formulation of other methods of credit control has also led to the
decline in importance of bank rate policy.
10. Financing through discounting of bills or other negotiable instruments
has become outdated as there are other modern methods of financing
and so bank; rate policy is less effective.
291

As far as India is concerned the bank rate policy has not been very effective
because:
(i) the existence of organized banking sector and the unorganized
indigenous banking sector. Any change in bank rate will affect only the
former and not the latter.
(ii) there is no co-ordination between the organized and unorganized sectors.
(iii) the Indian commercial banks always keep extra cash reserve to tide over
their/ financial crisis without relying on the central bank and
(iv) the bill market and the non-availability of eligible bills have made the bank
rate policy ineffective.

2. Open market operations :
The open market operations as a method of quantitative credit control are
interpreted in two ways. In a broad sense, it refers to the buying and selling of
government securities as well as other eligible papers like bills and securities of
private concerns by the central bank. In a narrow sense it means the buying
and selling of only government securities by the central bank in the money
market. The process of open market operations affects the volume of credit, the
level of business activity and the internal price level. The process is explained
below.


Suppose in an economy there is inflationary tendency and the expansion of
credit is very high, and die central bank wants to control this. Then the central
bank will start selling securities in the open market to both the banks as well as
the private individuals. When these securities are bought, payment is made in
terms of cash. This will bring down the cash reserve of the commercial bank
with which they can only crease lesser credit As a result the expansion of credit
will be reduced. Similarly, suppose the central bank wants to expand credit in
order to revive an economy in deflationary situation. Then it will start buying
securities in the open market from the commercial banks and others. This
means, the central bank will pay them cash adding to their cash reserve. This
will enable commercial banks to create more credit. Apart from expanding or
292
contracting credit creation, open market operation can also influence the
interest rate. For instance, when the central bank buys securities giving cash,
the interest rate will fall down and when the securities are sold, the interest rate
will go up.

The open market operations became very popular since the 1 World war. With
the increased availability of government and other securities, it has become
more useful. As the bank rate was proved to be ineffective, there was need to
make increasing use of open market operations. Further it has helped to
remove the shortage of money in the money market apart from helping to make
the bank rate policy successful. A major contribution of the open market policy
is that it is very helpful in checking the 'run on banking.' However, the success
of the open market operation depends on the following conditions:

1. Existence of a well developed securities market is a must for making the
policy effective. The non-fulfillment of this condition has made this policy
less effective in under developed countries.
2. The maintenance of excess cash reserve by the commercial banks defeats
the object of this policy easily.
3. The operations of extraneous factors like leakage of cash or injection
cash into the country may affect the effectiveness of this policy. Suppose
when the central bank buys securities, the injection of additional cash be
used to set right the balance of payment deficit or people may ; holding
more cash or the velocity of money may decline. As a result policy
becomes ineffective.
4. The attitude of the borrowers may stand in the way of this policy
succeeding, suppose the central bank wants to expand credit and so
buys securities. The availability of credit need not induce the investors to
borrow more from commercial banks. That is if the investor's attitude is
not in consonance with the policy of the central bank, the open market
operation^ will fail.
5. The central bank should have adequate stock of securities to effectively,
participate in the open market operations.
293
6. The commercial banks should not have any other way of getting financial
accommodation from the central bank as otherwise die open market
operations will be less effective.
7. It has been found in practice that this policy is more effective in
controlling^ credit creation or expansion rather than in stimulating
credit expansion as the borrowers are influenced by other factors apart
from the cheapness of credit.

3. Variable cash reserve ratio :
Considering the limitations of the bank rate policy and the open market
operations, the need to develop a very effective method, of credit control was
felt. Especially, the need was to directly control the power of the commercial
banks to create credit Variable cash reserve ratio was suggested as one more
method of quantitative credit control by Keynes. Further this method is
considered necessary for promoting the overall liquidity and solvency of the
banking system, apart from improving the public confidence on the banking
system.

The process of working of this method of credit control can be easily understood
with an example. Suppose in an economy there is over expansion of credit
which is possible with excessive cash reserves with the commercial banks. To
check this, the central bank may raise the cash reserve ratio say from 20% to
25% Then this will bring down the availability of cash reserve with the
commercial banks. With lesser cash reserve they can only create lesser credit.
Similarly, suppose the central bank wants to expand the credit creation by the
commercial banks. Then it will bring down the cash reserve ratio say from 25%
to 20% This will enable the Commercial banks to have more cash reserve with
which they can create more credit. It should be noticed that the cash reserve
ratio determines the credit multiplier in an economy. An increase in former will
contract credit through multiplier effect and reduction in the former will expand
credit through multiplier.

In India the variable cash reserve ratio is slightly altered and it is called
Statutory Liquidity Ratio (SLR). SLR means that every commercial bank should
294
maintain a certain amount of liquidity to meet its liabilities. This SLR includes,
the cash reserve with the RBI, cash-with other banks-and investment in
government securities, any increase in SLR will reduce the lendable funds with
commercial banks and decrease in SLR will increase the lendable funds with
them. SLR helps in not only credit control but it also helps in assisting the
government's borrowing programs. This method is also called as the method of
secondary reserves requirements.

Though the variable cash reserve ratio is considered superior to other methods
of quantitative credit control, it has the following limitations:
1. Commercial banks with excess reserve are least affected by the method.
2. Commercial banks with a very strong source of foreign funds can by-
pass this policy.
3. The central bank's policy of liberalizing or contracting the credit may not
be commensurate with the investor's attitude.
4. This policy also affects all commercial banks uniformly i.e., banks with
large cash reserve as well as small reserve. As a result the policy may
harm some banks in the process protecting the economy.
5. The commercial banks will lose their freedom because of the policy,
hence, they will always be cautious in maintaining additional reserve.
6. As the cash reserves maintained by the commercial bank do not fetch
any interest, in a way, this policy brings down the earnings of
commercial-banks.
7. As this method is very effective, it has to be very carefully applied by the
central bank as otherwise it has to undo itself all that it has attempted to
maintain economic stability.
8. This policy directly affects the securities market as increase in cash
reserve required by the central bank will force the commercial banks to
dispose of securities they have, causing depression in prices of securities
resulting in heavy financial loss.

In spite of all these limitations, the variable cash reserve ratio is by and large
effective method of controlling the quantum of credit in an economy this policy
295
has to be carefully adopted as otherwise, it may result in severally, unwanted
consequences on the economy.



QUALITATIVE CREDIT CONTROL OR SELECTIVE CREDIT CONTROL!
POLICY AND THEIR LIMITATIONS.

Qualitative or selective credit control policy refers to the set of policies
implemented by the central bank in order to channelize the available credit in-
the desired direction. For example, suppose in India the agricultural and small
scale industry sectors are to be encouraged, then the RBI may direct the
commercial banks to be more liberal in lending to these sectors and be strict
while lending to other sectors. This will help the economy to provide ample
opportunities for the priority sectors to grow. In other words, in every country
the government determines in advance the priorities and to ensure that the
banks conform to the priorities in their lending policies, the selective credit
control policies are implemented. Hence, while the quantitative credit control
policies aim at controlling the volume of credit created, and the money supply
in the economy, the qualitative credit control policies help in using the available
funds only for the important purposes and discourage unnecessary lending by
commercial banks. The objectives of the selective credit control policies are :
1. to divert available funds only to the urgent and desirable purposes,
2. to control and regulate a particular sector an economy without affecting
the entire economy as a whole
3. to discourage wasteful and uneconomical consumer expenditure on non-
essential items.
4. to correct the unfavorable balance of payments of a country and
5. to control and regulate even the non-banking financial houses
or intermediaries.

The important methods of selective credit control policies are :
1. Margin requirements
2. Regulation of consumer credit
296
3. Control through directives
4. Rationing of credit
5. Moral suasion
6. Direct action and
7. Publicity.

1. Margin requirements :
It is well known that commercial banks lend against valuables and securities.
These securities are the collateral for the amount lent. While accepting the
securities for the loan the banks first asses the market value of the securities
and then considering the amount of loan required the bank would require the
margin to be paid by the borrower which on most occasions is the difference
between the market value of the securities and the amount of loan required.
However, the central bank has the right to determine the margin amount
payable by the borrowers. This margin amount is stipulated in terms of
percentage of the value of the securities offered or the amount of loan required.
The central bank can vary this percentage of margin requirement from time to
time to regulate the flow of credit on certain securities. In other words, central
bank can also fix different percentages of margin requirements on different
types of securities against which the loan is given, this method is effectively
used to counter inflationary a deflationary conditions in an economy.

The major advantages of this method are:
1. it ensures use of available funds only for productive and useful
purposes,
2. it discourages speculative activities,
3. it helps to control inflation by diverting the funds available to produce
only goods which will help to bring down the price level and
4. it encourages sound investment projects.

However, this method has serious limitations as explained below :
1. fixation of very high percentage of margin may drive the borrowers to
black: money market and
297
2. it may encourage collusion and corruption among the bank officials to
show undue favors to certain borrowers.

Example : Suppose a person X approaches a commercial bank A for a loan of
Rs. 20000 to buy a motor cycle. The banker then would ask borrower to remit,
say 20% of the value of the motor cycle as margin money. Mr. X would remit
Rs. 4000 and then the banker would give him a loan of Rs. 200. Suppose the
central bank wants to discourage such lendings. It may increase the margin
requirement from 20% to 40% Then Mr. X should remit Rs. 8000 to the banker
to get a loan of Rs. 20000. This may discourage X from approaching the baker
for the loan^, Suppose Mr. Y wants a loan of Rs. 50000 to start a small scale
business unit. The-banker then may ask him to remit Rs. 5000 (just 10% of the
amount of loan) as margin money. Suppose the central bank want to
encourage such lendings it may, fix just 5% as the margin requirement for such
loans and then Mr. Y would have to. pay only Rs. 25000 as margin money.

2. Regulation of Consumer credit:
According to this method of selective credit control the commercial banks are
instructed to encourage borrowing for certain purposes and discourage certain,
other types of borrowing. Usually consumers approach the commercial banks
for loans to buy durable consumer good like T.V., refrigerators, washing
machines, etc. The banks would direct the consumers to pay a part of the price
of the item to be purchased and the, remaining amount is given as credit. The
central bank may regulate the consumer credit in different ways. Most popular
methods are :

(i) Central bank may extent or curtail the consumer loans to buy certain items
during a particular time. For example, during inflationary period, the central
bank may curtail the commercial banks from lending to enable consumers to
buy T.V. fridge, etc. Then the demand for these luxury items will come down
bringing down their price and indirectly helping to control general price level.
(ii) The central bank may alter the initial money to be deposited by the borrower
and through that encourage or discourage borrowing. For example, during
inflationary situation, the central bank may instruct the commercial banks to"
298
get 40% of the value of the item to be purchased as the initial deposit payable
by the consumer. Then this would discourage the consumer from borrowing.
During the normal period this initial deposit requirement may be reduced to
just 10%.
(iii) Changing the maturity period of the loan is one more method of consumer
credit regulation., Suppose the central bank wants to encourage the consumer
credit, then it may. allow maximum repayment period say 60 month's. On the
otherhand, if it wants to discourage the consumer credit, it may fix the
maximum repayment period as only 30 months. Accordingly the lending
operations will increase or decrease.
(iv) Changing the rate of interest on consumer credit is one more usual method
to regulate. Increase in rate of interest will discourage borrowing while reducing
the interest will encourage borrowing.

3. Control through directives :
This method means the periodical directions, instructions, information,
guidelines and warning issued by the central bank to the commercial banks to
make the latter follow the credit policies of the former. The main objectives of
this method are :
(i) to control the lending policies of the commercial banks.
(ii) to channelize the available credit to more productive and
urgent uses from less urgent and less productive purposes.
(iii) to completely prohibit lending towards a particular purpose
and
(iv) to determine the maximum amount that could be lent for
certain purposes.

Every central bank is empowered to issue such directive by virtue of the
statutory powers conferred on it and usually the central bank implement this
policy by offering incentives like liberal refinancing facility to banks which follow
the directives and restraining the erring banks by arranging for scrutiny of their
lending pattern or imposing penalties for violation. In practice the commercial
banks usually follow the guidelines and directives of the central bank and
conflict on the ground seldom arises.
299

4. Rationing of credit:
It is necessary for every commercial bank to approach the central bank to
improve its liquidity in times of need. Central bank can effectively use this
'dependence of commercial banks to control the credit creation or make them
work according to the need t>f the time. Rationing of credit can be interpreted
in two ways:
(i) the central bank may fix the maximum amount of financial
accommodation to an commercial bank on the basis of
rediscounting facilities.
(ii) the central bank may fix the quota for every commercial bank
for financial accommodation.

The central bank may use the policy in any one of the two ways or both the
ways, For instance, it may feel that a particular bank is creating excessive
credit. To control this central bank may fix the maximum amount of financial
accommodation that the particular commercial bank can get from central bank
through re-discounting of eligible bills with central bank. This will certainly
make the commercial bank to control its credit creation. But this method of
credit control has certain limitations. Firstly, the central bank is suppose to be
the lender of last resort for the commercial banks. But when it rations the
credit to the commercial banks, it appears to be contradicting its role as a
lender of the last resort. Secondly, the method is not so effective in a situation
where the commercial banks have built up sufficient reserve so that they need
not approach the central bank in times of need. In that case, rationing of credit
has no purpose to serve. Thirdly, this method can be effective only when there
is excess demand for credit over the supply of credit However, the central bank
uses this policy along with the other policies in order to improve the over all
effectiveness of the selective credit control policies.

5. Moral suasion:
Moral suasion refers to the persuasive approach of the central bank towards the
commercial banks in making the latter follow and implements the policies of the
former. Though the central bank is empowered to take direct action on the
300
erring or violating commercial banks, yet it exercises that option only rarely. In
its place, the central bank takes efforts to explain to the commercial banks the
need for following certain policies. This is done either through periodical
conference with commercial banks, or by appealing to the sentiments of the
commercial banks. In effect this method aims at bringing to commercial banks
into line through use of moral force instead of resorting to the legal powers. It
should be noted that this method has no legal back up or support. It is merely
applied using the conventional relationship between the commercial banks and
the central bank. It has been quite successful in countries like UK, France,
Holland and others. But it has not been very effective in USA under the unit
banking system. In India, the RBI has found this to be very effective as there
exists a very cordial relationship between the central bank and commercial
banks. Of course, the success of this policy depends on the prestige, influence
and leadership of the central bank Further since it has no legal back up in
times of credit expansion it is not effective.

6. Direct action:
Direction action is one more method of selective credit control in which the
central bank uses coercive measures against the erring commercial banks or
banks violating the central bank ruling. It may vary from general instructions to
the banks to special directives to the erring banks. Though this method has the
legal sanction, central banks around the globe rarely apply this method. As a
matter of direction action, central banks are vested with vast powers ranging
from refusing credit and re-discounting facilities or imposing penal rate of
interest on banks which have sought financial accommodation from central
bank beyond the prescribed limit. In several countries, the central bank is
empowered to formulate general credit policy or prescribe die rates of interest
on different types of loans and advances or to divert the available bank credit to
a particular industry etc. Though this method is very effective it is very rarely
applied in isolation. It is normally combined with other methods. But this
method has certain limitation like:

1. Direct action on commercial banks may make them work against the
central bank at least psychologically.
301
2. The commercial banks are at a loss sometimes to follow the policy of
central bank regarding productive and unproductive lending, essential
and non-essential borrowing, etc., in the absence of clear cut definition.
3. The central bank through this method is able to regulate the functioning
of commercial banks only. It cannot control directly any misuse of credit
by any borrower.
4. This role of central bank contradicts its traditional function as the last
resort.

7. Publicity :
Use of publicity as a method of selective credit control is a debatable question.
In advanced countries this is used as an effective method of credit control while
developing countries it is yet to be recognized as a measure. However the central
bank can public its views, opinions, policies, guidelines, directions,
observations, etc., periodically about the economic situation prevailing in the
country of economic -variable's behaviour, money market, public finance, trade,
industry, agriculture, etc. Such publications help to understand the changing
situations and the needs of a country. The commercial banks are able to
formulate their policies with the back ground information published, by the
central bank, this method is very widely used in most of the advanced countries
and in India the RBI publishes / various statements, returns, etc., helping the
country to follow the changing.; economic situations and through that guiding
the commercial banks. But the effectiveness of this method of credit control is
debatable and it is usually applied along with the other methods control along
with the other methods of credit control.

On the whole all the methods discussed above are not free from limitations
which are explained hereunder:
1. The selective credit control policies are applicable to commercial banks;
institutions in the unorganized sector and the non-banking financial
intermediaries are left out of the coverage. As a result these policies
may land commercial banks in a disadvantageous position.
302
2. In the absence of clear cut definition of productive and unproductive
lendings, commercial banks cannot be effectively controlled through
these policies.
3. These policies are ineffective as the commercial banks are unable to
ensure the use of funds for the purpose for which they are given.
4. Commercial banks are encouraged to resort to manipulations and
unhealthy practices to remain outside the effect of these policies.
5. In practice, these policies were not found to be effective in unit banking
system.
6. These policies have no relevance if the businessmen, investors and
other resort to different methods of raising funds than approaching the
commercial banks.
7. It has to be noted that credit is one of the factors affecting the price of
goods and services but control of credit-alone cannot bring about the
desired changes in price level. In this respect, the selective credit
control policies can be treated only as the alternative available and not
the only method of achieving economic stability.

FINANCIAL INSTITUTIONS

Industrial Finance Corporation of India (I-^CI) and evaluate its working
The IFCI was set up by the Government of India in July, 1948 under a special
Act with an authorized capital of Rs. 10 crores, (increased to Rs. 20 crores later)
with a view to achieve speedier industrial expansion of the country. Pre-
independent India could not advance industrially, since the British rulers at
that time had no interest in the growth of industries in India, Indian industries
needed institutional finance support to expand and modernize and this need
was met by the establishment of IFCI. The shareholders of IFCI consist of IDBI,
scheduled banks, insurance companies, investment trusts and co-operative
banks. The repayment of capital and a minimum annual dividend are
guaranteed by the Government of 1 India. The Corporation is authorized to
issue bonds and debentures in the open, market, to borrow foreign currency
from the World Bank and other organizations, accept deposits from the public
end borrow from RBI. The important functions of the Corporation are:
303
(i) To grant loans and advances to industrial concerns and to
subscribe to the debentures floated by them.
(ii) To guarantee loans raised by the industrial concerns in the
capital market.
(iii) To underwrite the issue of stocks, shares, bonds and
debentures of industrial concerns.
(iv) To directly subscribe to the shares of any concern.

The Corporation gives long and medium term finance only to companies
engaged in manufacturing, mining, shipping and generation and distribution of
electricity; with a ceiling of Rs. 1 crore to any single loan. The period of the loan
shall not exceed 25 years. The Corporation charges lower rates of interest in
case of projects in notified backward areas.

The following aspects are examined by the Corporation before a loan is granted:
(i) the importance of the industry to die national economy
(ii) the feasibility of the scheme,
(iii) the cost of the scheme,
(iv) managerial competence,
(v) nature of security offered,
(vi) adequacy of the supply of inputs like raw materials, availability
of technical personnel etc.
(vii) the quality of the product,
(viii) end use of the product.

The Corporation accepts only fixed assets of the borrowing company as security
and does not normally accept floating assets like raw materials and finished
products as security. Personal guarantee of the Directors is also insisted upon.
The Corporation exercises supervision and control over the borrower-company
by appointing directors to the Board of Management and as a last resort could
take over the management in case of persistent and willful default. Periodical
reports from the borrowers and inspections by the-Corporation help the
Corporation to watch the activities of the borrower.

304
The Corporation has rendered considerable service to our industries. Among the
many industries which have received assistance from the Corporation, mention
may be made of fertilizers, cement, power generation, paper, industrial
machinery, etc.

In March, 1975, the Corporation sponsored the Risk Capital Foundation (RCF)
to provide assistance to new entrepreneurs including technologists and
professionals for promoting industrial projects to provide loans free of interest
or at nominal rate of interest.

The Foundation was later (1988) converted into Risk Capital and Technology
Corporation Ltd. (RCTC).

In addition to providing risk capital, the new Corporation provides technology
finance by:
(i) providing substantial innovative technologies products,
processes, market services, technological up-gradation, energy
conservation, etc.
(ii) meeting the expenditure of national and international
consultants,
(iii) financing sponsored commercial R & D programs.

In the area of priority sector, the IFCI has started new promotional schemes
such as Interest Subsidy Scheme for Women Entrepreneurs, Consultancy Fee
Subsidy Scheme for providing marketing assistance to small scale units,
encouraging the modernization of tiny and small scale and ancillary unit and
control of pollution in the small and medium scale units. Lately, the IFCI has
evinced great interest in the development of backward districts.

Considering the financial facility available to the large and medium scale
industries, even after 4 decades of independence, the role played by IFCI is
something commendable. When the commercial banks have their own policy
restrictions in lending for large and medium scale industries, the big units
could not also raise funds easily through the capital market, general hesitation
305
of the common, public (both domestic and foreign) to invest in such big units,
IFCI is the only institution which has come forward to fund the large and
medium scale industries. Since its formation in 1948, till March, 1992 IFCI has
extended financial assistance to the tune of Rs. 14,300 crores to the industries
of which nearly Rs. 9,660 crores have been disbursed.

Though the IFCI has been criticized for charging high rate of interest, delay in
sanctioning of loans, insisting on personal guarantees of the Directors, etc., the
Corporation has been rendering extremely credit worthy service in the
industrial development of the country.

It has entered into the field of funding through underwriting debentures and
shares guaranteeing of deferred payments in respect of imports from, abroad by
industrial units, directly participating in the public issue of shares and
debentures by the industrial concerns, etc. Hence, this institution, has certainly
served the purpose for which it has been formed.

Industrial Development Bank of India (IDBI)

The IDBI was established under the Industrial Development Bank of India Act,
1964 as a wholly owned subsidiary of the RBI. It started functioning on July 1,
1964. The main objective in establishing this Bank was to provide long term
finance to industries. From February, 1976 the ownership of IDBI was
transferred to the Government of India, With the de-linking from RBI, the IDBI
became the apex body for all industrial financing institutions in the country.

The Bank plays a special role in:
(i) planning, promoting and developing industries to fill the gaps in then
industrial structure in the country;
(ii) co-ordinating the working of institutions engaged in financing,
promoting or developing industries and assisting in the development
of such institutions,
(iii) providing technical and administrative assistance for promotion,
management or expansion of industry and (iv) undertaking market
306
and investment research and surveys as also techno-economic
studies in connection with development of industry.

IDBI enjoys considerable operational flexibility. The Bank can finance all types
of industries irrespective of the form or size of an organization. Its activities are
not crippled by restrictions on the nature and type of security which it should
accept. The Bank is empowered to finance all types of industrial undertakings
engaged in manufacturing, mining, processing, shipping and other transport
industries and hotel industry.

The assistance rendered by the Bank can be grouped under three categories
viz., i. direct assistance, ii. indirect assistance and iii, special assistance.
1. Direct assistance: This category consists of project finance,
underwriting of and direct subscription to industrial securities,
modernization assistance scheme for all industries, soft loans,
technical refund loans and equipment finance loans. The Bank has
the option to convert its loans into equity. It can guarantee loans
raised by industrial concerns in the: open market from 'notified
financial institutions. It can also accept, discount or rediscount
bonafide commercial bills or promissory notes of industrial concerns.
2. Indirect assistance: This category is in the form of assistance through
other institutions. It can refinance term loans given by other financial
institutions like, IFCI, SFCs, etc., repayable within 3 to 25 years. It
can refinance term loans repayable between 3 and 10 years given by
scheduled banks/State.
3. Co-operative banks. The Bank can subscribe to stocks, shares, bonds
or debentures of IFCI, the SFCs or any other 'notified' financial
institutions.
4. Special assistance: The Bank has a special fund known as the
Development Assistance Fund to be used for assisting those industrial
concerns which are not able to secure funds in the normal course
because of low rate of return.
307
5. The Bank also renders assistance to Backward areas by giving loans
on softer terms, such as concessional rate of interest, longer grace
and repayment periods.

The Bank extends assistance to small scale industries and small road transport
operators indirectly through the State level institutions and commercial banks
by way of refinance.

The Bank has launched a Fund called national Equity Fund Scheme in 1988 for
providing support, in the nature of equity to tiny and SSI units and has set up
all Voluntary Executive Corps Cell to utilize the services of experienced
professionals for counseling SSI units tiny and cottage units and for providing
consultancy support in specific areas.

The principal sources of funds for the Bank are its own share capital and
reserves, borrowing from Government of India and RBI, market borrowing by
way of X bonds, etc. The authorized capital of the Bank is Rs. 1,000 crores
which can be raised further upto Rs. 2,000 crores.

The IDBI (as well as other term lending institutions) have introduced a two-tier
interest rate structure for loans for industrial projects in the large, medium and
small scale sector with effect from August, 1990. The first tier relates to the
initial two years or the construction period of industrial projects (whichever is
shorter) and the second tier applies to the period thereafter when industrial
projects are expected to commence production. For the first tier, the normal
interest rate would remain unchanged at 14% per annum, whereas for the
second tier, the normal interest rate would be 15% per annum. To impart
greater flexibility from July, 1991, the Bank has the freedom to charge interest
rate above the floor rate of 15%.
According to the provisional figures available during the year 1990-91, the
Bank sanctioned financial assistance to the tune of Rs. 5,604.6 crores and
disbursed Rs. 3,511.5 crores. Similarly, in 1992-93 alone, the Bank had
sanctioned Rs. 9,459.4 crores of financial assistance of which it disbursed Rs.
6,669 crores. Since its inception in July 1964, till the end of March, 1992 IDBI
308
had sanctioned financial assistance of nearly Rs. 64,696 crores and disbursed
nearly Rs. 47,088 crores.

Industrial Credit and Investment Corporation of India (ICICI)

ICICI was set up in 1955 under the Indian Companies Act. This was sponsored
by a mission from the World bank as a result of international co-operative effort
to encourage private investment in India. It started with an authorized capital of
Rs. 60 crores and a subscribed capital of Rs. 22 crores. The authorized and
subscribed capitals have since been increased to Rs. 100 crores and Rs. 49.5
crores respectively.

The aim of ICICI is to stimulate the promotion of new industries to assist the
expansion and modernization of existing industries and to furnish technical
and managerial aid so as to increase production and thus create employment
opportunities. With this aim in view the Corporation provides financial
assistance to enterprises as detailed below:
underwriting of direct subscription to shares, bonds, and debentures,
loans in rupees and foreign currencies
guaranteeing payments for credits given by Indian and foreign sources.
credit facilities to indigenous manufacturers who sell industrial
equipment on deferred payment basis.
equipment leasing facility
merchant banking services
project counseling for non-resident Indians

Regarding sources of funds for its activities, the Capital of the Corporation is
supplemented by borrowing from Government of India, the World Bank, IDBI,
other foreign governments/agencies, and issue of bonds/debentures in India
and foreign commercial markets.

The ICICI has promoted/sponsored the following institutions:
309
(a) Housing Development Corporation of India (HDFC) to provide long term
finance to middle and lower income group of individuals, co-operatives,
etc
(b) Credit Rating Information Services of India Limited (CRISIL) to provide
credit rating services to the corporate sector;
(c) Technology Development and Information company of India limited
(TDICI) to finance the transfer and up-gradation of technology and
provide ' technology information.

The provisional figures available for 1990-91 put the Corporation's assistance at
Rs. 3,857.5 crores as sanctioned and Rs. 1,936.5 crores as disbursed.

Adam Smith's canons of taxation and the principles of a sound tax
system '

Adam smith's Canons of taxation : .
Adam Smith laid down four canons of taxation. They are: i) canon of ability, ii)
canon of certainty, iii) canon of convenience and iv) canon of economy.
(i) Canon of ability : According to this principle of taxation, the people in
a country should contribute towards the government expenditure.
Their.:* contribution should be according to the ability to pay of each
individual. A rich man should contribute more and the poor either
should contribute less & or can be exempted. This principle of
taxation will ensure that the cost of public expenditure is shared by
the people in accordance with their individual ability.

(ii) Canon of certainty : Adam Smith insisted that the-government
should know in advance the amount of revenue that it could raise
and the time when it could mobilize the revenue. On the part of
individual tax payers, they must know clearly the amount of tax that
they have to pay; the time when they should pay and the method of
paying the tax. Adam smith felt that it is necessary that the people
should be certain about their tax commitment, so that there cannot
be any exploitation of the tax payers either by the government or by
310
the tax collectors. This implies, once the people are clear about the
amount of lax, they will plan their expenditure accordingly so that tax
payment will not be felt a penalty.

(iii) Canon of convenience : According to this canon, the tax should be
such that it is levied at the time when it is convenient for the people
to pay. Similarly the manner in which the tax has to be paid should
also be convenient for the tax payers. For example, the sales tax paid
on any commodity is included in the price and the consumer does not
feel when he pays the tax. At the same time, the government is able to
collect the tax effectively without any possibility of evasion or
avoidance.

(iv) Canon of economy : This is a very important principle stating that the
cost of collection of tax should be less than the tax revenue. In other
words, the purpose of imposing tax will be defeated if the government
has to spend
f
more money to collect less tax revenue. Only when
there is economy in tax collection, that the tax revenue realized can
be spent usefully. For example, in the case of direct tax like income
tax, the government may organize tax raids on people who evade tax.
If the cost of these raids is greater than the amount of tax
recoverable, then it is not wise. On this ground, indirect tax like sales
tax is more economical than income tax.

Several other canons of taxation have been introduced by the modem
economists. Some of these canons are : canon of simplicity, according to which
the tax structure should be easily understandable to the common men so that
payment of taxes will not be difficult. Another canon is canon of productivity
which implies that the taxes should fetch adequate revenue to the government
to meet the public expenditure. Other canons like canon of elasticity, canon of
flexibility, canon of diversity and canon of neutrality have also been introduced.
According to Mrs. Hicks, a sound tax system should have the following
characteristics:
a. It should facilitate financing of public services.
311
b. Tax, should be levied according to the ability of the people, the index of
ability being income and family circumstances and
c. similarly placed persons should pay similar taxes to avoid any
discrimination. From the discussion above, we may lay down the
following four broad characteristics as the principles of a sound tax
system.

1. Equality in tax burdens :
This principle suggests that when the taxes are levied they ensure equality in
tax burdens. In other words, through taxes the government can ensure that the
tax burden is spread in such a way that persons who are placed in similar
positions are made to bear the same burden of taxes. This implies that people
who are better-off should bear more tax burden than those who are worse-off.
Though this principle is universal, yet in the implementation of this principle
problem like indicators of equality, effectiveness in practice, the method of
achieving this equality, etc., will all be faced.

2. Productivity:
With the ever increasing responsibility of modern welfare state, the need for
financial resources is always felt. As the modern governments spend huge
amounts of money on public projects to maintain high level of public welfare,
they have to raise enormous funds through taxation. Unless taxes are
productive, the governments will find it difficult to implement public projects.
Especially in a developing country, taxes are to be highly productive so that
country can achieve growth with stability. Apart from being productive, taxes
should also be flexible and ensure regular inflow of funds for the government.
This implies that taxes., should not only fetch regular flow of revenue, but this
flow should increase on decrease depending upon the circumstances. Of course,
the productivity of taxes is a relative term and it depends on several factors
such as tax base, rate of tax, the exemptions and concessions granted, the
efficiency of collection, the tax payers psychology, etc. Hence, the fiscal
authorities should design the tax system in such a way at each tax levied is
productive and flexible.

312
3. Recognition of the rights and problems of the tax payers:
Government should not be aiming merely at high revenue through taxes.
While designing the tax system, it should take into account the various
problems and difficulties of the common public so that the taxes imposed will
be successfully implemented. The government should also recognize die rights
of the tax paying public. The tax system should be such that the public are able
to easily pay the tax with minimum inconvenience and their complaints and
grievances are sympathetically heard and redressed. No tax system can bring
the expected revenue unless the tax paying public understands the purpose of
the tax and cooperate with the tax administrators. Hence, the government
should make the tax laws simple and comprehensible and the collection
procedure simple. Tax payment should be a pleasure and must not irritate the
public. The tax administrators should be tactful, courteous, remain impartial
and be alert all the time to avoid any evasion and avoidance. A system to
enquire into the grievance of the tax paying public should also be formulated so
that the public will have a way of settling their problems and difficulties in
paying taxes. Only when the administrators are understanding and
sympathetic, the morale of the tax payers will be high and die tax system will
function smoothly.

4. Adaptability of the tax structure:
The tax system evolved should be such that it matches well with the prevailing
situation, hi a developing country, the burden of tax should not be very heavy
as this will directly affect the morale of the tax payers. At the same time the
government should also raise adequate revenue to meet its mounting public
welfare expenditure. The best tax structure is one which can be modified
suitably with changes in economy.

Distinction between direct tax and indirect tax
Direct and indirect tax:
Taxes are classified as direct tax and indirect tax. But the meaning of these
two types of taxes is not clear. For a long time economists interpreted these two
types in different ways. For instance, one group of economists considered taxes
313
on production as direct taxes and those on consumption as indirect taxes.
Taxes imposed on income are treated as direct taxes and those on expenditure
treated as indirect taxes. J.S. Mill distinguished these two types of taxes in
terms of the ability to shift the tax. Any person on whom the tax is imposed, if
he himself pays the tax, it is called direct tax and if he is able to shift the tax Jo
somebody who ultimately pays it then it is called indirect tax. For example,
income tax is paid by a person as it is levied on the income earned by him, so it
is a direct tax. On the other hand the sales tax imposed on the seller is shifted
to the buyer. Now-a-days the distinction between direct and indirect taxes is
explained with reference to the basis of assessments and not on the point of
assessment. Hence, taxes assessed on the basis of income are called direct
taxes and those assessed on the basis of expenditure are called indirect taxes.
However, even this classification is not free from difficulties. For instance, when
one man's income is treated as another man's expenditure, tax on one man's
income may become the tax on another man's expenditure. Hence, till date
there has been no satisfactory distinction between direct and indirect taxes.
However, in practice this distinction is retained more for the purpose of
grouping the different taxes.

Merits and demerits of direct tax:
Merits:
1. Direct taxes are based on the principle of ability to pay and so they help
to distribute tax burden equally.
2. As the tax is imposed on each individual, for example, based on his
income, he is certain about the amount of tax payable by him. Hence, the
direct tax satisfies the canon of certainty.
3. Direct taxes are also highly flexible. The revenue from them can be
increased or decreased depending upon the need of the government. For
example, the government can simply raise the rate of tax to get more
revenue and bring down the tax rate to reduce the revenue.
4. The tax paying people are more interested in the ways in which the tax
revenue is spent by the government. They feel proud of participating in
the public projects by paying tax.
314

Demerits:
1. Direct taxes like income tax, are considered as tax on honesty of the
people. Those people who can evade or avoid it are rarely prosecuted.
Hence, there is no incentive to pay the tax.
2. There is no logical basis for levying or determining the tax. As a result
political considerations overweigh the economic and other
considerations. For example, a communist government may impose
very stiff tax rate while a socialist government may not do so. Hence,
there is ample scope for arbitrariness in the imposition of tax.
3. From the view point of tax collection, the cost of collection of direct
taxes is very high compared to that of indirect taxes, For example,
income tax has to be collected from every person who should pay tax.
Hence, a very elaborate arrangement is required in the form of
administrative machinery which simply increases the cost of tax
collection.
4. One more difficulty is not all the tax paying individuals are aware of
the provisions of income tax. The provisions are so complicated that
unless an individual is clear about them he will be paying more tax.
In the case of corporate tax, every effort is made to minimize the tax
burden by taking advantage of the loopholes in the tax laws.
5. Another demerit of the direct taxes is that in case of any dispute, it
takes a long time for the common public to secure justice and still
more time to get back the excess tax paid.

The evaluation of the merits and demerits of direct taxes indicates the problems
experienced are more related to administrative aspect and not the economic
aspect. Efforts have been taken in India to simplify the assessment, exemptions,
procedures and refund of direct taxes. This has helped to increase tax revenue
from direct taxes. The tax administrators in India adopt persuasive techniques
instead of coercive methods to obtain as much tax revenue as possible and
minimize tax evasion and avoidance. Frequently amnesty schemes are
announced to provide opportunities to the public to turn honest

315
Merits of Indirect tax:
1. Indirect taxes are imposed at the point of consumption and so it is very
easy to collect them.
2. The cost of collection of indirect taxes is almost nil as every person will
pay the tax as he buys the commodity on which the tax is imposed.
3. It is very simple and easily understandable as only a fixed percentage of
the sale price is collected as tax.
4. A significant merit of indirect taxes is that it cannot be evaded or
avoided as the only alternative to not paying the taxes is not to
consume.
5. Like direct taxes, indirect taxes are also highly flexible. They can be
altered to suit the requirement of government's need for funds.
6. Another important merit is that even the poorest in a country will
contribute towards the cost of public service.
7. Indirect tax is the ideal way to discourage consumption of luxurious and
unwanted goods.

Demerits:
1. The fundamental defect of this type of tax is that it does not conform to
the principle of ability to pay as it affects every individual hi the same
way irrespective of his economic position.
2. The revenue from indirect taxes cannot be certain. This is because a tax
imposed on a commodity with highly elastic demand will bring down the
demand for the commodity and along with that the taxes. On the other
hand a tax on a good with inelastic demand can fetch the desired
revenue. A main difficulty is that the elasticity of good is influenced by
several factors and so the tax revenue may be uncertain.
3. As the indirect taxes are usually a fraction of the price paid, the tax
payers never feel the payment of taxes. Hence, they evince little interest
to know how the amount of tax revenue is spent.
4. Yet another problem of indirect taxes is that very stiff rates encourage
black marketing, smuggling and other illegal trading practices.
5. Sometimes, the indirect tax levied on a commodity will vary from state to
state causing lot of hardship for the tax administrators and encouraging
316
the people to buy the goods in the state where the tax is less and sell the
goods, in the state where the tax is high. This might affect the
businessmen in the latter state.
6. Though the cost of collection of indirect taxes is less, yet, the records to
be maintained and inspected are voluminous involving enormous time
and energy of the lax administrators. This gives wide scope for corruption
and malpractice among the officials.

Comparison of direct and indirect taxes:
Having discussed the merits and demerits of both the direct and indirect taxes,
it could be understood that indirect taxes are superior to direct taxes in several
respects. For example, indirect taxes can be selectively imposed on goods of
harmful nature to discourage the consumption of such goods. This selectivity is
not possible under direct tax. Between the two types of taxes, direct taxes
directly affect the incentive to work and save severely. But indirect taxes have
no such direct impact. In a developing country, to reduce income inequality
increased dose of indirect taxes is better. Though this may mean taxing the
poor also, yet in modern times, with overall improvement in standard of living,
slowly poor people should also be subject to the tax net. Moreover, in a country
where there is large scale tax evasion, tax avoidance, black marketing,
smuggling, etc., indirect taxes are the best instruments to put down such evil
practices. All these superiority of indirect taxes over the direct taxes need not
mean that direct taxes should be abolished. A balance should be maintained
between these two types of taxes so as' to discourage and avoid any attempt to
evade or avoid tax. The various problems associated with each one of these two
types of taxes should be seriously studied to overcome them. Especially the
administrative problems can be overcome only by exposing the officials to the
modem techniques of tax collection, giving them attractive incentives and
rewards for honest work, encouraging them to suggest modification to improve
the effectiveness of the taxes, etc.



317
DEFICIT FINANCING
Its purpose, effects and limits of deficit financing
Deficit financing is understood in different ways in different countries. It is
understood as the excess of current expenditure over current revenue which is
financed either through public borrowing or the creation of new money by the
government. So the deficit budget is also called deficit financing in USA. But in
India deficit financing is understood in a different way from deficit budget.
While the former refers to a situation where the current expenditure exceeds
current revenue of the government, the latter is taken to mean the excess of
aggregate expenditure (both on current and capita! accounts) over aggregate
revenue. The former is called deficit budgeting and the latter deficit financing in
India. Deficit financing in Indian context refers to the meeting of budgetary
deficit through the creation of new money adding to the existing money supply
in the economy. Deficit financing includes any or all of the following in India:

i) the government withdrawing its cash balance with the Central bank, ii) the
government borrowing funds from the Central bank, and iii) the government;
resorting to printing of new currency notes with a view to cover the budget
deficit

Purpose of deficit financing: :
There are several purposes for resorting to deficit financing. The following are
the; purposes:
1. War finance: A country in war experiences severe shortage of financial,
resources, especially the cost of modem warfare is so prohibitive that
the country resorts to deficit financing. During this period the country
cannot resort to taxation or public borrowing because of the situation
in the economy. But it should be noted that such a method of financing
the war expenditure, is very dangerous, as during the war period apart
from the destruction of, the existing assets, there is no possibility of
increasing the production. Further all the productive activities will be to
meet war requirements. Hence, with the addition to money supply,
there is no corresponding increase in the production. As a result,
318
deficit financing during the war time should be highly inflationary in
nature.

2. Economic depression: During the period of depression the purchasing
now of the people is very low and the private investment will not be
possible

because of the gloomy picture all round. Therefore economists
like Keynes suggested that public investment should be increased in
large scale. The funds for such a dose of public investment can come
from either taxation or public debt or deficit financing. If taxation is
resorted to for raising funds for public investment, as it means only a
transfer of purchasing power from the people to the government, while
during depression what is required is new additional, public
expenditure. Public borrowing or public debt as a source of public
expenditure is also having its own limitations. For example, public
borrowing only means addition to the financial burden of the
government and the pubic in terms of debt servicing or payment of
interest on public debt. Therefore as a third alternative deficit financing
is considered. Though there are objections to this alternative stating
that it is basically inflationary, Keynesian supporters argue the other
way. During depression the economy is in a pit and all the resources
are remaining unutilized or under utilized. In such a situation, if the
government resorts to deficit financing it will only help to increase
employment, output and investment. So there cannot be any inflation
until the economy reaches-the lull employment level, no more deficit
financing should be allowed as it then becomes highly inflationary.

3. Economic development; Alter the II World war, several countries
around the world became independent. In their effort to build up the
nation, these countries were in need of heavy dose of funds. This is all
the more felt because some of these countries selected planning as a
strategy of economic development. They had only three alternatives to
raise funds for their development efforts. They are taxation, public
borrowing and deficit financing. Taxation as a source of raising funds
was ruled out because of the nature of war shattered economy, low
319
purchasing power of the people and also the political reasons prevented
this alternative as most of the countries turned to be democratic one.
Public borrowing also could not be resorted to as people were already
impoverished and there was no way of inducing them to lend more.
Further the debt servicing was expected to over-weigh the government's
financial burden. Then every country preferred to use* deficit financing
as a method of financing their economic planning and economic
development. Even India relied on deficit financing right from the I Five
year plan. Of late deficit financing has become a permanent source of
funding of Plan requirements.

I) Effect of deficit financing on price level:
There are two opinions regarding the effect of deficit financing on the price level
especially in a developing country. According to one view, deficit financing need
not be inflationary in character especially if it is used during the peace time.
The advocates of this view argued that:
(a) In a developing economy the existence of non-monetized sector will
absorb the issue of new currency and shrink in its size over a period
of time. Therefore the additional money pumped into the economy
will not go to affect the price level.
(b) Over a period of time the demand for money for transactions and
liquidity purpose will increase. Therefore the additional money
injected will not be spent but will only be kept by the people.
Therefore, deficit financing need not be inflationary.
(c) A developing economy will have a large amount of unutilized
resources and during peace time when the government resorts to
deficit financing the additional money will be used only for resource
utilization and so it need not be inflationary in nature.

However, the following arguments are leveled to claim that deficit financing is
essentially inflationary in character:

(i) There will be a lag in the expansion of output and the injection of
additional money in the economy, such that the output will
320
increase at a lesser rate than the money supply. Consequently,
there will be inflation in the economy. This is because of certain
rigidities in the effort to increase the output. Therefore, the actual
output will fail short of the potential output.

(ii) Developing economies follow unbalanced growth strategy and so
they invest heavily on capital intensive projects which have a long
gestation period. As a result the return on investment in terms of
higher output will take a longer time and meanwhile increased use
of deficit financing will only affect the price level causing inflation.

(iii) In a developing economy majority of the people are poor and so their
marginal propensity to consume is very high. Hence, when their
income increases due to deficit financing, the demand for goods will
outstrip the supply causing the prices to go up.

(iv) Governments also resort to deficit financing for unproductive
purposes, which will only fuel the inflationary pressure.

(v) The developing countries have neither the necessary expertise nor
the efficient administrative set up to keep the inflationary pressure
caused by deficit financing under check. As a result deficit
financing should lead to inflation. Considering the above arguments
and also the practical experience, it is found that deficit financing is
inflationary in character.

II) Effect of deficit financing on income distribution :
Deficit financing is inflationary in character and as a result it affects a section
of the society favorably and the other section unfavorably. Rich people become
richer and the poor turns out to be poorer because of deficit financing especially
during the war period. The businessmen, traders, speculators, industrialists
and other benefit by deficit financing through inflationary pressure while the
workers, salaried income group, and others are affected badly. Hence, the
existing inequality in a developing country will be widened more by deficit
321
financing thereby defeating the ultimate purpose of socialism in bringing
about equality. Therefore deficit financing is unjust and it not only worsens the
income inequalities, it also prevents the attempt to improve the standard of
living.

III) Effect of deficit financing on unemployment:
Regarding the effect of deficit financing on unemployment, we have to classify
the economies as developed and developing economies. This is because the
Keynesian prescription of deficit financing helps the developed countries to
overcome the unemployment but it has not helped the developing countries in
this respect. This is because in developed countries, when the economy faces
depression, to revive the economy the government should undertake a large
scale public investment. Funds for this purpose cannot be raised through
taxation or public borrowing and so only deficit financing is the ideal method.
Defied financing has helped the developed countries to overcome
unemployment, because during depression the government increases the public
investment which will increase the effective demand and thereby constitute the
ground for increasing the private investment. With the operation of multiplier
then the output, employment and effective demand continue to increase pulling
the economy out of the pit. But such a result in a developing economy is not
possible, because,
(i) the nature of unemployment is not cyclical but chronic and caused
because of deficiency of capital
(ii) there exists a large scale voluntary unemployment and disguised
unemployment in the developing countries. Those who are coming
under the second category do not know that they are unemployed.
(iii) in developing economics the multiplier process takes place regularly
and smoothly and so unemployment is very much reduced. .But the
conditions for the successful operation of multiplier are not found in
developing countries and so the unemployment persists.
(iv) further in developing economies because of rigidities, large scale
investment in capital intensive industries, high marginal propensity
to consume and high marginal propensity to import affect the
possible increase in investment and employment opportunities. With
322
every increase in money supply, only the price level goes up and not
the output and employment. Hence, the use of deficit financing in
developing countries to solve the unemployment problem calls for a
lot of precautions and careful administration as otherwise it would
create several other complications.

IV) Deficit financing and economic growth:

It has been clearly proved that deficit financing m developing countries will
accelerate economic growth, provided certain precautions are taken. The
positive, role played by deficit financing in developing countries is because of
the following reasons:

Firstly, in developing economies, the physical and human resources are under
utilized and so the /created money' will facilitate, fuller utilization of these
resources.

Secondly, in developing countries, because of economic planning the national
income will be increasing and along with that the money supply should also
increase. This should happen, as otherwise, the prices may fall and discourage
any productive investment which should be disadvantageous for the economy.

Thirdly, the developing countries are characterized by the existence of non-
monetized sector. When the economy grows, the size of this sector will shrink,
which in fact means, that the additional money supply is being absorbed by this
sector and so there is very little scope for inflationary pressure in the economy
due to deficit financing.


Fourthly, with economic growth the standard of living of the people also goes
up. Then they would require more money to meet their increased demand or
otherwise, their liquidity preference will go up. This can be met only with
increased money supply.

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In spite of all the above arguments in favour of deficit financing, care should be
taken to take notice of certain points. Firstly, in developing countries the
existence of idle-human power is due to the limited growth of complementary
capita / resources. Therefore, the country concerned should aim at developing
more labour intensive industries. Secondly, in developing countries deficit
financing may be inflationary affecting the balance of payments position
distorting the pattern of investment.

The diversion of resources to the production and consumption of non-essential
resources cannot be ruled out. This in turn will aggravate inflation. Therefore,
the countries concerned should take the following steps to avoid facing the
above consequences. Firstly, the country should resort to a moderate dose of
deficit financing due to the poor absorption capacity of the country. Secondly,
the authorities concerned should effectively check the rising prices of essential
commodities, may be by following strict rationing and public distribution
policies. Thirdly, a well planned taxation policy will also help to contain the
inflationary pressure. Fourthly, the financial resources mobilized through deficit
financing should be used for investment in short period high yielding productive
projects. That is care should be taken to identify industries with short gestation
period so that with the increase in money supply there can be corresponding
increase in production. Inspite of all these efforts, the country may experience
inflation. But such inflation need not be taken as a serious problem, and in one
way it is also required to keep the initiative of the private sector investment. In
other words, it will only help in achieving a higher economic growth. Hence,
deficit financing does promote economic growth, provided the inflationary
pressure is held under complete control.

V) Views on limits of deficit financing:
Economists have favored deficit financing for several reasons. To them a
country needs enormous resources to achieve a higher rate of growth.
Especially a developing country will require huge resources for public
expenditure projects. A country like India wedded to public welfare, really
requires a huge quantum of funds. This can be arranged for in different ways.
One way is taxation, the second. is public borrowing and the third is deficit,
324
financing. While taxation in a developing country would bring down the effective
demand, the public borrowing may add to the financial burden of the people as
the cost of debt servicing and management of public debt is so prohibitive that
this cannot be an ideal source of funding economic recovery. Hence, only deficit
financing is left with as an alternative. If it is administered with proper care and
diligence, it should in fact be growth stimulating rather than inflationary.
Therefore, resorting to deficit financing need not be considered as a wrong step.
It is often said that if the, government can keep the inflationary rise in price
below a certain level, say 3% then deficit financing is the ideal method of
financing economic growth.

However, several precautionary steps are to be taken to ensure that deficit-
financing is justified and plays the role expected of it. The following are some of
the suggestive measures:

Firstly, the government should note the rate of growth of real income. If the real
income grow at a faster rate than the rate of money supply, then there will be
very limited increase in price. On the other hand if the growth of real income is
less than the rate of money supply, then the economy will experience inflation.
Hence, the government should carefully monitor the growth rate of real income.

Secondly, the government should, as far as possible use the funds obtained
through deficit financing in promoting short period income generating projects
which are productive in nature. This will facilitate absorption of increased
purchasing power by the increase in output.

Thirdly, a developing economy with the existence of a large amount of unutilized
physical and human resources may realize that deficit financing is helpful in
higher utilization of these resources. In that case the inflationary pressure
should be very much under control.

Fourthly, though deficit financing is the easiest way of raising resources for the
government, the government should use this source judiciously. This means it
325
should be conscious of (lie efficiency of its administrative machinery and
capacity.



Specially, a hard working, devoted and uncorrupted set up is required if the
inflationary effect of deficit financing is to be avoided.
Fifthly, the government should not use the funds raised through deficit
financing in funding long period gestation projects even if they are highly
productive. The investment in such projects will yield the return only over a
period of time and by that time the inflationary pressure might set in the
economy.

Sixthly, the impact of deficit financing on balance of payments situation of a
country should be studied closely so as to avoid any inflationary pressure
affecting the economy. Usually the favourable balance of payments is
inflationary in character and so the government must resist the temptation of
adopting deficit financing while there is balance of payments surplus.

The extent of deficit financing in India is given in the Table below. From the
table, we can understand that the deficit financing is one basic reason for the
drag in our development and the inflation prevailing in the economy. The
justification that in the initial stage of development every country is bound to
have deficit financing is no longer reasonable in Indian case, as the time has
come that our Five year plans should lead us to generate more resources from
other sources instead of depending too much on deficit financing. The amount
of deficit financing has increased from Rs. 330 crores during the I Five year
plan to a huge amount of Rs. 20,000 crores during the VIII plan. This implies
that our planners have started using deficit financing as the main source of
funds for meeting our plan expenditure. It should be noticed, that over the five
year plan period since I plan there has been an increasing reliance on deficit
financing that the peak is found during the VII Plan With consistent efforts, the,
planners are hoping to bring down this quantum of deficit financing to around
326
Rs. 20,000 crores during the VIII Plan. Whether this is going to be achieved or
not can be found out only in future.

DEFICIT FINANCING DURING FIVE YEAR PLANS
(Amount in Rs. Crores)

PLAN AMOUNT OF DEFICIT
FINANCING
I 330
II 650
III 1,150
IV 2,060
V 5,830
VI 5,000
VII 28,457
VIII 20,000


Objectives of fiscal policy and the role played by fiscal policy in a
developing country

The following are the objectives of fiscal policy:
1. Maximization of the aggregate saving is the first objective. Tins are
achieved by encouraging people to reduce the current and future
consumption. Specifically' the attempt is to bring down and control the
conspicuous consumption of the rich people.

2. Maximization of capital formation is the second objective. Through this
objective the country can try to achieve an accelerated economic growth.
This will help the country to overcome the stagnation and achieve a
higher rate of economic growth.

3. The third objective is to divert the available resources from the less
productive to most productive purposes. Through this it is hoped that
327
the resources will be applied more for socially useful projects. In a
country like India, where centralized planning is followed, the plan
determines the priorities of the country and the fiscal policy ensures the
accomplishment of these priorities through redistribution of productive
resources.

4. Fiscal policy also helps in protecting the economy from inflation.
Inflation in an under developed country is very dangerous, if it is not
controlled in the initial stage itself. Though inflation cannot be avoided
in the growth process, yet it has to be under full control as otherwise
the benefits of growth will be eaten away by inflation.

5. Fiscal policy also helps in removing the sectoral imbalance in the
economy in the process of growth. Usually in a developing economy, the
price level may go up in certain sector in the growth process affecting
that sector badly. Fiscal policy through appropriate tools can always
prevent this sectoral imbalance, and help to maintain overall price
stability.

6. Fiscal policy provides the necessary incentives for the industries which
are capable of generating employment opportunities in large scale. For
instance, the small scale industries are employment oriented and so
fiscal policy can extend incentives to them.

7. A very important objective of fiscal policy is to bring down and eliminate
inequalities in income and through that ensure equitable redistribution
of income and wealth in society. This may be considered as the social
objective of fiscal policy. But this objective is in contradiction with the
growth, objective. That is, to achieve rapid economic growth, the savings
in the economy should increase to facilitate rapid growth of capital
formation. For this purpose, the rich should save maximum. If the fiscal
policy tries to eliminate income and wealth inequality then the saving
potential of the economy will come down and affect the growth
prospects. Hence, the fiscal policy should neither be too much growth
328
conscious nor attach importance to social objective. An ideal mix of
these two objectives is the right fiscal policy.

Role of fiscal policy in a developing economy:
The important role played by the fiscal policy in a developing economy can be
explained through : i. fiscal policy during inflation, ii. fiscal policy during
depression, iii. fiscal policy and unemployment, iv. fiscal policy and income
inequalities and v. fiscal policy and economic growth.

To understand the role of fiscal policy in a developing economy, first we should
understand the four tools or instruments of fiscal policy. These tools are:

i. public expenditure, ii. taxation, iii. public borrowing and iv. public debt
management. Now let us understand how these tools have to be used to achieve
the various objectives of fiscal policy in a developing economy.

i. Fiscal policy during inflation:
Inflation is a period in which the purchasing power with, the people in the
economy is high. The first step to curb inflation is to control the purchasing
power with the people. This can be done using all the tools of fiscal policy. For
instance, during inflation, since the private expenditure is high the government
should bring down the public expenditure so that, to that extent the income
generation will be, controlled. Alternatively, the government can increase the
existing tax rates or impose new taxes. This will have the effect of taking away
the purchasing power from the rich and well-to-do people thereby curbing the
consumption expenditure. The tax revenue will then be used for public
expenditure purposes which will also be low during inflation. Hence, there will
be effective control of money supply in the economy. Another way in which the
fiscal authorities can function is

o indulge in public borrowing. The government
may start borrowing from the people in large scale so that the disposable
income with the people will be reduced bringing down the demand and prices.
If voluntary lending is not effective, then the government may resort to
involuntary lending or compulsory saving by the people. Through its debt
management policy also the fiscal authorities can control inflation. The anti-
329
inflation debt management requires the retirement or payment of bank-held
securities or debts through budgetary surplus. But this is very difficult in
practice as in a developing country the government cannot have budgetary
surplus.

ii. Fiscal policy during depression :
Depression is a period characterized by low income, low employment and low
consumption. Fiscal policy should change this situation. The government must
adopt deficit budget in order to increase the income stream in the economy
through increased injection of fresh purchasing power into the economy.
Secondly, the government must encourage consumption and investment and for
this purpose the taxation should be brought down. Liberalized corporate tax
policy will also help to increase the corporate expenditure giving the necessary
thrust for the revival of economic activity. Public expenditure during this period
must be increased. The government can achieve this either through pump
priming or compensatory spending. Pump priming refers to the initiation of
investment activity by the government through its expenditure on public
projects which will be followed up by the increased private investment.
Compensatory spending is resorted to when the private investment is not
adequate enough. Then the government also injects public investment through
public projects. Public debt policy can be suitably modified to fight against
depression. The government should borrow more from the rich people-and
spend this amount in-large: scale on public works, and social security projects.
All these steps will help to protect the economy and enable it to recover from
depression.

iii. Fiscal policy and unemployment:
Fiscal policy plays a vital role in generating employment opportunities in the
developing countries. In a developing economy, it should aim at solving the
problem of both cyclical unemployment and disguised unemployment. While the
former is of temporary nature, the latter has the snow-balling effect The latter
refers to a situation in which more than the required number of people are
employed in a job. In other words, by reducing the excess of labour from that
job, the productivity or production will not be affected. Hence, it has been found
330
that fiscal policy alone cannot solve this problem of unemployment in a
developing economy. It has to be coupled with monetary policy. For instance,
during inflationary period, the government should adopt surplus budget, along
with hard money policy, while during depression, deficit budget should be
combined with cheap money policy.

iv. Fiscal policy and income inequalities:
The Role of fiscal policy removing income inequalities in a developing economy
cannot be exaggerated. With public expenditure and taxation, the government
can very easily achieve income equality. The government should devise its
public expenditure scheme by focusing on the poor and down-trodden people in
the society. It may provide cheap food, cheap cloth, subsidized housing, free
medical aid, free education, etc., to the poor people thereby raising their
standard of living. For this purpose, the government should raise funds by
imposing taxes on the rich people so as to bring down their purchasing power.
It may completely or partially relieve the poor people from the tax net. This has
the effect of-taking away as much as possible from the rich people and spending
on poor people. It may also resort to large dose of indirect taxes so as to make
the rich bear the burden as the poor will be paying such taxes only if they
spend on items on which the government has imposed heavy indirect taxes.
Therefore, taxation and public expenditure are the two very useful instruments
of fiscal policy which can bring about the income equality in a developing
economy.

v. Fiscal policy and economic growth :
Economic growth calls for the application of all the tools of fiscal policy. In
developing economy, there may be no shortage of real or physical resources, but
there may be a severe shortage of financial resources which are required to
utilize the physical resources. The object of fiscal authorities should be to
mobilize much funds as possible so as to carry out large scale public projects. A
very effective method of mobilizing financial resources is taxation. The
government can resort to both the direct as well as indirect taxes so as to
generate as much funds as possible from all those who have the ability to pay.
Different type of direct taxes and indirect taxes may be levied to cover every
331
section of-the population. There can be specific taxes to curb certain
consumption activities.

Another instrument available is public debt. Apart
from the voluntary lending

schemes the government should also devise schemes
to encourage compulsory savings. Resources mobilized in this manner should
be spent in such a way that the infrastructural facilities are strengthened first.
This should be followed by the expenditure on growth oriented industries and
other related activities. Care should be taken to avoid creating or widening
sectoral imbalance so that the benefits of growth will be shared by all the
sectors in the economy. Government must use its planning machinery to
identify the right priorities so that the hard mobilized funds are utilized in the
best way possible. In this process now-a-days the governments also resort to
deficit financing. It is considered as a means of financing economic
development. But too much reliance on deficit financing will also be dangerous.
However, fiscal policy can play a vital role in helping to achieve a rapid
economic growth.

Public expenditure ii India and the causes for the mounting public
expenditure in India
Public expenditure refers to the expenditure incurred by the government (both
central and state) on various public projects. In these days, the welfare
governments have to incur heavy expenditure so as to provide the minimum
basic requirements to the poor and needy. Apart from this, the government
should also undertake various activities like defence, transport,
communication, power generation and distribution, medical, educational, etc.

All these will involve investing huge funds, which no private individual or
corporate body can afford to make. Further the public expenditure is incurred
mainly for the purpose of achieving economic growth and development and
without any anticipation of reward or return. Hence, public expenditure
incurred in large doses sometimes on wrong priorities may prove to be waste. In
India the size of public expenditure incurred by the government is so huge as is
clear from the table below.

EXPENDITURE OF THE CENTRAL GOVERNMENT
332
(in Rs. crores)
YEAR REVENUE
EXPENDITURE
CAPITAL
EXPENDITURE
TOTAL
EXPENDITURE
1950-51 350 180 530
1970-71 3,180 2,490 5,570
1980-81 14,540 9,630 24,170
1993-94
BUDGET
1,01,840 29,840 1,31,320



In the table above we have indicated only the central government expenditure
and if we include the state government expenditure, then the total expenditure
of the government stood at Rs. 36,850 crores in 1980-81 and went up to Rs.
1,98,16Q crores in 1993-94 (budget). From this it could be understood that the
public expenditure in India has been increasing year after year.

Before we analyse the factors responsible for this huge increase in public
expenditure, let us understand the components of public expenditure. Public
expenditure has two major components viz. 1. Non-plan expenditure and 2.
Plan expenditure. Both these are once again classified as Revenue expenditure
and Capital expenditure. The Non-plan revenue expenditure includes : interest
payments, defence revenue expenditure, major subsidies, debt relief to farmers
pensions, postal deficit, police, social services, economic services, grants to
states and Union territories, grants to foreign governments, etc.

The Non-plan capital expenditure includes: loans to public enterprises, loans, to
States and Union territories and loans to foreign governments, etc.
The Plan expenditure is used to finance various Central plans like agriculture,
rural development, irrigation and flood control, energy, industry and minerals,
transport, communication, science and technology, environment, social
services, etc. This also includes Central assistance for Plans of the States and
Union territories. In the table below we have represented the Total expenditure
of the government (both Central and State).

333


EXPENDITURE OF THE GOVERNMENT SECTOR (CENTRAL AND STATE)
(IN Rs. Crores)
PARTICULARS 1960-61 1980-81 1991-92
BUDGET
DEVELOPMENT
EXPENDITURE
1,730 24,430 1,16,730
NON-DEVELOPMENT 830 12,420 81,430
TOTAL EXPENDITURE 2,560 36,850 1,98,160

Reasons for the growth in public expenditure in India :
Several reasons could be given for the ever increasing public expenditure in
India. The important reasons are given below:
1. Increasing defence expenditure is one of the main reasons for the
increasing public expenditure. With perennial threat in borders, India
cannot but spend heavily on defence so as to keep the force with latest
equipments and implements.
2. The next reason is the mounting expenditure on social welfare schemes
like family planning, aids control, malaria eradication, etc,. Such
schemes are very important from the national health point of view.
Similarly the expenditure on noon-meal scheme by Tamilnadu and other
schemes aimed at the poor and down trodden cannot be given up just
because the government expenditure is on the rise.
3. The increasing expenditure on major irrigation projects and power
projects is another reason for the growth in public expenditure.
4. With the objective of improving the literacy, the government is spending
huge amount on education which is another reason for the rising public
expenditure.
5. Various services like community development programs, police, general
hospitals, public parks, roads, communication, etc., also take a huge
share in public expenditure.
6. Ever increasing expenditure on wages and salaries of government
employees is another basic reason for the increasing public expenditure.
334
7. The increasing cost of administering and managing the public sector
units and public utility concerns also account for a sizeable part of
public expenditure.
8. The ever growing public debt servicing is yet another reason for the heavy
public expenditure in India

When we study the above reasons for increasing public expenditure in India, we
will be able to understand that every developing country is going through a
similar experience. After all this is inevitable in the process of growth.

INDIA'S PUBLIC DEBT
Before independence, Indian public debt was basically productive in nature as-
,it borrowed mainly for the capital requirements of railway construction,
irrigation; works, etc. According to an estimate, by 1939 India's public debt
stood at Rs. 1,200 crores, of which nearly Rs. 925 crores was productive type.
Further the total public debt included about Rs. 730 crores of internal debt and
Rs. 470 crores was India's obligations in UK.

During the II World war, India's public debt shot up to Rs. 1,940 crores mainly
due to war expenditure and other capital expenditure.

In the post-independence period, India's public debt during the I Plan was
targeted for Rs. 520 crores while in the II Plan it was raised to Rs. 1,200 crores.
Subsequently, the government fixed higher target for public debt and mainly
this could be realized through government borrowing and small savings.

India's public debt consists of both internal debt and external debt. While the,
former includes loans raised from open market, compensation bonds, prize
bonds and 15 year annuity certificates, apart from treasury bills issued to RBI
and other commercial banks, the latter mainly included borrowing from
international institutions like IMF, IBRD, ADB, etc.

The public debt in India could be discussed under two sections viz. i.) public
.debt of central government and ii) public debt of state governments.
335

i) Public debt of central government:
The Central government mainly borrowed for development schemes, though in
these days it has started borrowing even to .meet its current expenditure. The
central government has been increasingly relying on the external debt as is
shown in the table below. The percentage of external debt in the total debt
increased from a mere 1.5 in 1950-51 to nearly 18 by the year 1993-94
(budget).

Of the total external debt, India borrowed more than 30% from the USA alone. It
is also interesting to note that the debt servicing has been increasing every year
with increase in debt and the interest payment of the Central government alone
is around Rs. 38,000 crores by 1993-94.

In the table below we have represented the debt and other obligations of the
central government.




PUBLIC DEBT AND OTHER LIABILITIES OF CENTRAL GOVERNMENT
ITEMS 1950-51 AMOUNT Rs.
crores %
1993-94 AMOUNT Rs.
crores %
Internal Debt 2,020 98.5 2,04,690 82
External Debt 30 1.5 46,450 18
Total Public Debt 2,050 100.0 2,51,140 100

Public debt of State governments:
As regards the state governments, the public debt is incurred mainly towards*
the welfare schemes and other social projects. The constituents of public debt
in the case of State governments are: i.e. internal debt consisting of market
loans, Ways and means advances from the RBI, and Loans from banks and
other institutions ii. Loans and advances from the Central government and iii.
Provident funds, etc. In the case of India, the loans and advances from the
336
Central government alone constituted nearly 60% of the total debt till 1971 and
by 1993 (budget) this component accounted for about 70% of the total debt.
This is shown in the table below.

Another important aspect of state government public debt is that it was only
around Rs. 3,300 crores by March, 1961, while it increased to about Rs.
1,68,780 crores as per-the budget estimate of 1993. It is said that the State
governments are using the overdraft facility from the RBI without any control
and this causes serious concern for the Central government. But this is so
because, the Central government is able to raise loans easily from various
sources and that too at a cheaper rate, but the State governments find it
difficult to raise funds through public borrowing. They depend mainly on small
savings and provident funds schemes. Though higher targets in small savings
are achieved by the State governments, yet not every state

is successful in this
regard. The debt position of the States is presented in the table

below:
DEBT POSITION OF THE STATE GOVERNMENTS
(In Rs. crores)
(Figures as end of March)

Items 1961 1971 1993 (Budget)
1. Internal Debt (a+b+c) 590 1,850 25,460
a) Market loans 500 1,230 22,060
b) Ways an means advance
from the RBI
40 380 390
c) Loans from banks and
other institutions
50 240 3,010
2) Loans and advances from
Central Government
2,020 6,360 95,630
3) Provident funds, etc., 130 540 22,230
4) Total debt (1+2+3) 2,740 8,750 1,43,320

REVIEW QUESTIONS
1. Explain the place of commercial banks in the Indian Financial System
2. Discuss the functions of commercial banks.
337
3. What is meant by credit creation? Explain the process of credit creation
with an example.
4. Discuss the performance of commercial banks in India. What are the
problems that they experience and suggest suitable measures to
overcome them.
5. Explain the features of lead bank scheme. What benefits are they
expected to generate and to what extent their functioning ensures this ?
6. Discuss the functions of central bank.
7. What the reasons for having both quantitative and qualitative credit
control policies?
8. Discuss the instruments of quantitative credit controls along with their
limitations.
9. Explain the various qualitative credit control instruments. To what
extent are they effective?
10. Critically explain the functions of Industrial Finance Corporation of
India.
11. Discuss the functions of IDBI and comment on its performance.
12. Explain the purposes for which ICICI was established. How far these
purposes have been achieved?
13. What do you mean-by canons of taxation? Discuss Adam Smith's
canons of taxation.
14. Distinguish between direct and indirect tax along with their merits and
limitations.
15. With an example, explain the meaning of deficit financing. Discuss its
purposes, effects and limits.
16. What is the need for fiscal policy? What are the objectives that fiscal
policy is expected to accomplish?
17. Briefly outline the extent of public expenditure in India. What are the
causes for mounting public expenditure in India?
18. Comment on Indian public debt.


CHAPTER V
338
Economic planning and development - Government and planningIndia's eight
Jive year plan and structural reforms - Industrial policies and promotion schemes
- Government policy and 537- Interface between Government and public sector

ECONOMIC PLANNING AND DEVELOPMENT
Objectives of Indian Five Year Plans and the achievements during the
earlier Five Year Plans

After attaining independence, India decided to adopt democratic socialism as its
philosophy to achieve rapid development and allow the benefits of development
to reach every section of the people. The setting up of a democratic socialist
country could be possible only if all the sectors in the economy could be
developed simultaneously. For this purpose India selected economic planning
as the instrument to achieve rapid economic growth and development. The
Centralized planning mechanism was adopted and since 1951, the country has
gone through seven five year plans and three annual plans and we are in the
course of the Eighth plan. The five year plans in India have set several
objectives. But the emphasis on any objective changed from time to time. While
the earlier plans emphasized economic growth of late the emphasis is on
modernization. Hence, the priority among the various objectives of economic
planning changed from time to time. However, all the five year plans in India
have the following objectives as principal objectives :

1. Economic growth, 2. Self-reliance, 3. Full employment
4. Modernization and 5. Social justice which includes reduction in income
inequalities and removal of poverty.
Each one of these objectives is discussed briefly hereunder.
1. Economic growth :
Economic growth has been considered as one of the primary objectives of
economic planning as it is hoped and once a higher rate of economic growth is
achieved all the other objectives laid for the plan would be automatically
achieved. But the experience in other countries has been that economic growth
has benefited only the rich at the cost of poor. However, India gave top priority
to the achievement of economic growth because of a long period of stagnation
339
under the British rule when India's resources had been plundered and so it
could not develop fast. Hence, India adopted achievement of higher rate of
economic growth as one of the principal objectives of planning.

Economic growth is measured in terms of the rate of increase in national
income over a period of time. During the I five year plan India set 11% of growth
in national income as the target for the five years of I Plan. India could easily
achieve this target and in fact the "achievement was 18% increase in national
income. Having been inspired by this remarkable achievement, India set a
target of 25% increase in national income over the five years of the II Plan. The
plan model suggested by Prof. P.C. Mahalanobis was adopted and priority was
accorded to industrial development with emphasis on large scale industries.
This led to the emergence of public sector units and along with this
developmental works on transport and power were also undertaken in a very
large scale. But at the end of the II Plan, the achievement was only 4% increase
in national income per year on an average. Hence the target was limited to 5%
growth per year in the UI Plan. But due to Chinese aggression and Pakistan
invasion, only 11.2% growth in national income over the five-years could be
achieved. Economists had a lot of hope on the outcome of this clan as they
expected with the success achieved through this plan, the economy would enter
the stage of self-sustaining growth. Further, rate of increase hi population was
almost equal to that of increase in national income and so no significant
addition was made to the per capita income. This made the government to give
up the long term planning approach and so three annual plans were gone
through. With so much experience in planning, the planners decided to set
growth with stability' as the objective of the IV Plan. The economists wanted to
overcome the influence of uncertainties on economic performance and so they
laid emphasis on building up huge buffer stocks of food grains and reducing the
dependence on foreign capital. During the IV Plan the achievement was only
3.4% growth in national income per year against a target of 5.7%.

The V Plan initially laid emphasis on self-reliance and removal of poverty but
subsequently the final draft accorded top priority only to economic growth.
Hence, a growth rate of 5.5% per annum was determined as the target and the
340
achievement was really commendable with 5.2% per annum. But this
achievement has not been smooth but highly erratic. Further growth was not
self-sustaining.

The VI Plan therefore set 5.2% per annum as the target and wanted to achieve
this target by improving the efficiency of capital stock utilisation raising the
investment rate, changing the investment pattern to suit growth requirements
and taking up all measure; to prevent emergence of foreign exchange crisis. At
the end of the plan, the target was almost achieved though this could not be
viewed as a great achievement as the acceleration in growth during this period
had occurred after a year of negative growth.

The VII Plan has aimed for 5% per annum of growth rate. The target of growth
rate was expected to be achieved in this plan as the growth rate in major
sectors of the economy was found to be around 5.5% per annum.
Encouraged by this achievement, the VIII Plan has set a target of 5.5% per
annum and it remains to be seen how this is going be achieved with all round
difficulties, specifically that of balance of payments.

2. Self reliance:
During the I and II Plans self-reliance was mentioned as one of the objectives,
though the objective could not be clearly defined. In the HI Plan also the same
position continued. Only from the IV Plan the concept of self-reliance could be
clearly defined and understood. The IV Plan clearly pointed out that the
dependence on foreign countries for concessional import of food grains should
be reduced so that whatever way India could earn foreign exchange should, be
sufficient to meet her requirements of exchange. But the failure on the
agriculture front due to monsoon failure forced imports of a large quantity of
food grains and the rise in prices of several essential commodities, import of
essential articles worsened the balance of payments position. Therefore in the V
Plan export promotion measures were given priority. Since 1977-78, India could
successfully reduce the imports of food grains with increased buffer stock.
Simultaneously the encouraging growth of domestic basic industries like iron
and steel, machine tools, heavy engineering, etc., made India to export these
341
items and she could acquire expertise in sophisticated technology. But a very
serious obstacle to the achievement of this objective was the sharp rise in
petroleum products. Hence, efforts are underway to develop alternative sources
of energy as well as discover new petroleum deposits.

3. Full employment:
This objective has been included in the plan objective right from the day the
planning as a methodology of development was adopted by India. But this
objective has not been achieved in any of our plans. It was never accorded the
priority that it richly deserves. As a result employment generation during the
plans has not been significant; the main reason for this is that our planners
have been linking employment with investment targets. To them if the
investment increases the employment should also be generated. The ever
growing unemployment since the I Plan clearly proves that the increasing
investment has not been generating employment. Further with ever increasing
population, there is sizeable addition to the number of people seeking
employment or the labour force. Nothing spectacular has been done through
the plans to increase the employment opportunities along with the increase in
labour force. All the schemes relating to generation of rural employment, self-
employment, etc., have not in any way solved the problem of unemployment.
Every year the backlog of unemployment is swelling and unless something
drastic is done the objective of achieving full employment will only remain on
paper.

4. Modernization:
Modernization has been specified as one of the plan objectives only from the VI
Plan. It is taken to mean only upgradation of technology. To make this objective
very clear the planners defined Modernization as :

"Modernization connotes a variety of structural and institutional changes in the
framework of economic activity. A shift in the sectoral composition of
production, diversification of activities as advancement of technology and
institutional innovations has all been part of the drive to change a feudal and
colonial economy into a modem and independent entity." Inspite of this clear
342
definition, in practice Modernization is restricted only to technological
advancement. In agricultural sector the technological advancement has not
been very high though certain achievements like, increase in the area under
high yielding varieties^ increase in consumption of chemical fertilizers, increase
in the area under irrigation, etc., have been recorded. Several other areas like
Modernization of canal

system, irrigation and water management, use of new
sources of energy, etc., are still to reach any commendable position. As regards
the industrial sector, though, Modernization has taken place to a large extent,
yet the productivity remains at a low level. While in other countries, a high
degree of advancement in technology has been achieved; in India progress has
been slow and tardy in this regard. The VII and VIII Plans have aimed at
improving the situation by giving top priority to the development and use of
modern techniques in the existing as well as new industrial units. A major
stumbling block in this task is the funds required. While import of foreign
technology is resisted, development of domestic technology is

taking place at a
very slow pace. It is hoped that the New Industrial Policy announced by the
government in July, 1991 can create the necessary atmosphere

for updating our
technology.

5. Social justice:
This objective of Indian planning implies:
a) Reduction in income inequalities and
b) Removal of poverty.

a) Reduction in income inequalities :
In the initial stages of planning it was expected that with economic growth, the
fruits of growth will trickle down to the lower strata of the economy. But this did
not happen. Therefore reducing inequalities in income has to be spelt out as an
objective planning from the IV Plan onwards. India is an example of a complex
nature of income inequalities. In the rural areas the aftermath of feudal system
has created a very wide disparity in income and in the urban centres the rapid
industrialization has brought about a very serious and wide income disparity.
The root causes for income inequalities in India are capital gains receipts,
entrepreneurial and speculative profits and astronomical salaries and
343
perquisites for the business executives. The Planning Commission itself has
pointed out that such serious inequalities in income could be set right only
through restrictive measures and fiscal efforts. But a very important set back is
the lack of reliable data about the magnitude of income inequalities. In the
absence of this, any measure to check this problem cannot be effective. In the
case of taxation, it is found to be regressive in nature, that only the middle
income group is severely affected while the high and very high income groups
continue to remain unaffected. Hence, a fresh look into this problem is urgently
required that social justice can be ensured.

b) Removal of poverty :
Removal of poverty as an objective of planning was introduced only from the VI
Plan. Till the VI Plan, the benefits of growth did not percolate to the poor and
downtrodden. Therefore the VI Plan determined to combat poverty. For this
purpose the Planning Commission decided to introduce specific programs
aimed at the poor. These policy programs should aim at apart from influencing
the content of food for mass, more regional and class distribution of output. The
VI Plan defined poverty in terms of calorie intake and this has helped to
measure the poverty in the VII Plan. According to VII Plan the poverty has come
down from 50% to 37.4% during the first four years of the VI Plan. The Plan
attributed this to the success of IRDP and NREP programs. But these two
programs have not been very successful as they are implemented with least
efficiency. Economists like Raj Krishna, K. Sundaram and Tendulkar have
pointed out that the achievements under these schemes are exaggerated.
However, the VII Plan expected to bring down the poverty from 37% to 26% by
the end of the Plan. The VIII Plan continues to lay emphasis on rural
development schemes to solve the problems of employment, poverty and income
inequalities.
Based on the detailed discussion about the objectives of economic planning in
India, it can be understood that planning is a method of growth strategy. But in
India planning failed in the initial stages mainly because of uncertainties but
from the W Plan, planning efforts are more efficient, thanks to the application of
latest techniques of planning. The emphasis in Indian planning has been on
achieving a higher level of growth, though some deviations were made during
344
the IV, V, VI and VII Plans. But these deviations in effect only underline the
need for accelerating economic growth. Hence, achieving economic growth has
been in the back ground of Indian plan objective since 1951. This is also clear if
we look into the way the objectives like poverty alleviation, equitable
distribution of income and wealth and employment generation are all given up
whenever they are found to; be conflicting with the objective of higher economic
growth. But our experience over these four decades of planning has been that
even a higher rate of economic growth cannot benefit the entire society,
particularly the poor people. Fortunately the economic policies announced by
the government in mid-91 have taken this fact into consideration that measures
have been introduced to make our industries and producers face the
international competition, to give a boost to our export, to reduce the extent of
reliance on imports, to increase the productivity of labour, to modernize the
industries, etc. The effect of such liberalization on the economy has to be seen
only in due course of time.

Mixed economy
Evolution of the concept of Mixed economy:

There was no reference to the mixed economic system in Economic literature in
the past. Economists were mainly familiar and advocated the Laissez faire or
free enterprise system, as several countries could develop fastly following the
free enterprise system, in which there was no or little government intervention.
The entire economic system operated with the price mechanism at its center
point. The producers produced what the consumers wanted and this provided
very little scope for the government to intervene in the system. The Classical
economists and their ardent supporters believed that the invisible hand will
direct the economy and with private initiative and enterprise, every country
should be able to record a faster growth as proved in the case of UK, USA,
Europe, Australia, and other countries. But over a period under the leadership
of Karl Marx, a new economic system was developed called socialism, in which
there is no scope for any private enterprise as everything is owned and
controlled by the government. The government decided the type of
developmental activities and the requirements of the society and used the
345
available resources in the provision of these requirements. Several countries
like USSR, Communist China, Vietnam, Cuba and others preferred this socialist
system In which government is made the custodian of the society. The main
reason for the emergence of this new economic system was the failure of
capitalism during the 1929 depression to revive every economy from depression.

Keynes himself thought that capitalism without some of its evils could certainly
help economic recovery. Hence, a time came when economists felt that per cent
free enterprise or cent per cent government governed economic development
cannot work satisfactorily. A compromise between these extremes was thought
of as an ideal economic system. The new system called mixed economic system

contained the merits of both the capitalism and socialism and appeared to be
full of promise. This mixed economic system is adopted by India as indicated by
the First Industrial Policy Resolution 1948.
346
Characteristics of mixed economy:
i. Co-existence of public and private sectors:

In a mixed economy, one will find the existence of both the private and public
sectors. In such a system, the government will undertake the responsibility to
build and develop certain sectoral activities and leave the other activities for the
private initiative. In India, the government announced the adoption of the mixed
economy system through its 1948 Industrial Policy Resolution. The government
clearly earmarked the industries to be completely under the state control, the
industries which are to owned and controlled by the state as well as the private
sector and industries which are completely left for the private sector. In this
way the Resolution provided for the simultaneous existence of both private and
public sectors.

ii. State participation in economic development:

This is the second feature of mixed economy, according to which the state
reserves its right to design and decide the type of development to be achieved.
In such a set up, die government strives to promote the welfare of the country
by ensuring social order, social justice and establishing all the necessary
institutions which are required to achieve the desired pattern of growth and
development.

iii. Distribution of ownership and control of resources:
This is the next feature of mixed economy. In this system, the government itself
enters the field of production so that the available resources are fully utilized.
This will also help to avoid concentration of wealth in the hands of a few and
enable distribution of ownership and control of productive activities. As a result
there is no scope for exploitation of any group, say labour, by any other group.
In this way the weaker section of the community is well protected and taken
care of. Only the

mixed economy will enable the government to attain the
objectives of the Directive Principles of the Indian Constitution.

iv. Directing the investment in socially desirable projects and channels :
347

Mixed economy facilitates the flow of investment into channels which confers
the society with several benefits. For example, the Indian government has
invested huge amount in several projects to develop the infrastructural
facilities. This forms the basis for the development of other sectors. The
investment in this infrastructural area will not come forth from the private
sector as the return is nil. Hence, the government in a mixed economic set up
provides the thrust by developing the necessary background and strength
which will encourage the private sector to invest in profitable opportunities. In
this way the government plays a key role in a mixed economic system.

v. Scope for achieving balanced economic development:
Left to itself, the private sector would establish its enterprises only in urban or
sub urban areas and that too in already well developed states. This will mean
other areas will have no scope for development. But in a mixed economy, the
government will itself undertake the initiative to set up industries in backward-
areas and encourage the private initiative to set up industries in such areas by
offering several concessions and exemptions. In the absence of mixed economy,
several states in India would have remained industrially backward.

vi. Ultimate control and regulation in the hands of government:
This feature of mixed economy clearly spells out that in every activity affecting
the economy, the government will be the ultimate authority. Though the private
sector is assigned its role to perform, the government will still monitor and
control the way in which the private initiative is performing its role. Infact,
according to the 1948 Industrial Policy Resolution, the government made it
clear that the industries already established by the private sector belonging to
that category in which new industries will be established by the government
alone, the government would undertake the review of the working of these
industries in private sector after a period of ten years and if found not
satisfactory, they would be taken over by the government. Though this was
criticized as a threat of nationalization, yet through such a provision the
government underlines its authority. Similarly in the banking and insurance
348
sectors, the government nationalized banks emphasizing its powers to control
and regulate any sector.

vii. Co-operation in the field of economic development:
According to this feature of mixed economy, the government formulates the
design for development and invites the private sector to participate in the
development. It clearly spells out the guidelines which would govern such co-
operative efforts and the limits of freedom granted to the private sector. In
Indian case, the government prepares the plans for development and spells out
the areas left for the private initiative and the areas that will be under state
control. Hence, there is scope for the development of private sector, though only
according to the design developed by the government

Planning process under mixed economy:
As has been already stated, in a mixed economy there is a need to achieve a
compromise between self-interest and social interest. This is a very difficult task
as the government has to carefully foresee the type of development it wants to
achieve and closely monitor the activities of the private sector to ensure that the
social interest is never at stake. Obviously, planning is a very difficult exercise
in a mixed, economy set up. The success of planning will depend upon: i) the
extent to which the public sector is able to rise to achieve the social gains aimed
for, ii) the success of the state in guiding and regulating the private sector
activities towards social goals and iii) the extent to which the state is able to
check the distortions taking place in investment by private sector affecting the
interest of the public sector. Hence in the planning process the state has taken
up the following steps to ensure the accomplishment of the objectives of the
mixed economy.

(a) By holding complete ownership of defence and heavy industries, the,
government has provided an industrial base with which the private
sector is expected to plan its investment activities.
(b) The state also has made huge investments in economic
infrastructures so as to help the extension of market for goods,
349
raising the productivity in agricultural; and industrial sectors,
encouragement of further productive investment.
(c) The government has complete control of the financial institutions
including banks so that it can ensure that the banks and other
institutions play a key role in the development activities of the state.
The government could also realize the expected gains by encouraging
the priority activities in every sector. The economic institutions are
made to support the weaker sections of the community.
(d) Through powerful legislations like MRTP Act, FERA, etc., the
government, could ensure that there is no scope for exploitation of the
common people by; the private enterprise. Such a legal framework
lays down the rules of the, game and ensure fair play in a mixed
economic set up.
(e) As a method of protecting the weaker and downtrodden' people, the

government has policies like rationing, price controls, etc. Such
regulations

are built in the planning mechanism itself so that the
private sector cannot exploit the community.
(f) Towards the improvement of welfare in the economy, the state has
undertaken several specific programs aimed at specific target groups.
For example schemes aimed at the backward and schedule tribe
providing them reservation in educational, employment and other
opportunities, rural oriented schemes" for the rural folks, health for
all schemes, provision of free educational and medical facilities upto a
certain level, etc. All these schemes aim at improving the social
welfare. In all these activities the private sector is also welcome to
play its role.
(g) The government makes effective use of the tools of fiscal policy viz.
taxation and public expenditure, so as to achieve the objectives of
economic planning.

Distortions in the planning process:
We have explained above that the fundamental objective of the mixed economy
is to subordinate the self-interest for the national-interest. Whether this has
been achieved in Indian situation is a moot question. Inspite of various types
350
of regulations and controls, the fruits of mixed economy have not appeared to
have reached the common men. Even after four decades after the adoption of
mixed economy principle, we come across glaring distortions which go to prove
that mixed economy in practice has not been very effective. This is mainly
because of the influence exercised by the private enterprise through political
influence, corruptive activities, dishonest bureaucrats, powerful national and
international lobbying, etc. The extent of distortions could be understood if we
study the following points:
1. One of the basic objectives of Indian planning is to eradicate poverty,
but five decades after the adoption of planning strategy, the proportion
of population below the poverty line has not significantly changed.
2. The planning mechanism has failed to check the rise in price level.
Inflation has come to stay in India with no policy being effective. When
double digit inflation is controlled and results in single digit inflation,
the country boasts of having achieved something very great.
3. The emergence and existence of black money is yet another yardstick to
prove the failure of the mixed economy. The high level of taxation has
only resulted in effective tax evasion and tax avoidance. As a result the
distance between the rich and the poor remains wide.
4. Till date there has been no effective method to prevent the concentration
economic power in the hands of a few. The rich becomes richer and the
poor, the poorer.
5. Inspite of five decades of planning, unemployment is very much on the ^
increase and the backlog in every plan is assuming dangerous
proportions. This is mainly because of the failure to control the growth
of population and the adoption of capital intensive production
techniques.
6. The failure to achieve re-distribution of income is yet another glaring
distortion. AH the efforts to bridge the gap between the wages of rural
and urban workers or increase the real wage of the working class has
not succeeded.

When we study the above points, it is clear, that mixed economy has not carried
us in the desired direction. This is mainly because of the inability of the
351
government as it is frequently yielding lo the pressure exerted by the vested
interests. Even the recent liberalization measure could be viewed from this
angle. But a country cannot remain independent of the international pressures,
especially when India is depending upon the IMF and IBRD, all its internal
policies are indirectly governed by these lending agencies. Whether this is right
or wrong is a question that could be answered only after we evaluate the gains
of liberalization policy. But on the whole, the expected benefits of mixed
economy have not been realized as, is clearly proved by the distortions
discussed above.

Sources of finance for Indian Five Year Plans
Financial resources for the five year plans in India are mobilized from various
sources. These sources could be broadly classified as i) internal sources and ii)
external sources. The government is mobilizing funds through both these
sources and over a period we find that some of the sources have become
permanent as in (he case of deficit financing. Before we study the pattern of
financing the Five year plans, let us understand the components of the sources
of finance. It may be noted that sources of finance refer to only the sources of
finance for public sector.

Internal sources of finance include the following:
(a) surplus from current revenues, i.e., excess of current revenues over
current expenditure,
(b) contribution of public enterprises,
(c) mobilization of internal private savings through market borrowing,
small savings, provident funds, etc.,
(d) additional resource mobilization in the form of additional taxes and
additional revenue from public enterprises.
(e) deficit financing


External sources of finance mainly includes :
a) loans and grants from foreign countries,
b) loans from international institutions like IMF, IBRD,IDA, etc.,
352

Pattern of financing of Five year plans:
In the table below we have shown the various sources of finance for the Indian
five year plans upto VI Plan. It may be noted that the total amount available
from the domestic source has gone up from Rs. 1,440 crores in the 1 Plan to Rs.
86,610 crores in the VI Plan. In percentage terms we find that the domestic
source of funding constituted nearly 73 during the I Plan and which increased
to 78 by the VI Plan. Similarly the external assistance which was Rs. 190 crores
(10%) in the I Plan, went up in absolute terms to Rs. 8,530 crores, though in
percentage term it has declined to 8% of the total. It could also be noticed that
the amount of deficit financing has consistently increased from Rs. 330 crores
during the I Plan to a whopping Rs. 15,680 crores during the VI Plan. This
could be used to understand the unhealthy practice which the government is
following. It is well known that such a huge amount of deficit financing would
only be inflationary, if [he production does not correspondingly increase. It may
be observed that the inflationary rise in price in India is namely due to this
huge size of deficit financing of Indian Five Year Plans.









SOURCES OF PLAN FINANCE : I TO VI PLAN
(Amount in Rs. Crores)
PLAN DOMESTIC
BUDGETARY
RESOURCES
EXTERNAL
ASSISTANCE
DEFICIT
FINANCING
TOTAL
I 1,440 190 330 1,960
II 2,560 1,090 950 4,600
III 5,090 2,390 1,150 8,630
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IV 12,010 2,090 2,060 16,160
V 32,120 5,830 5,830 43,780
VI 86,610 8,530 15,680 1,10,820

As regards the VII plan, the Domestic resources fetched Rs. 35,988 crores, the
Capital receipts (net) accounted for Rs. 1,03,232 crores, the external assistance
was to the tune Rs. 15,139 crores and deficit financing was Rs. 28,457 crores.
All these sources of funds augmented totally Rs. 1,82,816 crores for the Plan.

In the VIII Plan, it has been estimated that the Domestic resources would total
to Rs. 2,83,915 crores, the Net capital inflow from abroad would be Rs. 28,7QO
crores, and the Deficit financing would be limited to Rs. 20,000 crores. The
total-finance resource for the VIII Plan is fixed at Rs. 3,32,615 crores.

Among the domestic budgetary resources, the surplus from the current reserves
has not been very significant as in almost all die plans we had only deficit in
this account. The contribution from public enterprises was quite insignificant
atleast up to the VI Plan as the percentage of contribution hardly exceeded 10%
even during the VII Plan the contribution on this account was only about 7%.
Having realized that the contribution from the public sector has not been
commensurate with the investment made in this sector, several measures are
taken during the VIII Plan that, it is estimated that the public sector
contribution during this Plan would be not less than 34%.

The inflow from domestic private savings and additional resource mobilization
during the I to VI Plans have been quite significant. It is interesting to observe
that domestic saving in India has been quite consistently high around 30%
during the I to VI Plans. Subsequently also this domestic saving has been high,
but the conversion of savings into productive investment is not coming forth.
Once that is achieved, the financial resource from this side will assume
significant proportion. On the whole we find that the pattern of financial
resources for the implementation of our Five year plans has remained almost
the same, though-there is some change in the contribution from each source in
absolute terms over the plan period.
354

Government and public sector
Since 1948, the public sector in India has been playing a significant role in
every sphere along with the private sector. These two sectors have been
functioning as complementary to each other, though the government policies
have been usually more favourable to public sector than to the private sector.
Inspite of this, the private sector has also emerged victorious in several fields
and since the announcement of Liberalization polices in 1991, we can
reasonably expect the private sector to reach its potential and the public sector
would also strive its best to withstand the domestic and international
competition. Hence, the future offers excellent scope for both the sectors, but it
is clear that only the most efficient sector can survive, so how the private and
public sectors are going to react to this challenge will be known in due course.
However; jet us now discuss the role of public and private sector in India in
detail.
1. Role of public sector;

First of all it is necessary to understand that the public sector includes the
autonomous corporations, the departmental enterprises owned and controlled
by both the State and Central Governments. The role of public sector would be
discussed with reference to various indicators like employment, investment,
output, national income contribution, savings, capital formation, capital stock,
etc.

a) Public sector and employment generation:

One of the important contributions of public sector to the Indian economy is
that it has generated huge employment opportunities and this has reduced the
problem of unemployment to a large extent The employment opportunities in
public sector includes government administration, defence, health, education,
research and development, enterprise owned by Central and State governments.
It offered employment for 107 lakhs of people in 1971 which slowly increased to
154.8 lakhs in 1981 and it has touched 190 lakhs in March, 1991. This
constituted nearly 71 % of the total employment generated in the economy, in
355
1991. As regards the sector-wise employment opportunities created by the
public sector, in 1989 public sector accounted for 47.8% of the total
employment generated by it through employment in government administration,
community, social and personal services, followed closely by transport, storage
and communications with 16.1% and manufacturing 10.1%.

Hence, it is clear that with the growth of public sector, the country is benefited
with more and more employment opportunities.


b) Public sector and income of the public sector:

The share of public sector income in the net domestic product has been
increasing consistently from 7.5% in 1950-51 to about 25% in 1987-88. In a
matter of about 35 years the public sector contribution to net domestic product
has risen appreciably and constitutes one fourth of the total net domestic
product. This is mainly because of the rapid expansion of the public sector
since 1951. This 25% of contribution in net domestic product, is certainly
better than 9.6% ,of contribution by the public administration. However, the
private sector income constituted 75.1% of the total net domestic product. It
should be noted that the public sector units are run on service motive and very
little commercial motive.

c) Public sector and saving and capital formation:

This is yet another crucial yardstick to evaluate the contribution of public
sector. The percentage share of public sector in total domestic savings increased
from. 1,7, to 2.3 of Gross national product at market prices. But in absolute
terms it increased from Rs. 169 crores in I Plan period to Rs. 7815 crores in VII
Plan. When we consider the percentage share in total savings, the contribution
of public sector has actually gone down from 17 in I Plan period to 11 in the VII
Plan.

356
However, the contribution of public sector in capital formation (gross domestic)
is really commendable. It increased from a modest figure of 3.5% of Gross
national product at market prices in I Plan period to 10.7% in VII Plan. As a
result the ratio of percentage contribution by public sector and private sector in
total domestic, capital formation changed from 33 : 67 in the I Plan to 47 : 53 in
the VII Plan; From this it is clear that the contribution by the private sector
during the same period has declined from 67% to 53%

d) Public sector and capital stock :

Capital-stock refers to the total stock of plant and machinery, equipment and
tools and other capital goods available at a point of time for further production.
Based on the data available up to 1979-80, it was found that the percentage
share of public sector in total capital stock between 1960-61 and 1979-80
increased from 26 to 37 while that of private sector declined from 74 to 63
during the same period. In absolute terms, the capital stock increased from Rs.
16,377 crores in 1960-61 to Rs. 68,478 crores in 1979-80 in public sector (i.e.,
an increase by over Rs. 52fOOO crores) but in the private sector the increase
was from Rs. 46,583 crores to Rs. 1,16,089 crores (i.e., an increase by over Rs.
65,000 crores). The increase is less, pronounced in public sector because of the
following reasons:

1. Public sector investments are mostly in economic infrastructure which
do not contribute any output.
2. Public sector is mostly concerned with high capital intensity projects
like railways, iron and steel, power, irrigation, etc.
3. The gestation period of public sector projects are very long.
4. The-capacity utilization is very much less in public sector units.
5. Most of the projects of public sector are having higher capital-output
ratio.

e) Public sector and infrastructure:

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The economic development of a country depends on the development and
maintenance of infrastructural facilities. The essential requirement is provided
by public sector. The industrialization is accelerated only through
infrastructural development. Investment in power, roads, bridges, irrigation,
etc., is non-income yielding, long gestation period oriented, and heavy
investment projects. Hence these are not attractive for private sector. But
without them the country cannot develop faster. Therefore it is apt to state that
the public sector units are responsible for the creation of infrastructures which
constitute the backbone of economic development and industrialization.

f) Public sector and industrial base:

There is no denying the fact that public sector has provided a strong base for
our industrialization. Our industrial policy has clearly assigned a significant
role for public sector, till the end of the third five year plan; industrialization
was taking place at a slower pace because only the important public sector
units were established till then. Since the private sector could not really rise up
to meet the task, since the IV Plan the establishment of public sector units
started on a brisk rate and the industrialization has been accelerated to a
commendable level. Further private sector with its commercial objectives could
not undertake several of the projects and investment requirement of these
projects was also beyond the potential of the private sector. Hence, if at all India
today is having a strong industrial base," it is mainly due to the contribution of
the public sector.
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g) Public sector and export promotion:

Public sector has responded well to the needs of the nation by taking up the
task of exporting our products and finding market for them in other countries.
In this respect the contribution of State Trading Corporation.

Minerals and Metal Trading Corporation, Hindustan Steel Limited, Hindustan
Machine Tools, etc., are worth noting. Infact, these units are primarily
responsible for exploiting the captive market for our goods abroad. The foreign
exchange earnings of the public sector has gone up from a modest figure of Rs.
35 crores in 1965-66 to Rs. 170 crores in 1969-70, to Rs. 5,831 crores in 1984-
85 and then to Rs. 9,198 crores in 1991-92. The increase has been more than
300 times comparing 1965-66 figures with that of 1991-92. Though there may
be criticisms about the performance of the public sector units, yet there can be
no dispute about the export achievements of public sector units within a period
of 25 years.

h) Public sector and saving of foreign exchange through import
substitution:

India's balance of payments has been a cause for worry since Independence, the
main reason being increasing imports. This trend had to be reversed and the
government rightly selected public sector to establish units to produce
domestically the goods imported so as to conserve the foreign exchange and
also utilize more the-domestic resources. Units like Hindustan Antibiotics
Limited and Indian Drugs and Pharmaceutical Limited, have together effectively
checked the inroads attempted by the multinational corporations in the
field of drugs and pharmaceutical. Similarly Indian Oil Corporation Limited
and Oil and Natural Gas Commission have succeeded in bringing down our
dependence on other countries for crude to some extent. They are very active in
identifying oil deposits and natural gas. Their efforts are supplemented by
research and development to invent methods of using the natural gas and
reduce the imports of crude. In this respect the public sector works towards
achieving self sufficiency. With concerted efforts it should be possible for India
359
to achieve self-sufficiency in the near future. However, the poor performance of
the public sector is causing concern, as unless steps are taken to improve their
performance, the achievement of self-sufficiency may be delayed.

i) Public sector and generation:

A close scrutiny of the public sector performance will certainly make one to note
the contribution towards internal resources made by the public sector. For
example, the internal resources generated by the public sector during V Five
year plan was Rs. 3,439 crores, during VI Five year plan Rs. 11,721 crores and
during the period 1985-86 to 1989-90, the generation was Rs. 37,678 crores.
In 1990-91 and 1991-92 also the public sector undertakings together generated
Rs. 24,376 crores. This indicates that the public sector units have turned the
comer and with die measures taken up already to spruce up their working we
should be able to realize still greater generation of internal resources.

j) Public sector and contribution to exchequer:

Public sector contribution to the Central Exchequer is, in terms of dividend,
corporate tax, excise duty, customs and other forms. These contributions add
to the mobilization of resources for our planned development. It is interesting to
note that the contributions totaled Rs. 27,570 crores in the VI Plan period, Rs,
70,893 crores during the VII Plan and Rs. 19,520 crores in 1990-91 and Rs.
20,366 crores in 1991-92. It may be noticed that the annual contributions
during the VIII Plan period is nearly 75% of the contributions during VI Plan.
Among the different forms in which these contributions are made, Excise duty
and Customs alone constituted more than 82% of the total in the VI Plan
period, while this 76% during the VII Plan. Subsequently, in 1990-91 these two
accounted for 82% of the total contributions and in 1991-92 it was almost 81%
indicating that public sector units do make a valuable contribution to the
Exchequer. Since the performance of the public sector is poor, their
contribution in terms of dividend is very insignificant and this has Co be
changed at the earliest so as to make them contribute sizably even in this form.

360
k) Public sector and growth of ancillary units :

Public sector also makes a valuable contribution by helping the growth of
ancillary units and small scale units. The Bureau of Public Enterprises have
undertaken the study to find out the public sector units which could transfer
their production and other facilities to small scale sector. Under this scheme
about 1800 units were set up till 1986. The public sector also enters into
regular contracts for purchasing the entire production or 50% of the production
of small scale and ancillary units. Such purchases from ancillary units
amounted to Rs. 451 crores in 1985-86.

I) Public sector and development of states and backward regions :

One of the objectives in establishing public sector units is to facilitate the states
and the backward region to develop faster. In this connection, public sector has
certainly creditable performance. Public sector contributes to the State

government's resources in terms of sales tax and other state level taxes. Public
sector investments are directed towards the projects in the backward regions
and

industrially poor districts. In this way the public sector works in its own
way to
:
eliminate the industrial imbalance in states and districts.

So far we have explained in detail the contributions made by the public sector
towards Indian economic development. It is often said, that even when their
performance is poor, the public sector contributions have been so much, and by
improving their performance, we should be able to make them contribute their
full potential to achieve a higher rate of economic development. It is satisfactory
to note that efforts in this direction to improve the public sector performance
have been initiated and by the turn of the century public sector will emerge as
the main contributor to our economic development.

Industrial policy resolutions of 1948,1956 and 1980

Industrial policy comprises of the procedures, principles, rules, policies and
regulations which together govern the industrial sector to guide the industrial
361
development or the country in conformity with the objectives of five year plans
and the needs of the economy. As the economy develops, the government has to
closely study the process of economic development and make necessary
changes and modifications in the policies so as to make the policies relevant for
the situation or the environment prevailing in the country at different points of
time. Sometimes the changes in policies are so drastic that a new approach at
the industrial development or the development of any other sector is arrived at.
When these changes are announced the reactions from the sector concerned are
studied closely by the government and necessary amendments are made to the
policies already announced. In Indian scene, the situation prevailed
immediately after independence was completely different from what is being
witnessed today. Hence, if we study the industrial policies announced in the
later 40's and early and middle '50's we would get a background with which we
will be able to understand and appreciate the changes that have been
announced in 1991. This would also help us to understand the justifications for
the drastic changes announced at periodical intervals. Hence, we would discuss
LOW in brief, the features of 1942, 1956 and 1950 Industrial Policy Resolutions.

INDUSTRIAL POLICY 1948

Immediately after independence, the government had to give a guideline for the
industries in India and so it announced its policies for industries. The political
freedom attained in 1947, posed a challenge to the government 10 devise its
own policies. With the production at low levels, population increasing partition
impacts, rising price level, industries to be developed to accelerant economic
development, etc., the 1948 Industrial policy resolution was announced.
Through that the government clearly- accepted its responsibility of ensuring
planned development of industries of various types. The 1948 policy laid the
foundation for anew experience as would be clear from the following features of
the policy. The industries were classified into the following four categories:

1. The strategic industries to be completely owned by the government
included manufacture of arms and ammunition, production and control
of atomic energy, ownership and management of railway transport, etc.
362
No private sector participation or existence will be permitted in Ibis
category of industries.
2. The second group included the basic and key industries. Private sector
existence in this group would be tolerated for a period of 10 years after
which their performance would be evaluated. New units in this category
will be established only by the government and the existing ones would
be taken over by the government if their performance is found in he no:
satisfactory after the review. The industries include in this category
include: aircraft manufacture, coal, iron and steel, ship building radio
and mineral oils, etc.
3. In this category government included the basic industries like
salt, automobiles, tractors, prime movers, electrical engineering, heavy
machinery, machine tools, heavy chemicals, fertilizers, electro-chemical
industries, non-ferrous metals, rubber manufacture, power and
industrial alcohol, cotton and woolen textiles, cement, sugar, paper and
newsprint, air and sea transport, minerals and industries relating to
defence. Private sector will be given complete freedom to enter into this
category, but the government can intervene and regulate any of them, if
found necessary.
4. All the other industries formed the fourth category. Mainly left for
private sector, the government pointed out that progressively it may
participate but not eliminate the private sector. Both individual as well
as co-operative undertakings will be permitted in this sphere.

This policy also gave importance to small scale industries and suggested that
both the central and state governments should join together in solving the
problems freed by the small scale industries. As these industries would offer
good scope for absorbing the displaced laborers and agricultural workers and
wee also ideal for co-operative type of organization, the government felt that
they must be developed. As regards the foreign capital, the government clearly
pointed out that there is need for free flow of capital as well as technology. At
the same time the government also said that it should regulate; no
discrimination will be made between the Indian and foreign undertakings with
regard to the applications of the provisions of the policy resolutions. Profits and
363
repatriation of capital would be permitted subject to the provisions of the
foreign exchange control. Further if any undertaking is nationalized, then air
and equitable compensation would be paid.

Evaluation:
The main aspect of this policy is that it laid the foundation for the introduction
of MIXED ECONOMY in India. Under this the government will encourage co-
existence of both private and public sector units in industries according to the
provisions of the policy. This paved the way for the participation of government
aid die corporate sector in the industrial building process of the country. This
also facilitated a direct comparison between the performances, of both the
sectors, in terms of various indicators. Being the first policy resolution the
government had made a good beginning. But this policy was criticized for being
classificatory. It gave an impression that the private sector, even in spite of
possessing the potential was not allowed to play its due role in the industrial
development. Secondly, there was a threat of nationalization, specifically, in the
case of industries under the second category. Thirdly, the government
intervention was present even in the case of third category of industries. Hence,
on the whole, being the first policy, the government could not make the policy
more imaginative, except, of course, introducing the principle of mixed
economy.

INDUSTRIAL POLICY 1956

A new policy was necessitated after 1951, because, India adopted a socialistic
pattern of society, the Constitution guaranteed Fundamental Rights and
Directive Principles of State policy and the First five year plan was completed by
1956. After reviewing the developments and achievements, the government
came out with the Industrial Policy Resolution of 1956. For all the later policies,
this became the basis and until 1980, the provisions of this policy remained
more or less in force.

The following are the important features of this Policy:

364
The industries were classified into three categories. This was indicated in terms
of Schedule A, Schedule B and Schedule C industries. The Schedule A
industries are completely slate owned and the state is responsible for the
development and growth of them.

The Schedule B included industries which were under the control of
government, especially new units. The private sector is also permitted to enter
into this category, but it will be given only a supplementary role.

The Schedule C industries included all the remaining industries, the future of
which would be completely in the hands of private sector. Of course,
government regulation in general would be formulated and made applicable to
them as any other industries. The first classification (Schedule A) included 17
industries, the Schedule B included 12 industries and Schedule C included all
the rest.

The government clearly indicated that the above classification is not very rigid,
and private participation and presence even in the first category in the nature of
allied units, user of by-products, etc., would be permitted, similarly the
government may enter the Schedule C industries if the planning and
development warrants it. The private sector is expected to work in close unison
with the state. The government assured fair and free treatment to private sector
units and non-discriminator}' treatment was also promised. The government
continued to encourage the growth and development of small scale and village
industries by extending subsidies, tax concessions, protection from large and
medium industries, and assisting them in Modernization to improve their
competitive strength. The Resolution also aimed at reducing the regional
disparities in the growth and development of industry so as to achieve balanced
industrial development throughout the country. The Resolution also highlighted
the need to protect and improve the conditions of industrial workers in the
country. Mainly several machineries for settling industrial disputes were
thought of. The government continued with its policy regarding foreign capital
without much change.

365
Evaluation :

This resolution assigned a major role to the public sector. It created a condition
in which the public sector units could be established and developed well. This
was felt necessary to achieve the desired rate and pattern of development of
industries in India. The government made it clear that it had no intention to
wipe out the private sector, instead it wanted the private sector to emerge as the
supplementary sector for the public sector and join the latter to achieve rapid
industrial and economic development. After the resolution came into force, over
a period it was found that the private sector developed faster by taking
advantage of loopholes and exceptions in the Resolution. There were cases
where licenses were issued to private sector while public sector should have
been given the license. Hence, it was found that this Resolution in fact, led to
the rapid growth of private sector.

INDUSTRIAL POLICY OF 1980
As already pointed out the Industrial policy of 1956 formed the basis of this
policy in 1980. This new policy had the following objectives:
(h) to achieve the optimum utilization of the installed capacity.
(i) to achieve maximum production and through that achieve
higher productivity and employment generation.
(j) to rectify the regional imbalance by focusing on the backward areas.
(k) giving priority treatment for agro-based industries.
(l) to promote inter-sectoral relationship.
(m) to encourage the growth of export oriented and import substitute
industries.
(n) to speed up the growth of small scale units, etc.

With these objectives in view, the new policy laid down the following provisions:
1. After reviewing the performance of the public sector units the
government has decided to introduce measures.

2. for improving the efficiency of these units so as.to make them
contribute more towards the economy.
366

3. In order to promote economic federalism, the policy provided for
integration of industrial development in the private sector. The
government also decided to eliminate the artificial division between
small and large scale industrial units. In each district a few nucleus
plants will be set up which would generate opportunities for a
number of small, cottage and ancillary units. This would ultimately
create the scope for faster industrial development in the industrially
backward districts.

4. To provide the scope for more and more small and cottage industries,
the government redefined these units as below:
a. the limit of investment for tiny units was to be raised from Rs. 1
lakh to Rs. 2 lakhs
b. the limit of investment for small scale units was to be raised from
RE. 10 lakhs to Rs. 20 lakhs and
c. increase the limit of investment for ancillaries from Rs. 15 lakhs
to Rs. 25 lakhs.

5. To promote industrial growth in rural areas and also to improve the
employment opportunities there and raise their percapita income, the
policy provided for promoting industries in the rural areas. This was
also expected to maintain the ecological balance in the country.
Greater attention would be given to the growth of handlooms,
handicrafts and khadi and other village industries.
6. Another important provision was that the government decided to
regularize the unauthorized excess capacity with the industrial units,
especially the FERA & MRTP units by allowing them automatic
expansion by 25% of the existing licensed capacity on a selective
basis.
7. To prevent spread of industrial sickness, the government indicated
that very stringent steps would be taken against those units which
are deliberately mismanaged and indulging in financial improprieties.
As regards the existing sick units, arrangements would be explored to
367
revive them or to encourage their mergers with healthy units by
introducing suitable tax concessions to encourage such actions. When
other methods of revival of sick units are not found feasible, then the
management of such sick units would be taken over.



EVALUATION

This policy has several lapses. Its claim to eliminate the division between small
scale and large scale units is something contradicting the basis of such
divisions. There was a need to treat the small scale with liberal treatment so
that in a labour intensive economy, these units can create employment
opportunities. There is nothing wrong with such specific preferential treatment
of small scale units. But this policy aimed at removing such differences.
Secondly, this policy created a precedence by regularizing the unauthorized
excess capacity created by large units, instead of taking action against such
erring big units. While the big units welcomed this move of the government, yet
this has resulted in the expectation that the government would continue to have
such liberal treatment in future also. This indirectly has also affected the
growth prospects of new industries and the existing medium and small scale
units. Though the government justified its move by stating that such a move
would facilitate fuller utilization and higher output, yet the consequence of such
a move was not thought about. However, it may be pointed out that the seeds of
liberalization were sown through this policy and the government's intention to
select capital intensive path of development.

The features of 1991 Industrial policy

The government announced its new Industrial policy in July 1991. The new
policy has outlined several changes which have together opened a new era to
the growth and development of industrial sector in India, The conventional
regulations and restrictions have been replaced with liberalization and relief.
Consequent to the announcement of the new policy, there has been all round
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jubilation in the industrial sector. The following are the salient features of the
new industrial policy.
Even by 1985-86, the government realized the need to encourage the industrial
sector to stand on its own legs and towards achieving this a number of policies
and procedural changes have been announced. This was expected to increase
productivity, reduce costs and improve the quality with which the domestic
industries are expected to face competition with strength. There was an honest
attempt to release the public sector from a number of constraints and it was
given a large measure of autonomy. Technological and managerial
Modernization programs were taking place in large scale. All these measures
together contributed to the achievement of an impressive annual growth rate of
8.5% during the VII Five year plan. Having understood the effectiveness of all
the policy changes in the past, the new industrial policy will continue to pursue
a sound policy to encourage entrepreneurs, develop the indigenous technology
through intensive research and development activities, dismantle the regulatory
system, improve the capital market, etc. Small scale sector would get a special
attention and the government promised to come out with a new policy towards
he small scale industries. Foreign technology and investment would be
welcomed to improve the domestic production base and increase the exports.
The MRTP Act would be suitably modified to encourage competition. Public
sector will be made to run on commercial lines and play a vital role in economic
development.

The essence of this new policy will be discussed under the following heads:
1. Industrial licensing, 2. Foreign investment, 3. Foreign technology agreement,
4. Public sector, 5. MRTP Act and 6. Small scale and tiny sector policy.

INDUSTRIAL LICENSING POLICY

To achieve the objectives of the strategy of the industrial sector in the 90's a
number of changes in the system of industrial approvals have been brought
about. The domestic producers will be able to withstand the competition in he
country as well as abroad only through procedural reforms. Hence, the role of
government will be changed from that of exercising control to one of providing
369
help and guidance. Changes in the policy towards public sector in the last few
years have clearly indicated that private sector enterprises will be allowed to
compete in many areas hitherto earmarked for public sector. Consequently, the
new policy has completely reclassified the Indian industries as below:

Eight industries have been completely reserved for the public sector. They are:
(a) Arms and ammunition and allied items of defence equipment, defence
aircraft and warships, ii. atomic energy, iii. coal and lignite, iv. mineral
oils; v. mining of iron ore, manganese ore, chrome ore, gypsum,
sulphur, gold and diamond, vi. mining of copper, lead, zinc, tm,
molybdenum and wolfram, vii. mineral specified in Schedule to the
Atomic Energy Order, 1953 and viii. railway transport.
(b) Eighteen industries have been listed as industries which require
compulsory licensing. However, this provision would not apply in
respect of the small scale units taking up the manufacture of any of the
items reserved for exclusive manufacturing in small scale sector.
Compulsory licensing would be required in the following industries:

i. coal and lignite, ii. petroleum other than crude and its distillation
products, iii. distillation and brewing of alcoholic drinks, iv. sugar, v.
animal fats and oils, vi., cigars and cigarettes of tobacco and
manufactured tobacco substitutes, vii. asbestos and asbestos based
products, viii. plywood, decorative veneers and other wood based
products such as particle board, medium density fiber board, block
board, ix. raw hides and skins, leather, chamois leather and patent
leather, x. tanned or dressed fur skins, xi. motor cars, xii. paper and
newsprint except bagasse based units, xiii. electronic aerospace and
defence equipment of all types, xiv. industrial explosives, xv. hazardous
chemicals, xvi. drags and pharmaceutical xvii. entertainment electronics
and xviii. white goods like domestic refrigerators.

As regards the provisions of the industrial licensing policy,
(i) Industrial licensing has been completely abolished for all projects
except for the industries classified above, i.e., the area reserved for
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public sector and the list of 18 industries and the areas reserved for
small scale industries will continue.
(ii) Public sector will continue to maintain monopoly in industries coming
under the areas of security and strategic considerations.
(iii) In projects where imported capital goods are required, automatic
clearance will be given provided the foreign exchange availability is
ensured through foreign equity. Or alternatively if the value of
imported, goods does not exceed 25% of the total value of plant and
equipment subject to the ceiling of Rs. 2 crores, automatic clearance
will be given. However, this would come into effect only from April,
1992 in view of the current balance of payments position. In all the
other cases, the prior approval and clearance from the Secretariat of
Industrial approvals in the Department of Industrial development will
be required.
(iv) Except the list of industries requiring compulsory licensing, the other
industries will not require any approval from the Central government
for their location in areas other than cities of more than one million
population. In cities with more than one million population, non-
polluting industries like electronics, computer software and printing
will be permitted outside 25 kms. of the periphery. If such cities
require industrial re-generation policies will be made more flexible.
However, the existing zoning and land use regulation and
environmental legislation will continue to regulate industrial
locations. All efforts will be made through incentives and other
methods like infrastructural development, to disperse the industry to
rural and backward areas.
(v) New Broadbanding facility will be provided to the existing units so as
to enable them to produce any article without additional investment.
The exemption from licensing will be applicable to all substantial
expansion of existing units.
(vi) The mandatory convertibility clause will no longer be applicable for
term loans from the financial institutions for new projects.
(vii) A very significant step is to abolish all the existing registration
schemes.
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(viii) In case of substantial expansions and new projects, it is enough if the
entrepreneurs file the information memorandum.
(ix) The list of industries requiring compulsory licensing and industries
for automatic approval of foreign technology agreements will be
notified in the Indian Trade Classification (Harmonized system),

FOREIGN INVESTMENT

Foreign investment carries with it the benefits of technology transfer, marketing
expertise, modem managerial techniques and new possibilities for promotion of
exports. As this requirement is felt in this world of industrial change and co-
operation, the new policy has clearly contained the following provisions related
to foreign investment:
(i) In high priority industries approval will be given for direct foreign
investment upto 51% foreign equity and all the bottlenecks in this
process will be removed- Clearance in such cases will be given if the
foreign equity covers the foreign exchange requirements for imported
capital goods. The necessary amendments will be made in the FERA.
(ii) The general policies governing (he domestic units in regard to import
of components, raw materials and in intermediate good and payment
of know-how fees and royalties will also be applicable to the high
priority industries in which foreign investment is limited to 51%
However, the payment of royalty will be routed through the RBI to
enable it to monitor the outflow of foreign exchange on account of
dividend payment also to ensure that such payments are balanced by
export earnings over a period of time.
(iii) All the other foreign investments not included in the Category I slated
above will require prior clearance.
(iv) Trading companies primarily export oriented will also be permitted
under the foreign equity proposals as indicated in (i) above. However,
the provisions of the Export-Import policy applicable to the domestic
units will also be applicable to such trading companies.
(v) To encourage substantial inflow .of foreign investment, a Special
empowered board would be constituted. This Board would negotiate
372
with the large international firms and approve direct foreign
investment in select areas. This is expected to fetch foreign technology
and open the industries in India to wider world market. Such
investments will be subjected to favourable treatment based on the
merits irrespective of the rules, regulations and procedures in
practice.

FOREIGN TECHNOLOGY AGREEMENT
A welcome change in the outlook of the government as evidenced by the new
policy is the realization that the sophisticated technology, from abroad can be
brought in only through liberal and less restrictive procedure and policies. The
interference of the government in this regard is to be reduced so as to enable
the domestic industries in achieving a high rate of industrialization. As a result
of this liberalization, automatic approval for technology agreements related to
high priority industries will be made with respect to certain specific parameter.
Other industries which can enter into such agreements without incurring the
expenditure of foreign exchange will also be extended liberal treatment. The
industrialists are left to themselves to decide and enter into foreign technology
agreements depending upon the commercial viability of their enterprises. In due
course this measure is expected to pave the way for exchange of superior
technology from India with other countries. With the overall liberalization, the
competition will be high and it is expected that industries will invest much more
in research and development activities. Keeping in view all these expectations,
the government has announced the following changes in regulations governing
foreign technology agreement:
(i) No prior permission is needed for hiring foreign technicians, foreign
testing of indigenously developed technologies. Such activities
involving payments will be governed by the guidelines of the RBI and
such payments can be made through the blanket permits.
(ii) Automatic permission will be given for foreign technology agreements
relating to the high priority industries. The royalty payments through
such agreements will be subjected to certain provision. Upto the
payment of Rs. 1 crore, royally will be @ 5% for domestic sales and
8% for foreign sales or exports. However, the total royalty payment
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should not exceed 8% of sales over a 10 year period from the date of
agreement or 7 year period from the dale of commencement of
production.
(iii) In the case of industries not covered in the high priority list automatic
permission will be given for technology agreement provided it does riot
entail any foreign exchange payment commitment.
(iv) In all the other cases, the general procedures in practice will be
adhered to and such industries will require approval.

PUBLIC SECTOR

The public sector was given the predominance in the industrial development
over the last four decades and the amount of investment made in this sector,
though justified from the point of view of socialistic democracy, it has been
struggling with so many problems like poor productivity, excess staffing, lack of
continuous technological up-gradation, inadequate attention to research and
development, etc. The rate of return on investment in public sector has been so
low that it has prevented the automatic growth of these assets to the
government. The main reason for this poor performance of the public sector has
been the taking over of the sick units from the private sector and the number of
units which are in the consumer goods and service sector. Hence, in the new
policy the government has rightly given the emphasis to the development of
public sector in the field of essential infrastructure goods and services,
technology development and building of manufacturing capabilities,
manufacture of products such as defence equipment. The public sector will also
enter the other areas not strengthened if they generate good profits and the
management will be granted more autonomy through a system of memorandum
of understanding. Private sector will be invited to induce competition in these
areas. In selected industries in public sector, the government would disinvest a
part of the equity share holding to provide market discipline to the performance
of the public sector. Based on these views the new policy has the following
provisions regarding the public sector:
(i) A review of the public sector portfolio investment will be made to give
the emphasis on the role of public sector in the strategies, high tech
374
and infrastructure. Public sector units will be allowed entry into areas
not strictly reserved for it.
(ii) The Board for Industrial and Financial Reconstruction will be
approached to help the sick units to rehabilitate them. To protect the
interest of workers who are likely to be affected due to rehabilitation
of public sector sick units, a social security system is proposed to be
devised.
(iii) A significant policy aimed at raising the resources and encouraging
public participation in the growth of public sector units is that the
government will offer a part of its share holding in the public sector to
the mutual funds financial institutions, general public and workers.
(iv) In the direction of strengthening the management of public sector
units the Board of public sector management will be made more
professional and given more powers. Further to make (he
management of such units more autonomous and accountable a
system of memorandum of understanding will be adopted. Apart from
improving the expertise of the government in implementing the MOU,
the government also would place in the Parliament the MOU to
facilitate detailed discussion.

MRTP ACT

A major deviant of the new policy is in respect of the MRTP Act. The new policy
aims at removing the unnecessary bureaucratic controls and allows the
industries to breathe in an atmosphere of freedom. The efforts of the
government in the past intervening in the investment decisions of the MRTP
companies have been proved to be counter-productive. Hence, the newly
empowered MRTP Commission will enquire into complaints received from
individual consumers or classes of consumers. The following is the essence of
the provisions in the new policy regarding MRTP Act:
(i) The limits of assets in respect of the MRTP companies and dominant
undertakings have been removed and suitable amendment in the
MRTP Act will be made in due course.
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(ii) The need to obtain the prior approval of the central government for
establishing/new units, expansion of existing units, merger,
amalgamation and take over as well as appointment of Directors have
all been removed.
(iii) The MRTP Act will be used only for controlling and regulating
monopolistic, restrictive and unfair trade practices. As a follow-up the
MRTP Commission will be authorized to inquire suo moto or
complaints lodged by individual consumers or classes of consumers
regarding monopolistic, restrictive and unfair trade practices.
(iv) All the necessary amendments will be made in the MRTP Act to give
more punitive and compensatory powers: the MRTP Commission
unemployment, small scale industries should be established and
encouraged to grow with government assistance in every way
possible. Since then, the government has shown a priority for the
development of small scale industries and this concern has yielded
the fruits that today the small scale sector has emerged as an
important segment of Indian industrial sector. The investment of the
small scale and ancillary industries has been raised periodically and
as per the Industrial policy of 1990, the investment limit for small
scale industry is raised from Rs. 35 lakhs to Rs. 60 lakhs and units
which export 30% of output by the third year, will have a higher
investment limit of Rs. 75 lakhs. In the case of ancillary units the
investment limit has been raised from Rs. 45 lakhs to Rs. 75 lakhs.
Small scale units today include both the traditional and modern
units. While the former is basically labour intensive, capital light,
using simple indigenous technology, and the modern units are capital
intensive using up-to-date technology.

Role of small scale industry (SSI)
1. SSI and production: SSIs have significantly added to their level of total
production, which simply means that they make a sizeable addition to
national income. The production level increased in value from Rs. 7,200
crores in 1973-74 to Rs. 1.78,700 crores in 1991-92, an increase by
mere than 20 times within a span of two decades.
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2. SSI and employment: One of the important reasons for establishing SSI
is to generate employment opportunities, especially in the rural areas.
This objective has been certainly achieved as could be seen from the
figure, SSI provided employment for 39.7 lakhs of people in 1973-74 and
in 1991-92 this has touched 128.8 lakhs people, a three fold increase.
This implies that with more encouragement and solutions to the
problems, SSIs can play a vital role in rural and urban employment
generation.
3. SSI and export earnings: A significant contribution of SSIs is in the field
of exports. Over the period, our products have consistent demand in the
world market, as it proved by the exports figures. From a modest
earnings of Rs. 393 crores in 1973-74 this sector has earned Rs. 12,568
crores in 1991-92 roughly 30 times increase. This constituted 28.7% of
the total exports in 1991-92. A very important point to be observed is
that our exports consists of mostly non-traditional items.
4. SSIs and dispersal of industries : One best way of industrializing the
rural areas is to establish SSI. This would relieve the urban centers from
the industrial congestions and other problems associated with it and
help the rural areas to get industries. With SSI in the rural areas, the
seasonal unemployment is eliminated, unskilled laborers are used,
farmers are able to supplement their agricultural income, etc. However,
in India the regional dispersal of SSI is mostly concentrated in six states:
Maharashtra, Tamilnadu, West Bengal, U.P., the Punjab and Gujarat
and these states alone account for 59% of the total SSIs in India. But
this concentration was mostly due to specialization by particular
districts.
5. SSIs and industrial disputes : Unlike the large and medium industries,
SSIs do not have serious industrial disputes and even if there are any,
they do not affect all the units like the large and medium segments.
Since in most units there is direct contact between the proprietor and the
workers, the possibility of disputes is very much minimized. The loss of
man-days due to disputes is very high in medium and large scale
industries than in SSIs. This implies that thee industries ensure
regularity in production, supply, etc.
377
6. Inter-relationship between SSIs and large scale and medium scale
industries: This is very important aspect. SSIs today forms the backbone
of the large and medium industries in that they supply the components,
implements, etc., required by the large and medium scale industries and
also function as the user of industrial waste to produce by-products.
There are several products flowing from the large and medium scale
industries which actually are the output from small scale units under
sub-contracting provisions.
7. SSIs and utilization of resources: SSIs in India also make a valuable
contribution to the economy. Economic development can be accelerated
and consolidated only when the available resources are fully utilized. In
this respect, SSIs make use of physical, human and financial resources
available in the rural areas. In the absence of SSIs, vast physical and
human resources will remain unutilized and to that extent the national
income will be low and employment will be less. At the same time, the
SSIs have also facilitated the growth of entrepreneurship in our country.
Persons with requisite qualities come forward to set up SSIs and once
they succeed, slowly his encourages the others and in this manner the
entrepreneurship skill develops and spreads.

Having discussed the role of SSIs in Indian economic development, we now turn
to understand their problems. It was pointed out earlier that the SSIs are best
suited for our country and they have contributed in so many ways to the
economy but the country is yet to realize the full potential of this sector. This is
because this sector is crippled by several problems. An understanding of these
problems will help us to assess the policy prescriptions of the government and
to suggest the necessary changes in them.
1. Funds requirement : SSIs like any other industrial unit, require both
fixed capital and working capital. Though the fixed capital requirement of SSIs
is low, yet the small entrepreneurs who come forward to start these units do not
have sufficient fund of their own. This being the situation, for their working
capital, these SSIs need some source. As most of the SSIs are located in the
rural areas they approach for funds with several agencies ranging between the
friends and relatives of entrepreneurs, money lenders, and other specialized
378
financial agencies. A major obstacle in their way of getting funds is that being
small their credit worthiness is never accepted as satisfactory by the lenders. It
is estimated that more than 50% of the Sols seek financial assistance of some
sort or other. Government has established several institutional agencies to meet
the requirements of (he SSIs. But these agencies have their own rules and
regulations insisting on securities, furnishing technical and other details at
periodical intervals, project funding pattern, justification for the project and the
repayment: capacity, marketing arrangements, other legal formalities to be
fulfilled, etc. The small entrepreneurs not being professional are unable to cope
with these rigidities of these specialized institutional agencies. The application
form for loans and the procedure for filling it and getting the loan are all
lengthy, that the SSIs struggle for funds.

2. Shortage of raw materials: This is another basic problem of SSIs. When
these units are started, they estimate the availability of raw materials and then
make arrangement for purchasing them from the source. But there are several
inputs like chemicals which are always in perennial shortage. As a result these
units have to compete with other medium and large scale units to get these raw
materials. Since these raw materials are in scarcity, the demand being high, the
cost of them is high. The SSIs do not have any professional assistance who can
liaise with the government or other agencies to get the raw materials supply.
Therefore, they are unable lo compete with the large and medium scale
industries. Though the government shows some priority in supply of these raw ,
materials to the SSIs, the claimants are in large number and so the raw
materials are bought at high cost The market variation in price is such that the
medium anpVlarge units buy in bulk and maintain stock which the SSIs cannot
afford to do as this would lock up their capital. As a result of these, the SSIs
incur higher cost of production which eats away a large part of their profits.

3. Shortage of power : Most of the modem SSIs depend on power for
their working. As they are mostly located in semi-urban and rural
areas, the supply of power is not regular. This directly affects their
level of production. Even when power is available it is supplied only
for restricted hours. Hence, when these units are started, they
379
assume the availability of regular power and estimate their
production level. But in reality when they are unable to achieve that
production level, they lose heavily. They cannot also afford to make
alternative arrangements for power supply as is found with medium
and large scale units with generators and other captive power plants.
This results in under utilization of capacity having impact on their
profitability.

4. Problem of marketing: Yet another important problem for the small
scale units is marketing their products. With their rural bias in
location, these units have to either sell in the rural areas or identify
customers in the nearby towns or cities. Never can they hope to
market their products in distant places. With local demand at a low
level and the selling in distant places becoming difficult, they cannot
avoid stockpiling which means they run short of working capital
Except in the case of ancillary units which may have a permanent tie-
up with large or medium units, the other SSIs always have the
problem in marketing their products. Neither can they indulge in
aggressive advertising or sales promotion nor can they adopt modern
methods of selling. Though some of the units are 100% export
oriented, yet not all of them can afford to approach the distant
markets. Even if the government assists them through policies like
Stores purchase policy under which certain items required by the
government organizations are to be purchased only from the SSIs, yet
selling through this channel means waiting for a long time to get the
bills cleared by the government. Hence, these SSIs neither can market
their products efficiently themselves or through other agencies. As a
result, most of the units indulge in reducing their production level,
which affects their economies of scale. So in every way the marketing
problems are experienced by the SSIs.

5. Procedural wrangles with the government: It is often said that the
government offers several concessions, subsidies, priorities, etc., to
the SSIs. True, but what is offered by the government is very much
380
less than what is needed by this sector. As a result several claimants
for these limited assistance force it on the officials to determine
certain norms for allocation or extension of these facilities. In other
words, whatever the government can offer is rationed among the SSIs.
At this stage, the general concessions offered to the industrial sector
make the situation worse. The SSIs have to compete with the other
medium and large units to get their share. At this stage deliberate
discrimination, official apathy, red tapism, corruption among officials,
etc., are all becoming rules rather than exceptions. Further the
procedures involved in obtaining the government assistance are so
cumbersome that the SSIs do not have the professional talent to
complete them.

6. Problems relating to exports: Small scale units in India have made a
significant deviation from the export of traditional items. Today
these units produce a number of products like electronic components,
spectacle names, leather goods, handlooms, chemicals, dyes,
cosmetics, etc. These goods have great demand in other countries.
Our Indian products are comparable in quality with the products
from other countries, but prices of our products are higher than those
from other countries. This is because of various reasons: lack of
knowledge about the market for different products, market
information relating to consumer preference, selling terms, exchange
rate regulations, packing and forwarding procedures, remittance,
facilities, absence of bank guarantees, payment of various duties, etc.
In each one of these areas, the SSIs lack experience and guidance.
Hence inspite of producing good quality products our units are
unable to succeed in marketing them abroad. The various agencies
and boards established for this purpose are unable to really assist the
SSIs. There is complete lack of co-ordination among various agencies
and producers. As result this sector, which can fetch considerable
foreign exchange resources, is unable to realise it.

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7. Labour problems : SSIs are encouraged mainly because the are
labour intensive. But over the years, these units have started losing
considerable mandays due to labour problems. There are several
statutory regulations like Provident Fund contributions, Employee
State Insurance, etc., which the SSIs have to comply with. Whenever
there is any violation, the labour problems erupt and affect the
smooth functioning leading to accumulating loss.

8. Lack of Modernization: SSIs by nature depend on indigenous
technology. But whenever there is scope for improving the technology
by importing if from abroad, the requirement of funds emerge s a
hurdle. Hence, with old technology production becomes costlier, and
these units are unable to find market for their products and compete
with other rivals.

9. Difficulty in location of units : SSIs are encouraged to move towards
the rural areas and backward regions. But the facilities in these
places are very limited or under developed, that even though units are
established in these locations, their operations are severely hampered
by the limited availability of the facilities. Of late there is objection
from the rural folks on the ground of environmental pollution. For
instance, a tannery will not be allowed nearby the villages as it is
feared that there will be water pollution. Similarly there is objection to
the location of chemical units, meat producing units, etc., and this
leads to competition for the place where the facilities are available and
where there is not much of social resistance.

10. High rate of industrial sickness : The industrial sickness is found
afflicting this sector very much. Among the industries which are
declared sick, maximum number of units is found only in the small
scale sector. The reasons for this are the problems so far explained.
Whenever the SSIs fall sick, the effort to revive them is not at all on
the lines found with the medium and large scale units. As a result the
sickness is prevalent more among SSIs and the funds required for
382
reviving them rim to several crores. Government with its financial
stringency cannot also come forward to bale out this sector from
industrial sickness. By 1991, 2,21,472 small scale units were found
to be sick resulting in the lock up of total bank credit to the tune of
Rs. 2,792 crores. Of these units, 2,02,998 units were declared non-
viable units involving an outstanding baiik credit of Rs. 1997 crores.
The magnitude of industrial sickness among SSIs has been a main
concern of the government in these days. Efforts taken to solve the
occurrence of sickness among the SSIs are not found to be effective
for one reason or the other.

Having discussed the problems of the SSIs, let us now study the measures
required and policies taken by the government to solve these problems.

1. Institutional agencies: The government has taken a keen interest in the
development of SSIs. Having identified the basic problems of this sector,
the government has introduced an institutional structure to look after
various aspects of this sector. The Small Industries Development
Organization has been established by the Central government mainly to
co-ordinate, monitor and formulate policies for SSJs. It has Small
Industries Service Institutes, branch institutes extension centers and
regional testing centers and production and training centers. The
National Small Industries Corporation (NSIC) has been established to
provide them" raw materials and capital equipment and assist them in
marketing of goods, etc. such corporations are also established at the
state level. To attend to the developmental functions of the SSIs, the
Small Industries Corporations have been set up at the slate level. Apart
from these, several specialized Boards for each segment of the small
scale sector have also been established like Coir Board, Central Silk
Board, Coffee Board, etc.

2. Technical assistance: One of the important areas where the SSIs need
assistance is in technical matters. Right from the stage of production
down to packing and forwarding, they require guidance. Though initially
383
they are started with the internal technical expertise, over a period, they
have to be guided properly for updating their technology so as to
maintain their cost of production and profitability. The installation and
maintenance of machines and equipments, servicing them etc., are also
areas where the SSIs need help. To extend this assistance, several
agencies like Small Industries Service Institute, Small Scale Industries
Development Corporation and such others are established which
take care of the technical assistance to SSIs. The various Boards set up
for different SSIs also extend their help in this regard. Apart from
guiding the SSIs, these institutions^ are also engaged in research and
development and their research findings are also disseminated to benefit
the SSIs.

3. Industrial estates: Though SSIs can be easily formed, it is very difficult
to get a location in these days where all the infrastructural facilities are
available at a reasonable price. For this purpose the government has
started establishing industrial estates. Industrial estates are areas
where all the basic infrastructural facilities are provided by the
government. Facilities like water, work sheds, transport, communication,
roads, power, etc., are made available in the industrial estates.
Individuals who want to locate their SSIs in such estates should apply to
the government and get the work sheds allotted. They will make the
necessary payments to the governments in lump sum or installment as
the case may be. The government locates these industrial estates in
backward regions and rural and semi-urban areas so that when SSIs are
started, these regions slowly develop. The government has also set up the
SIDBI mainly to extend assistance for supporting the activities of the
State governments, and their agencies in connection with the
development of SSIs. Special concessions are also granted to these
agencies when they plan for locating the industrial estates in the rural
areas.

4. District Industries Centres (DICs) : DICs are institutional agencies which
have links with the Development blocks on the one hand and the special
384
agencies on the other. They provide guidance to entrepreneurs and SSI
owners in almost every stage since the formation and also in pre-
formation and post-formation, marketing, finance, credit guarantee, raw
materials, training, etc. They also guide the unemployed candidates with
all the necessary details regarding the starting of SSIs. By March, 1993,
there were 433 DICs covering 431 districts in India.

5. Financial assistance: One of the basic problems of the SSIs is the lack of
funds. To overcome this, several steps have been taken since 1960.
Briefly we may refer to the following steps :

(a) Under the control of RBI, the government introduced a Credit
Guarantee Scheme for the supply of institutional credit to SSIs.
(b) IDBI is extending refinancing facilities to the State Governments
Commercial banks, and State finance corporations.
(c) The State governments provide seed capital and margin money to the
entrepreneurs of SSIs to enable them to get assistance from the
Commercial Banks and State Finance Corporations.
(d) Small industries development fund was set up by the IDBI in May,
1992 mainly to increase the refinance facility to the banks and other
institutional agencies to enable them to participate in a greater way in
extending assistance to the SSIs.
(e) A significant development was the establishment of Small Industries
Development Bank of India with the main purpose of functioning as
the principal financing institution. It would concentrate on
Modernization and technological up-gradation, promotion of
employment oriented industries, improving the marketing facilities,
etc.
(f) Arrangement for die supply of raw materials : Raw material shortage
has been crippling the SSIs for a long time. This problem is being
solved by the government through the State Small Scale Industries
Corporations. These corporations are made in charge of distributing
the scarce raw materials among the SSIs so that every unit will be able
to get its quota. Government is also exploring a scheme for
385
maintaining a buffer stock of raw materials, especially those which are
in heavy demand, so that the SSIs will not have any difficulty in
getting their supply from the authorized agencies.
(g) Marketing assistance : In order to provide marketing assistance to the
SSIs, the government has come out with several schemes like :
(a) Stores purchase policy under which the government has
earmarked items which should be purchased by the government
organisations and departments only from SSIs.
(b) Price preference to the products purchased from the SSIs by the
public sector units.
(c) To improve the competitiveness of the SSI products, the
government has provided quality control and testing facilities at
various places.
(d) Organization of exhibitions, sales emporia, etc., at various places
to enable the SSIs to market their products.

8. Fiscal incentives: The government also has extended several fiscal
concessions and incentives to SSIs to encourage them to grow. These
incentives include, tax holidays for new units, investment allowance,
exemption from taxation, offering capital subsidies to units located in
backward regions, exemption from excise duty, etc.

Apart from the above steps and measures taken, the government also allots
huge amounts of money for establishing and developing SSIs. The table below
has the details regarding the total expenditure incurred by the government plan
wise. It could be noted from the table that the expenditure on SSIs has been
increasing from the I Plan and by the VIII Plan it has gone up nearly 130 times.





GOVERNMENT EXPENDITURE ON SSIs.
(Amount in Rs. crores)
386
PLAN TOTAL EXPENDITURE
I 48
II 187
III 248
IV 242
V 592
VI 1,945
VII 3,249
VIII 6,334


In the Industrial Policy 1991 the SSI sector has been given special emphasis.
The following are the important provisions:
(i) To facilitate SSIs to have access to capital market, equity participation in
them is allowed for other industrial undertakings not exceeding 34% of
the total share holding, this is expected to provide funds for
Modernization, improving the technology, etc.

(ii) To liberalize the flow of funds through commercial banks by involving
them in financing and also to extend the Single window scheme as well
as the Equity Fund scheme.

(iii) To invoke the provisions of the Partnership Act to limit the liability of the
new entrepreneurs in the event of failure of SSI.

(iv) To improve the effectiveness of collection of dues,

(v) factoring services may be extended to SSIs.
(vi) Involving the public sector units, co-operatives and other professional
agencies to improve the marketing of the products of SSIs.

(vii) Allocating the raw materials to the SSIs and tiny industries on priority
basis.
387

(viii) To achieve co-ordination in the production programs of large, medium
and small scale units.

(ix) To establish and extend quality control and testing facilities,

(x) To encourage location of SSIs in the rural and backward regions.

(xi) To make the Small Industries Development Organization as nodal agency
for SSIs mainly in export promotion.

With (lie above steps already taken, the government has clearly shown its
interest in the development of SSI sector. But a main problem is yet to be solved
and that is the extent of industrial sickness in the small scale sector. The
number of units afflicted is on the increase year after year and unless some
positive and preventive steps are immediately taken, the SSI sector will not be
able to reach its potentials and make the invaluable contributions to the Indian
economy.

REVIEW QUESTIONS
1. Explain the objectives of Indian five year plans and to what extent they
have been accomplished?
2. Trace the evolution of mixed economic principle in Indian economy.
What are the characteristics of mixed economy?
3. Explain the planning process under mixed economic set up? What
distortions that can take place in the course of such a planning
process?
4. Comment on the sources of finance for Indian five year plans.
5. How would you justify the existence of public sector in India ? What role
does public sector play in Indian economy?
6. Critically evaluate Industrial policy resolutions of 1948, 1956 and 1980?
7. Discuss in detail the Industrial policy of 991 which set the liberalization
process on?
388
8. Explain the role of small scale industries in India. To what extent the
government policy has been supportive of the small scale industries?

Discuss the problems of small scale industries and suggest suitable measures
to overcome them?
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CHAPTER VI
New Economic Policy Environment in India - Privatisation - Liberalisation and
Globalisation - Experiences and issues - Environmental assessment and
evaluation.

PRIVATISATION

Since the time the government in several countries und