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ECONOMICS - II

RESERVE BANK OF INDIA

The Reserve Bank of India was set up in 1935 (by the RBI Act, 1934) as a private bank with
two extra functions :-

regulation and control of the banks in India


being the banker of the government

After nationalisation in 1949, it emerged as the central banking body of India and
governments have been handing over different functions to the RBI as given below :-

1. It is the issuing agency of the currency and coins (Under section 22 of the RBI
Act,1934)
2. Distributing agent for currency and coins issued by the Government of India.
3. Government Banker, Adviser and agent to government,
4. Announces the credit and monetary policy for the economy.
5. Stabilising the rate of inflation.
6. Stabilising the exchange rate of rupee
7. keeper of the foreign exchange reserves
8. Agent of the Government of India in the IMF.
9. Performing a variety of developmental and promotional functions under which it did
set up institutions like IDBI, SIDBI, NABARD, NHB etc.

Credit and Monetary Policy

Definition - The policy by which the desired level of money flow and its demand is regulated
is known as the credit and monetary policy.

Monetary policy refers to the policy of the central bank with regard to the use of monetary
instruments under its control to achieve the goals specified in the RBI Act, 1934.

All over the world it is announced by the central banking body of the country - as the RBI
announces it in India.

The primary objective of monetary policy is to maintain price stability while keeping in mind
the objective of growth. Price stability is a necessary precondition to sustainable growth

Instruments of Monetary Policy are broadly classified into two types :-

1. Quantitative or General measures


2. Qualitative or selective measures

There are many tools by which the RBI regulates the desired/required kind of the credit and
monetary policy are :-

1. CRR
2. SLR
3. Bank Rate
4. Repo Rate
5. Reverse Repo Rate
6. PLR

CRR - Cash Reserve Ratio - Cash form of reserves - 1970s

The cash reserve ratio is the ratio (fixed by the RBI) of the total deposits of a bank in
India which is kept with the RBI in the form of cash.
The average daily balance that a bank shall maintain with the Reserve Bank as a share
of such per cent of its NDTL(net demand and time liabilities deposits) that the
Reserve Bank may notify from time to time in the Gazette of India.
Another weapon available to RBI for credit control is the use of variable cash reserve
requirements. Under the RBI Act, 1934, every commercial bank has to keep certain
minimum cash reserves with RBI- initially, it was 5 per cent against demand deposits
and 2 per cent against time deposits - these are known as the statutory cash reserves.

SLR - Statutory Liquidity ratio - Non-cash form of reserves - 1970s

The statutory liquidity ratio (SLR) is the ratio (fixed by the RBI) of the total deposits
of a bank which is to be maintained by the bank with itself in non-cash form
prescribed by the government.
The share of NDTL that banks shall maintain in safe and liquid assets, such as,
unencumbered government securities, cash and gold. Changes in SLR often influence
the availability of resources in the banking system for lending to the private sector.
Statutory - by law, Liquidity ratio - Which can be easily converted into cash.
The lesser the amount of SLR, the more banks have to lend outside.
Apart from cash reserve requirements which commercial banks have to keep with RBI
(under RBI Act, 1934), all commercial banks have to maintain (under section 24 of
the Banking regulation Act, 1949) liquid assets in the form of cash, gold and
unencumbered approved securities. This is known as statutory liquidity requirements.

Bank Rate - 1970s

Rate at which RBI lends money to commercial banks for longer period of time (365+)
It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange
or other commercial papers.
The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934.
This rate has been aligned to the MSF rate and, therefore, changes automatically as
and when the MSF rate changes alongside policy repo rate changes.
The clients who borrow through this route are the GoI, state governments banks,
financial institutions, co-operative banks, NBFCs, etc.

Repo Rate - 1992


Rate at which RBI lends money to commercial banks for shorter period of time (364
days maximum)
The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to
banks against the collateral of government and other approved securities under the
liquidity adjustment facility (LAF).
Repo means repossessing or repurchasing.
Basically, this is an abbreviated form of the 'rate of repurchase' and in western
economies it is known as the 'rate of discount'.
In practice it is not called an interest rate but considered a discount on the dated
government securities, which are deposited by institution to borrow for the short term.
When they get their securities released from the RBI, the value of the securities is lost
by the amount of the current repo rate. This rate functions as the benchmark rate for
the inter-bank short-term market (i.e., call money market) in India.
Higher the repo rate costlier the loan banks forward and vice versa.
It has direct impact on the nominal interest rates of the bank's lending.

Reverse Repo Rate - 1996

The (fixed) interest rate currently 50 bps below the repo rate at which the Reserve
Bank absorbs liquidity, on an overnight basis, from banks against the collateral of
eligible government securities under the LAF.
It is the rate of interest the RBI pays to its clients who offer short-term loan to it.
It is the reverse of the repo rate and this was started in November 1996 as part of
liquidity Adjustment Facility (LAF) by the RBI.
It is reverse of the repo rate and this was started in November 1996 as part of liquidity
Adjustment Facility (LAF) by the RBI.
In practice, financial institutions operating in India lend their surplus funds with the
RBI for short term period and earn money.
It has a direct bearing on the interest rates charged by the banks and the financial
institutions on their different forms of loans.
This tool was utilised by the RBI in the wake of over money supply with the Indian
banks and lower loan disbursal to serve twin purposes of cutting down banks losses
and the prevailing interest rate.

Marginal standing facility - 2011

Last option given by RBI to commercial banks once they exhaust all borrowing
options including the liquidity adjustment facility by pledging through government
securities, which has lower rate(i.e., repo rate) of interest in comparison with the
MSF.
MSF - Penal rate. The MSF would be a penal rate for banks and the banks can borrow
funds by pledging government securities within the limits of the statutory liquidity
ratio.
A facility under which scheduled commercial banks can borrow additional amount of
overnight money from the Reserve Bank by dipping into their Statutory Liquidity
Ratio (SLR) portfolio up to a limit [currently two per cent of their net demand and
time liabilities deposits (NDTL)] at a penal rate of interest, currently 50 basis points
above the repo rate.
This provides a safety valve against unanticipated liquidity shocks to the banking
system.
This scheme has been introduced by RBI with the main aim of reducing volatility in
the overnight lending rates in the inter-bank market and to enable smooth monetary
transmission in the financial system.
The MSF rate and reverse repo rate determine the corridor for the daily movement in
the weighted average call money rate.

Marginal Stabilising scheme - 2004

This instrument for monetary management was introduced in 2004.


Surplus liquidity of a more enduring nature arising from large capital inflows is
absorbed through sale of short-dated government securities and treasury bills. The
cash so mobilised is held in a separate government account with the Reserve Bank

Types of Monetary System


1. Contractionary Monetary Policy or Dear Money Policy
1. It is pursued to control Inflation
2. CRR is increased. Due to this increase lending capacity of the banks decrease
3. SLR is also increased
4. Bank rate is increased. This leads to RBI charging higher rate of interest on bank
lending due to which banks borrow less from RBI.
5. Repo Rate is increased
6. Reverse Repo Rate is also increased. This leads to, RBI paying more interest on
Banks deposits. Thus Banks prefer to deposit extra money with RBI instead of giving
loans to public.
7. It is called Dear Money Policy as loans get expensive for the public

2. Expansionary Monetary Policy or Cheap Money Supply


1. This policy is adopted to increase money supply in the economy in order to stimulate
economic growth.
2. It is also pursued to overcome recession.
3. CRR, SLR, Repo Rate, Re Repo Rate, Bank Rate should be reduced.
4. It is called Cheap Money policy as interest rates are low thus borrowing money
becomes cheap.
Since 2010 RBI has adopted Contractionary Money Policy. In 2009 to stimulate economic
growth after global recession, RBI adopted Expansionary Monetary Policy
Discounting of Bill
If the holder of the bill needs funds, he can approach the bank for encashment of the bill
before the due date. The bank shall makes the payment of the bill after deducting some
interest (called discount in this case). This process of encashing the bill with the bank is
called discounting the bill. The bank gets the amount from the drawee on the due date.

INFLATION - A persistent increase/rise in the general level of prices and decrease in value
of money. If the price of one good has gone up, it is not inflation, it is inflation only if the
prices of most goods have gone up. Inflation is defined as the rate (%) at which the
general price level of goods and services is rising, causing purchasing
power tofall.
INFLATION IN INDIA

Every economy calculates its inflation for efficient financial administration as the multi-
dimensional effects of inflation make it necessary. India calculates its inflation on two price
indices i.e., the wholesale price index (WPI) and the consumer price index (CPI). While the
WPI inflation is used at the macro level policy making, the CPI inflation is used for micro
level analysis. The inflation at the WPI is the inflation of the economy. Both the indices
follow the 'point to point' method and may be shown in points (i.e., digits) as well as in
percentage relative to a particular base year.

DEMAND PULL INFLATION

Inflation created and sustained by excess of aggregate demand for goods and services over
the aggregate supply . In other words , demand pull inflation takes place when increase in
production lags behind the increase in money supply. Demand-Pull Inflation is commonly
described as too much money chasing too few goods.

Demand pull inflation - The inflation resulting from an increase in aggregate demand is
called demand pull inflation. Such inflation may arise from any individual factor that
increases aggregate demand, but the main ones that generate ongoing increases in aggregate
demand are :

1. Increase in money supply


2. Increase in government purchases
3. Increase in the price level in the rest of the world.

COST-PUSH INFLATION

Due to 'inflation tax' the price of goods and services in India have been rising as the
government took alternative recourse to increase its revenue receipts. We see it taking
place due to higher import duties on the raw materials also. The non-value added tax
structure of India in the past was also having cascading effect on the prices of
commodities in the country. The government needed higher revenues to finance its
planned development.
Inflation which is created and sustained by increase in cost of production which is
independent of the state of demand (e.g. Trade unions can bargain for higher wages
and hence contributes to inflation).
Cost Push inflation - Inflation can result from a decrease in aggregate supply.
The two main sources of decrease in aggregrate supply are :-
An increase in wage rates and An increase in the price of raw materials.
These sources of a decrease in aggregate supply operate by increasing costs, and the
resulting inflation is called cost push inflation.
Definition: Cost push inflation is inflation caused by an increase in prices of inputs
like labour, raw material, etc. The increased price of the factors of production leads to a
decreased supply of these goods. While the demand remains constant, the prices of
commodities increase causing a rise in the overall price level. This is in essence cost
push inflation.
Description: In this case, the overall price level increases due to higher costs of
production which reflects in terms of increased prices of goods and commodities which
majorly use these inputs. This is inflation triggered from supply side i.e. because of less
supply. The opposite effect of this is called demand pull inflation where higher demand
triggers inflation.
Apart from rise in prices of inputs, there could be other factors leading to supply side
inflation such as natural disasters or depletion of natural resources, monopoly,
government regulation or taxation, change in exchange rates, etc. Generally, cost push
inflation may occur in case of an inelastic demand curve where the demand cannot be
easily adjusted according to rising prices.

VARIANTS OF INFLATION

1. Philips Curve -
The Phillips curve is an economic concept developed by A. W. Phillips (in his
paper 'The relation between Unemployment and the rate of change of money
wage rates in the United Kingdom, 1861-1957')showing
that inflation and unemployment have a stable and inverse relationship. The
theory states that with economic growth comes inflation, which in turn should
lead to more jobs and less unemployment.
Philips curve is a graphic curve which advocates a relationship between
inflation and unemployment in an economy.
Inflation and unemployment has a inverse relationship. Lower the inflation,
higher the unemployment and higher the inflation, lower the unemployment.

2. Bottleneck Inflation -
This inflation takes place when the supply falls drastically and the demand
remains at the same level.
Such situation arise due to supply-side accidents, hazards or mismanagement
which is also known as 'structural inflation'.
This would be put in the 'demand-pull inflation' category
With few exceptional years, India has been facing the typical problem of
bottleneck inflation (i.e., structural inflation) which arises out of shortfalls in
the supply of goods, a general crisis of a developing economy, rising demand
but lack of investible capital to produce the required level of goods.
Whenever the government managed to go for higher growths by managing
higher investible capital it had inflationary pressures on the economy (seen
during 1970s and 1980s, especially) and growth was sacrificed at the altar of
lower inflation.
Thus, the supply-side mismatch remained a long drawn problem in India for
higher inflation
Bottle neck inflation is a variant of Demand pull inflation.
Bottleneck is the inefficiency, inability or hindrance which the supply side
faces to equal the demand.

3. Core Inflation
This nomenclature is based on the inclusion or exclusion of the goods and
services while calculating inflation.
Popular in western economies, core inflation shows price rise in all goods and
services excluding energy (Crude oil) and food articles.
In India, it was first time used in the financial year 2000-2001 when the
government expressed that it was under control- it means the prices of
manufactured goods were under control
Basically, in the western economies, food and energy are not the problems for
the masses, while in India these two segments play the most vital role for
them.

4. Inflation Premium
The benefit of debtor during inflation time is called Inflation Premium.
The bonus brought by inflation to the borrowers is known as the inflation
premium.
The interest banks charge on their lending is known as the nominal interest
rate which might not be the real cost of borrowing paid by the borrower to the
banks.
To calculate the real cost, a borrower is paying in its loan, the nominal rate of
interest is adjusted with the effect of inflation and thus the interest rate we get
is known as the real interest rate.
Real interest is always lower than the nominal interest if the inflation is taking
place - the difference is the inflation premium.
At times, to neutralise the effects of inflation premium, the lender takes the
recourse to increase the nominal rate of interest.
5. Inflation targeting
The announcement of an official target range for inflation is known as
inflation targeting.
It is done by the Central Bank in an economy as a part of their monetary
policy to realise the objective of a stable rate of inflation.
India, commenced inflation targeting in February 2015 when an agreement
between the GOI and the RBI was signed related to it - the Agreement on
Monetary Policy Framework. The agreement provides the aim of inflation
targeting in this way - "it is essential to have a modern monetary framework to
meet the challenge of an increasingly complex economy. Whereas the
objective of monetary policy is to primarily maintain price stability, while
keeping in mind the objective of growth".
In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to
provide a statutory basis for the implementation of the flexible inflation
targeting framework.
The amended RBI Act also provides for the inflation target to be set by the
Government of India, in consultation with the Reserve Bank, once in every
five years. Accordingly, the Central Government has notified in the Official
Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the
period from August 5, 2016 to March 31, 2021 with the upper tolerance limit
of 6 per cent and the lower tolerance limit of 2 per cent.
The Central Government notified the following as factors that constitute
failure to achieve the inflation target:(a) the average inflation is more than the
upper tolerance level of the inflation target for any three consecutive quarters;
or (b) the average inflation is less than the lower tolerance level for any three
consecutive quarters.
Prior to the amendment in the RBI Act in May 2016, the flexible inflation
targeting framework was governed by an Agreement on Monetary Policy
Framework between the Government and the Reserve Bank of India of
February 20, 2015.

6. Inflation Accounting
During lending, Inflation is taken into account, it is called Inflation
Accounting.
When a firm calculates its profits after adjusting the effects of current level of
inflation, this process is known as inflation accounting.
Such profits are the real profit of the firm which could be compared to a
historic rate of inflation (Inflation of the base year)

7. Inflation Taxation
Inflation is itself a tax.
Inflation erodes the value of money and the people who hold currency suffer
in this process.
As the governments have authority of printing currency and circulating it into
the economy (as they do in the case of deficit financing), this act functions as
an income to the governments.
This is a situation of sustaining government expenditure at the cost of people's
income.
This looks as if inflation is working as a tax. This inflation tax is also called
seignorage - It means, inflation is always the level to which the government
may go for deficit financing - level of deficit financing is directly related by
the rate of inflation.
It could also be used by the governments in the form of prices and income
policy under which the companies pay inflation tax on the salary increases
above the set level prescribed by the government.
It has 2 perspective - Hidden tax and slab fixing economic tool

8. Inflationary gap (Budget Surplus)


The excess of total government spending above the national income (i.e.,
fiscal deficit) is known as the inflationary gap.
This is intended to increase the production level which ultimately pushes the
prices up due to extra-creation of money during the process.
The gap between the real demand and surplus in the economy which lead to
inflation is called inflationary gap.

9. Deflationary gap ( Budget deficit)


The shortfall in total spending of the government (i.e., fiscal surplus) over the
national income creates deflationary gap in the economy.
This is a situation of producing more than the demand and the economy
usually heads for a general slowdown in the level of demand, This is also
known as the output gap.
The gap which creates deflation which decreases the prices.

10. Shoe-leather Cost inflation - Increased costs of transactions caused by inflation or


shoe-leather costs are the result of people trying to avoid holding money.
A shoe-leather cost is one of the impacts of inflation.
In a period of high inflation people are discouraged to hold large amounts of cash
because its value deteriorates quickly relative to the rising prices in the economy.
As a result, people tend to hold most of their money in a bank account and keep only
very small amounts of cash with them. This causes them to make regular trips to their
bank to withdraw cash to pay for goods and services. These regular trips wear out
their shoe-leather, thus creating a 'shoe-leather cost'.
The shoe-leather cost is now used more generally to describe all the costs associated
with having to hold small amounts of cash
11. Skewflation

Economists usually distinguish between inflation and a relative price increase.


'Inflation' refers to a sustained , across-the-board price increase, whereas 'a relative
price increase' is a reference to an episodic price rise pertaining to one or a small
group of commodities. This leaves a phenomenon where there is a price rise of one or
a small group of commodities over a sustained period of time, without a traditional
designation, 'Skewflation' is a relatively new term to describe thus category of price
rise.
In India, food prices rose steadily during the last months of 2009 and the early
months of 2010, even though the prices of non-food items continued to be relatively
stable. As this somewhat unusual phenomenon stubbornly persisted, policymakers
conferred on how to bring it to an end. The term 'skewflation' made an appearance in
internal documents of the Government of India, and then appeared in print in the
Economic Survey 2009-18 GoI, MoF.
The skewdness of inflation in India in the early months of 2010 was obvious
from the fact that food price inflation crossed the 20 percent mark in multiple months,
whereas wholesale price index(WPI) inflation never once crossed 11 Percent. It may
be pointed out that the skewflation has gradually given way to a lower-grade
generalised inflation (with the economy in the middle of 2011 inflating at around 9
per cent with food and non-food price increases roughly at the same level).

12. Inflation Spiral


An inflationary situation in an economy which results out of a process of wage and
price interaction. 'when wages press prices up and prices pull wages up' is known as
the inflationary spiral. It is also known as the wage-price spiral. This wage price
interaction was seen as a plausible cause of inflation in the year 1935 in the US
economy, for the first time.

13. Stagflation

A situation in an economy when inflation and unemployment both are at


higher levels, contrary to conventional belief.
Such a situation first arose in 1970s in the US economy (average
unemployment rate above 6 per cent and the average rate of inflation above 7
percent) and in many Euro-American economies. This took place as a result of
oil prices increases of 1973 and 1979 and anticipation of higher inflation. The
stagflationary situation continued till the early 1980s.
Conventional thinking that a trade-off existed between inflation and
unemployment (i,e,, philips curve) was falsified an several economies
switched over to alternative ways of economic policies such as monetaristic
and supply-side economics.
When the economy is passing through the cycle of staggnation (i.e., long
period of low aggregate demand in relation to its productive capacity) and the
government shuffles with the economic policy, a sudden and temporary price
rise is seen in some of the goods - such inflation is also known as stagflation.
Stagflation is basically a combination of high inflation and low growth.

14. Reflation

Reflation is a situation often deliberately brought by the government to reduce


unemployment and increase demand by going for higher levels of economic
growth.
Governments go for higher public expenditures, tax cuts, interest rate cuts, etc.
Fiscal deficit rises, extra money is generally printed at higher level of growth,
wages increase and there is almost no improvement in unemployment.
Reflation can also be understood from a different angle- when the economy is
crossing a cycle of recession (low inflation, high unemployment, low demand,
etc.) and government takes some economic policy decisions to revive the
economy from recession, certain goods see sudden and temporary increase in
their prices, such price is also known as reflation.

15. Base effect


It refers to the impact of the rise in price level (i.e., last year's inflation) in the
previous year over the corresponding rise in the price levels in the current
years (i.e., current inflation).
If the price index had risen at a high rate in the corresponding period of the
previous year, lending to a high inflation rate, some of the potential rise is
already factored in, therefore, a similar absolute increase in the price index in
a current year will lead to a relatively lower inflation rates.
On the other hand, if the inflation rate was too low in the corresponding period
of the previous year, even a relatively smaller rise in the price index will
arithmetically give a high rate of current inflation,

12) HEADLINEINFLATION:

A measurement of price inflation that takes into account all types of inflation that an
economy can experience.

It also counts changes in the price of food and energy. Because food and energy prices
can rapidly increase while other types of inflation can remain low, headline inflation
may not give an accurate picture of how an economy is behaving.
In India, headline inflation is measured through the WPI which consists of 676
commodities (services are not included in WPI in India).
It is measured on year-on-year basis i.e., rate of change in price level in a given month
vis a vis corresponding month of last year. This is also known as point to point
inflation.
13) COREINFLATION:

An inflation measure which excludes transitory or temporary price volatility as in the


case of some commodities such as food items, energy products etc. It reflects the
inflation trend in an economy.
It is, therefore, a preferred tool for framing long-term policy.

CAUSES OF INFLATION
1. Factors on Demand Sides
Increase in money supply
Increase in Export
Increase in disposable income
Deficit financing
Foreign exchange reserves
2. Factors on Supply Side
Rise in administered prices
Erratic agriculture growth
Agricultural price policy
Inadequate industrial growth
3. Black money (fake currency)
4. Increase in public expenditure
5. Decrease in the aggregate supply of goods and services

Measures to Control Inflation

1. Monetary Measures
A. Quantitative Methods
Raising the Bank rate - To control inflation the central bank increases the bank
rate. With this cost of borrowing of commercial banks from central bank will increase
so the commercial banks will charge higher rate of interest on loans. This discourages
borrowings and thereby helps to reduce the money in circulation.
Open Market Operations - During inflation , the central bank sells the bills
and securities. These cash reserves of commercial banks will decrease as they
pay central bank for purchasing these securities. Thus the loan able funds with
commercial banks decrease which leads to credit contraction.
Variable Reserve Ratio - The commercial banks have to keep certain
percentage of their deposits with the central bank in the form of cash reserve.
During inflation, the central bank increases this cash reserve ratio this will
reduce the lending capacity of the banks.
B. Qualitative methods
Fixation of Margin requirements - Commercial banks have to maintain certain
fixes margins while granting loans. In inflation central bank raises the margin
to contract credits and reduces the price level.
Regulation of consumer credit - For purchase of durable consumer goods on
installment basis, rules regarding payments are fixed. During inflation initial
payment is increased and the number of installments is reduced. These result
in credit contraction and fall in prices.
Control through Directives - Certain directives are issued by central bank to
commercial banks and they are asked to follow them while lending. This keeps
in check the volume of money.
Rationing of credit - The central bank regulates the amount and purpose for
which credit is granted by commercial banks.
Moral Suasion - this refers to request made by the central bank to commercial
banks to follow its general monetary policy.
Direct action - Direct action is taken by central bank against commercial banks
if they do not follow the monetary policy laid by it
Publicity - The central bank undertakes publicity to educate commercial bank
and public about the trends in money market. By undertaking these measures
the central bank can control the money supply and help to curb inflation.
Credit Control
Issue of new currency
2. Fiscal Measures
Reduction in Unnecessary Expenditure
Increase in taxes
Increase in savings
Surplus Budgets
Public Debts
To increase in production
Rational wage policy
Price Control
Rationing

1) Recession:

Recession is a slowdown or a massive contraction in economic activities. A


significant fall in spending generally leads to a recession.
Such a slowdown in economic activities may last for some quarters thereby
completely hampering the growth of an economy. In such a situation, economic
indicators such as GDP, corporate profits, employments, etc., fall.
This creates a mess in the entire economy. To tackle the menace, economies generally
react by loosening their monetary policies by infusing more money into the system,
i.e., by increasing the money supply.
This is done by reducing the interest rates. Increased spending by the government and
decreased taxation are also considered good answers for this problem. The recession
which hit the globe in 2008 is the most recent example of a recession.
Recessions generally occur when there is a widespread drop in spending (an adverse
demand shock). This may be triggered by various events, such as a financial crisis, an
external trade shock, an adverse supply shock or the bursting of an economic bubble.

2) DEPRESSION:

A state of the economy resulting from an extended period of negative economic


activity as measured by GDP.
It is often described as a more severe form of a recession that leads to extended
unemployment, a spike in credit defaults, broad declines in income and production,
currency devaluation and a deflationary economy.
The level of productivity in an economy falls significantly during a depression. Both
the GDP (gross domestic product) and GNP (gross national product) show a negative
growth along with greater business failures and unemployment.
When a recession continues to take its toll on any economy, the built in process
triggers further cuts in investment as well as consumption spending due to loss of
confidence among investors and consumers. Also, the financial crisis may lead to
decreased availability for credit. Excessive fluctuations happen in relative value of
currency. Overall trade and commerce get reduced. The Great Depression of 1929 is
considered to be the most classic example of a depression in economic history.

UNEMPLOYMENT
CONCEPT OF UNEMPLOYMENT

In India, a person working 8 hours a day for 273 days in a year is regarded as employed on a
standard person year basis. Thus, a person to be called an employed person, must get
meaningful work for a minimum of 2184 hours in a year. The person who does not get work
even for this duration, is known as unemployed person.

TYPES OF UNEMPLOYMENT

1. Structural Unemployment - Structural unemployment is the situation in which a


country is unable in providing job to all job seekers because the resource available
in the country are limited. It refers to one more situations where the skills and location
of unemployed workers do not match the unfilled vacancies. It can happen because
investment has failed to keep pace with growth in labour force. The remedy calls for
major investment in new industries, training of workers, or large scale migration from
depressed regions.
Basically, Indias unemployment is structural in nature. It is associated with
the inadequacy of productive capacity to create enough jobs for all those who are able
and willing to work.
Structural unemployment is unemployment that results when there are more
people seeking jobs in a labor market than there are jobs available at the current wage rate

2. Disguised Unemployment - This refers to the situation of unemployment that is not


open for everyone to see; it remains invisible. For example, in Indian villages, where
most of the unemployment exists in this from, people are found to be apparently
engaged in agricultural activities. But such employment is mostly a work-sharing
device i.e., the existing work is shared, how so ever large may be the number of
workers. In such a situation, even if many workers are withdrawn, the same work will
continue to be done by fewer people. It follows that all the workers are not needed to
maintain the existing level of production. The contribution of such labourers to
production is, thus, zero or near zero.
Marginal value of additional worker is zero (e.g. issue in agriculture).
1. Underemployment - It is a situation under which employed people are contributing
to production less than they are capable of. For example, a diploma holder in
engineering, if for the want of an appropriate job, starts shoe-shining, may be said to
be underemployed. Apparently, he may be deemed as working and earning in a
productive activity and in this sense contributing something to production. But, in
reality, he is not working to his capability, or to his full capacity. He is, therefore, not
fully employed. Here, too, his underemployment is disguised.
Settling down par down than our potential. e.g., a person who is capable to be
a manager, is working only as a clerk.
2. Open Unemployment - Under this category, fall all those who have no work to do.
They are able to work and are also willing to work, but there is no work for them.
Such unemployment is in the nature of involuntary idleness. They are to be found
partly in villages, but largely in cities. Such unemployment can be seen and counted
in terms of the number of such persons. Hence, it is called open unemployment. Open
unemployment is to be distinguished from disguised unemployment and
underemployment in the sense that while in the case of former, workers are totally
idle, in the latter two types, they appear to be working and do not seem to be idling
away their time.
3. Educated Unemployment - It is concerned with joblessness among the educated i.e.,
matriculate and higher educated. Of these, there may be some suffering from open
unemployment. There may again be others who are underemployed or belonging to
the category of what we have earlier termed as underemployment. The latter type of
unemployed persons may not be getting work suitable to their qualification to enable
them to make full use of their capacities. Mostly towns and cities are facing this
problem of educated unemployment. Even when a person who is educated/trained and
skilled, fails to obtain a suitable job suited to his qualifications, he is to be educated
unemployed.
4. Cyclical Unemployment - Associated with the downswing and depression phases of
business cycle, is to be found in capitalist or market oriented developed economies.
Caused by the lack of coordination among the innumerable decision-makers in the
fields of savings and investment, the trade cycle, in its downward phase, renders many
persons as unemployed. It is caused by trade cycles at regular intervals. Generally
capitalist economies are subject to trade cycles. The down swing in business activities
results in unemployment. Cyclical unemployment is normally a shot-run
phenomenon.
Cyclical unemployment is the difference between the actual rate of unemployment
and the natural rate of unemployment.

5. Frictional Unemployment -This type of unemployment characterises developed


economies as they push towards further development. At a higher level of
development, many changes take place in the industrial structure of these economies,
with old industries, contracting and dying out, and new industries coming up.
In such a situation, it is necessary that workers move from industry to
industry, leaving those which are decaying and joining those which are leading the
way to further growth and which promise higher wages and rewards. In between the
time of leaving and joining, the time for which the workers get no work, is a period of
unemployment, called frictional unemployment. This period can be used for getting
training and/or acquiring new skills. Such unemployment is, therefore, a necessary
price for progress.
6. Seasonal Unemployment - Seasonal unemployment is the unemployment caused by
seasonal variations in production or demand or both. When the workers engaged in a
particular work or occupation, get employment only for a limited period and remain
idle for the remaining period, it is called seasonal unemployment. It is very common
in Indian agriculture. Agricultural workers in India do not get work throughout the
year. They remain unemployed for about three to four months in a year, unless they
find some temporary employment during this period.
7. Technological Unemployment - Technological unemployment is the unemployment
caused by technical progress; the skills of particular types of worker are made
redundant because of changes in the methods of production, usually by substituting
machines for manual services.
8. Natural Rate of Unemployment - The natural rate of unemployment is the normal
unemployment rate around which the actual unemployment rate fluctuates; the
unemployment rate that arises from the effects of frictional and structural
unemployment.
The natural rate of unemployment is unemployment caused by supply side
factors rather than demand side factors
M.Freidman argued the Natural rate of unemployment would be determined
by institutional factors such as :
i. Availability of job information
ii. Skills and education
iii. Degree of labour mobility
iv. Flexibility of the labour market
v. Hysteresis - A rise in unemployment caused by a recession

NATURE OF UNEMPLOYMENT

Nature of unemployment in India may be summed up as under :

1. Inadequate Work - . One aspect of the problem is the non availability of work to the
extent needed for entire labour-force. For those in disguised unemployment, it means
that they are not getting work to engage themselves fully during their working hours.
If they seem to be working, they are infact sharing the existing work. Actually almost
each one is under-employed, so that none is working to one's full capacity.
Among them, there are some who are only seasonally employed. For rest of
the time, they are either without work or do some other odd jobs or share with others
on some other work. Disguised unemployment account for a major proportion of the
work-force, mostly in agriculture and activities allied to it.
Besides those in disguised unemployment, there are those in open
unemployment. These are the workers who just do not have any work to do. Such
unemployed persons are also found mostly in the rural areas. Their number, taking
both the rural and urban unemployed, though small as against those in disguised
unemployment, is on the increase.
2. Low-Productivity Work - Another aspect of the problem concerns income of those
employed. Most of them are very poor because their earnings are very small, which in
turn, are caused by low-productivity of their work. These poor people are working
because they can hardly afford to remain unemployed and wait for high-paid jobs.
They engage themselves in any work that comes their way and any income, they are
offered. With labour-force increasing and productivity remaining almost the same,
average income remains very small. The reality, however, is that most of such
employed are no better than those totally unemployed, as both the categories of
workers are living at subsistence level.
3. Chronic or Structural - Unemployment in our country is in nature, a chronic/
permanent one, and is rooted in the underdeveloped character of economy. It is the
incapacity of our low-level economy to offer adequate work opportunities to labour-
force that has given rise to this problem. It is, thus, the supply-side of employment-
situation which is at fault. Unless the economy develops and per head capital
increases, the deficient supply-side will continue.

CAUSES OF UNEMPLOYMENT IN INDIA


Important causes of unemployment in India may be summarised as follows -

1. Jobless Growth - Economic growth is usually expected to generate employment.


However, in India, most of the economic growth has been jobless. For 30 years from
1950-51 to 1980-81, GDP growth rate was as low as 3.6 per cent per annum. At this
rate of economic growth, many jobs could not be created. GDP growth accelerated to
5.6 per cent per annum in the 1980s and stayed at this level in the 1990s. At this
higher rate of GDP growth, one would normally expect that many new employment
opportunities would be forthcoming. But this was not to be. During last two decades,
there was a steep decline in employment elasticity in almost all the major sectors.
2. Increase in Labour Force - Over the years, mortality rate has declined rapidly
without a corresponding fall in birth rate and the country has, thus, registered an
unprecedented population growth. This was naturally followed by an equally largle
expansion in labour force. In Indian context, social factors affecting labour supply are
also as much important as demographic factors. Since Independence, education
among women has changed their attitude towards employment. Many of them now
compete with men for jobs in the labour market. The economy has, however, failed to
respond to these challenges and the net result is continuous increase in unemployment
backlog. In rural areas, unemployment has increased mainly in disguised form, in
urban areas it is open and visible.
3. Inappropriate Technology - In India, while capital is a scarce factor, labour is
available in abundant quantity. Under these circumstances, the country should have
labour-intensive techniques of production. However, not only in industries, but also in
agriculture, producers are increasingly substituting capital for labour.
According to W.A. Lewis in his 'Theory of Economic Growth' stated - "In all
those countries where unskilled labour is available in excess supply, great care is
needed in exercising choice in respect of technique because monetary wage fails to
reflect the real cost of labour. Lewis asserts that investment in such a situation in
capital equipments may be profitable to individual capitalists, but it is certainly not
beneficial to the society, because it increases unemployment and not production"
4. Inappropriate Education System - The education system in India is defective. It is,
in fact, the same education system which Macaulay had introduced in this country
during the colonial period. According to Gunnar Myrdal, India's education policy
does not aim at the development of human resources. It merely produces clerks and
lower cadre executives for the Government and private concerns. Myrdal considers all
those who receive merely this kind of education not only as inadequately educated but
also wrongly educated. Any education system which fails to develop human resources
properly, would need drastic changes like unemployment.
5. Neo-liberal Economic Policy - With the introduction of neo-liberal structural reforms
in India, income inequalities have increased. The income inequalities have increased
during the decade of economic reforms. Growing income inequalities generally lead
to demand constraints and unemployment. Hence, neo-liberal economic policy of the
government aggravated the unemployment situation.
6. Underdevelopment - It is stressing that Indian economy, by and large, continues to
be in a state of underdevelopment. The volume of economic activities, determined
largely by agriculture, is low. The non agricultural sector, in particular the modern
industrial sector, which could provide increasing avenues of employment, is growing
at a very slow pace.
The slow capital formation over a long period also inhabited the growth-
potential of activities in agricultural and industrial sector.
Inadequacy of irrigation facilities, shortage of fertilizers and power,
unsatisfactory transport facilities etc., all caused by the slow growth of capital-goods
sector, have adversely affected the expansion rate of work opportunities in
agriculture.
Similarly, the development of industries has also been hindered by the non-
availability of machines, power, transport, essential raw materials, etc.
7. Inadequate Employment Planning - Employment planning in India has not
contributed adequately to the solution of this problem. Employment till recently did
not form an integral part of planning strategy in the sense that this objective was never
quantified as a time bound programme. No consideration was given in the plans for
devising an appropriate wage-rate policy as an instrument of employment expansion
or promotion of labour intensive techniques in a big way.
8. Rapid Population Growth - The rapid growth of population, in particular since
1951, has adversely affected the employment situation largely in two ways. In the first
place, it has directly affected it by making large additions to labour force. The second
consequence of rapid population growth has been to worsen indirectly the
unemployment situation by reducing the resources for capital formation.

The important causes of Unemployment in India are as follows:


1. Rapid growth of population and increase in labour force.
2. Underdevelopment of the economy.
3. Slow growth in the agricultural sector.
4. Defective system of education.
5. Absence of manpower planning.
6. Degeneration of village industries.
7. Inappropriate technology.
8. Slow growth of industrial sector.
9. Immobility of labour.
10. Jobless growth.

CONSEQUENCES OF UNEMPLOYMENT IN INDIA


Unemployment is the root of a number of social and economic problems because when a
person is unemployed or even underemployed, he or she is unable in managing bread and
butter for himself and his family. It causes a bundle of problems. Some of the important
problems are as under:-

1. Poverty - Poverty can be defined as a social phenomenon in which a section of the


society is unable in fulfilling even the basic necessities of life. When a substantial
segment of society is deprived of the minimum level of living and continues at a base
subsistence level, the society is said to be plagued with mass poverty. In India, the
generally accepted definition of poverty is based on the minimum level of living
rather than a reasonable level of living.
The term 'Poverty' is used in two references - Absolute Poverty and
Relative Poverty.
Absolute poverty of a person means that his income is so meagre that he lives
below the minimum subsistence level. He is not in a position to fulfill his basic
necessities. On the other hand, relative poverty means the inequality of income in the
society. In the society, we find that some people are very rich while other persons are
very poor. Form this point of view, we may say that USA is a rich country and India
is a poor country.
Poverty line has been defined in India on the basis of nutrition intake.
According to Indian Planning commission, it is 2400 calories per person per day in
rural areas and 2100 calories per person per day in urban areas. Poverty is the
immediate consequence of unemployment because when a person is unemployed, he
earns nothing and becomes poor. As per the estimates of 1999-2000, 26.1% of the
total population of labour country was living below the poverty line. As per the
estimates of 2004-05, 21.8% of the total population of country was living below the
poverty line.
2. Income Inequalities - Unemployment causes income inequalities also. Indian
economy is beset with gross economic inequalities. There are inequalities in income,
with a very few cornering a very large chunk of total income and very large number
getting a very small proportion. These inequalities are more severe in respect of the
consumption level of the few at the top and the many at the bottom.
3. UnderUtilisation of Resources - An important economic consequence of
unemployment is that a lot of resources available in the country remain under-utilised.
Perhaps it is the reason why India is said to be a rich country, inhabited by the poor.
We have vast natural resources but we are unable in utilising these resources to the
desired extent. We fail to produce what we can and what we should. The single most
important cause responsible for this situation is unemployment and underemployment.
4. Social Problems - Unemployment is the mother of a number of social problems,
mainly because of two reasons: firstly, an unemployed person has nothing to do. He
has no work to engage with. This situation causes dispute, misunderstanding, quarrels,
etc. Secondly, an unemployed person has no source of income. In most of the cases,
such persons fail to provide required food, clothes, shelter, medicines, etc for
themselves and their family. It compels them to do what they do not like to do and
should not do. It causes the crimes of theft, dacoity, robbery etc.

SUGGESTED REMEDIAL MEASURES


1. Expanding Volume of Work - Foremost solution to the problem of unemployment
lies in enlarging the opportunities for work. This needs to be done to clear the backlog
of unemployment and to provide jobs to the large additions being made to labour-
force. The work to be expanded has to be both in the sphere of wage-employment and
self-employment.
2. Raising Capital Formation - It is also necessary that the accumulation of capital is
stepped up. It helps employment expansion in two principal ways:
One, it becomes possible to maintain the existing activities, as also to expand
the current activities and to set up new ones. An increase in agricultural production
depends much upon new irrigation facilities, more implements, etc. In the same way,
setting up of industrial and service activities requires capital assets as buildings,
machinery, etc.
Secondly, capital formation directly generates employment in capital goods
sector. The production of 'mother machines' i.e., the machines which produce
machines, give rise to employment. This also provides capital goods for the
production for consumer goods and services.
Thirdly, a rise in capital formation will add to the capital stock of country.
This will, by raising capital per worker, increase substantially the productivity of
labour and raise the income of those who work.
3. Appropriate Mix of Production Techniques - . It is also necessary to choose such a
combination of capital-intensive and labour-intensive technologies of production as
may generate maximum employment.
4. Special Employment Programmes - it is necessary, as an interim measure, to
undertake special employment programmes. Different types of people for whom
special employment programmes are needed, are landless agricultural labourers,
marginal farmers, village artisans, tribal people living in the remote areas of country
as also the people living in the hilly areas. Specific employment programmes have to
be such as suit specific group of people and specific areas. These programmes may be
in the form of direct employment as rural capital works, or in the form of providing
assets like animals, sewing machines, hand/power driven looms etc., or these may be
in the form of the supply of infrastructural facilities like marketing, credit etc. to help
them.
5. Manpower Planning

MINIMUM SUPPORT PRICE

1. Minimum Support Price (MSP) is a form of market intervention by the Government


of India to insure agricultural producers against any sharp fall in farm prices - a
guarantee price to save farmers from distress sale.
2. Minimum Support Price is the price at which government purchases crops from the
farmers, whatever may be the price for the crops. Minimum Support Price is an
important part of Indias agricultural price policy.
3. The MSPs are announced at the beginning of the sowing season for certain crops on
the basis of the recommendations of the Commission for Agriculture costs and prices
(CACO,1985).
4. The Cabinet Committee on Economic Affairs (CCEA), Government of India,
determines the Minimum Support Prices (MSP) of various agricultural commodities
in India based on the recommendations of the Commission for Agricultural Cost and
Prices (CACP).
5. The major objectives are to support the farmers from distress sales and to procure
food grains for public distribution.
6. In case the market price for the commodity falls below the announced minimum price
due to bumper production and glut in the market, government agencies purchase the
entire quantity offered by the farmers at the announced minimum price.
7. In the absence of such a guaranteed price, there is a concern that farmers may shift to
other crops causing shortage in these commodities.
8. The MSPs are fixed at incentive level, to fulfil the following purposes :
a) to induce more investment by the farmers in the farm sector
b) to motivate farmers to adopt improved crop production technologies and
c) to enhance production and thereby farmers income.

Determination of MSP

In formulating the recommendations in respect of the level of minimum support prices and
other non-price measures, the Commission takes into account, apart from a comprehensive
view of the entire structure of the economy of a particular commodity or group of
commodities, the following factors:-

1. Cost of production
2. Changes in input prices
3. Input-output price parity
4. Trends in market prices
5. Demand and supply
6. Inter-crop price parity
7. Effect on industrial cost structure
8. Effect on cost of living
9. Effect on general price level
10. International price situation
11. Parity between prices paid and prices received by the farmers.
12. Effect on issue prices and implications for subsidy

The Commission makes use of both micro-level data and aggregates at the level of district,
state and the country. The information/data used by the Commission, inter-alia include the
following :-

1. Cost of cultivation per hectare and structure of costs in various regions of the country
and changes there in;
2. Cost of production per quintal in various regions of the country and changes therein;
3. Prices of various inputs and changes therein;
4. Market prices of products and changes therein;
5. Prices of commodities sold by the farmers and of those purchased by them and
changes therein;
6. Supply related information - area, yield and production, imports, exports and domestic
availability and stocks with the Government/public agencies or industry
7. Demand related information - total and per capita consumption, trends and capacity of
the processing industry;
8. Prices in the international market and changes therein, demand and supply situation in
the world market;
9. Prices of the derivatives of the farm products such as sugar, jaggery, jute goods,
edible/non-edible oils and cotton yarn and changes therein;
10. Cost of processing of agricultural products and changes therein;
11. Cost of marketing - storage, transportation, processing, marketing services, taxes/fees
and margins retained by market functionaries; and
12. Macro-economic variables such as general level of prices, consumer price indices and
those reflecting monetary and fiscal factors.

MARKET INTERVENTION SCHEME


1. The market intervention scheme (MIS) is similar to MSP which is implemented on
the request of state governments for procurement of perishable and horticultural
commodities in the event of fall in market price.
2. The scheme is implemented when there is at least 10 percent increase in production
or 10 percent decrease in the ruling rates over the previous normal year.
3. Proposal of MIS is approves on the specific request of State/UT governments if the
State/UT governments is ready to bear 50 percent loss incurred on its implementation.

PROCUREMENT PRICES

1. The MSP is announced before sowing, while the procurement price was announced
before harvesting - the purpose is to encourage the farmers to sell a bit more and get
encouraged to produce more.
2. FCI, the nodal central agency of Government of India, along with other State
Agencies undertakes procurement of wheat and paddy under price support scheme .
Coarse grains are procured by State Government Agencies for Central Pool as per the
direction issued by Government of India on time to time. The procurement under
Price Support is taken up mainly to ensure remunerative prices to the farmers for their
produce which works as an incentive for achieving better production.
3. Before the harvest during each Rabi / Kharif Crop season, the Government of India
announces the minimum support prices (MSP) for procurement on the basis of the
recommendation of the Commission of Agricultural Costs and Prices (CACP) which
along with other factors, takes into consideration the cost of various agricultural
inputs and the reasonable margin for the farmers for their produce.

ISSUE PRICE

GREEN REVOLUTION

It is the introduction of new techniques of agriculture which became popular by the name of
Green Revolution in early 1960s at first for wheat and by the next decade for rice, too. It
revolutionised the very traditional idea of food production by giving a boost by more than
25o per cent to the productivity level. The Green revolution was centred around the use of the
high yielding variety (HYV) of seeds developed by the US agro-scientist Norman Borlaug.
The new wheat seeds which he developed in vivo claimed to increase its productivity by
more than 200 per cent.

In India, in 1960-61 a new technology was tried as a pilot project in seven districts
and was called Intensive Agricultural District Programme (IADP). Later, the High yielding
varieties programme was also added and the strategy was extended to cover the entire
country. This strategy has been called for various name : modern agricultural technology,
seed-fertiliser-water technology or simply green revolution.

COMPONENTS OF THE GREEN REVOLUTION

The Green Revolution was based on the timely and adequate supply of many
inputs/components.

1. The HYV Seeds


They were popularly called the 'dwarf' variety of seeds with the help of repeated
mutations. These seeds were non-photosynthetic, hence non-dependent on sun rays
for targeted yields.
2. Chemical Fertilizers
The seeds were to increase productivity provided they got sufficient levels of nutrients
from the land. The level of nutrients they required could not be supplied with the
traditional compostes because they have low concentration of nurients content and
required bigger area while sowing - it meant it will be shared by more than on eseed.
That is why a high concentration fertilizer was required which could be given to the
targeted seed only - the only option was the chemical fertilizers -urea (N),
phosphate(P),and potash(k).
3. The Irrigation
For controlled growth of crops and adequate dilution of fertilizers, a controlled means
of water supply was required. It was important compulsions - firstly the area of such
crops should be at least free of flooding and secondly, artificial water supply should
be developed.
4. Chemical pesticides and Germicides
As the new seeds were new and non-acclimatised to local pests, germs an diseases
than the established indigenous varieties, use of pesticides and germicides became
compulsory for result oriented and secured yields.
5. Chemical Herbicides and Weedicides
To prevent costlier inputs of fertilisers not being consumed by the herbs and the
weeds on the farmlands, herbicides and weedicides were used while sowing the HYV
seeds.
6. Credit, storage, marketing/distribution
For farmers to be capable of using the new and the costlier inputs of the green
revolution, availability of easy and cheaper credit was a must. As the farmlands
suitable for this new kind of farming was region-specific (as it was only Haryana,
punjab and western uttar pradesh in India) storage of the harvested crops was to be
done in the region itself till they were distributed throughout the country.
IMPACT OF THE GREEN REVOLUTION
The green revolution had its positive as well as negative socio-economic and
ecological impacts on the countries around the world.

1. Socio-economic Impact
Food production increased in such a way that many countries became self-sufficient
and some even emerged as food exporting countries. But the discrepancy in farmers'
income, it brought with itself increased and inter-personal as well as inter-regional
disparities/inequalities in India. Rise in the incidence of malaria due to water-logging,
a swing in the balanced cropping patterns in favour of wheat and rice etc., were
negative impacts.
2. Ecological Impact
The most devastating negative impact of the Green Revolution was the ecological
one.
i. Critical Ecological Crisis - On the basis of on-field studies it was found that
critical ecological crisis in the Green Revolution region are showing up -
a) Soil fertility being degraded (due to the repetitive kind of cropping
pattern being followed by the farmers as well as the excessive
exploitation of the land; lack of a suitable crop combination and the
crop intensity etc.)
b) Water table falling down (as the new HYV seeds required
comparatively very high amount of water for irrigation - 5 tonnes of
water needed to produce 1 kg of rice.
c) Environment degradation - due to excessive and uncontrolled use of
chemical fertilizers, pesticides and herbicides have degraded the
environment by increasing pollution levels in land, water and air. In
India it is more due to deforestation and extension of cultivation in
ecologically fragile areas. At the same time, there is an excessive
pressure of animals on forests - mainly by goats and sheeps).
ii. Toxic Level in Food chain - Toxic level in the food chain of India increased
to such a high level that nothing produced in India is fit for human
consumption. Basically, unbridled use of chemical pesticides and weedicides
and their industrial production combined together had polluted the land, water
and air to such an alarmingly high level that the whole food chain had been a
prey of high toxicity.

FOREX RESERVES

The total foreign currencies of different countries an possess at a point of time is its 'roeign
currency assets/reserves'. The forex reserves of an economy is its 'foreign currency assets'
added with its gold reserves, SDRs (Special Drawing rights) and Reserve Trenche in the IMF.

Thus, in a nutshell, Foreign Exchange Reserves include-


1. Reserves held in US Dollars, The Euro, The British Pound or the Japanese Yen
2. Foreign bank notes, foreign bank deposits, foreign treasury bills and short term and
long term foreign government securities
3. Gold reserves
4. Special Drawing Rights and International Monetary Fund reserve positions

THE FOREIGN EXCHANGE RESERVES OF INDIA CONSIST OF BELOW FOUR

CATEGORIES.

Foreign Currency Assets


Foreign currency assets expressed in US dollar terms include the effect of
appreciation/depreciation of non-US currencies (such as Euro, Sterling, Yen) held in
reserves.
Gold Reserves
The Reserve Bank holds 557.77 tonnes of gold; of which, 265.49 tonnes are held overseas in
safe custody with the Bank of England and the Bank for International Settlements (BIS).
Gold as a share of the total foreign exchange reserves in value terms (USD) stood at about 5.6
per cent as at end-March, 2016.
Special Drawing Rights
Special Drawing Rights (SDRs) are supplementary foreign exchange reserve assets defined
and maintained by the International Monetary Fund. It was created in 1969 to supplement a
shortfall of preferred foreign exchange reserve assets, namely gold and the US dollar, the
SDR's value is defined by a weighted currency basket of four major currencies: the Euro, the
US dollar, the British pound, and the Japanese yen Currently, the value of one SDR is equal
to the sum of 0.423 Euros, 12.1 Yen, 0.111 pounds, and 0.66 US Dollars. This basket is
reevaluated every five years, and the currencies included as well as the weights given to them
can then change.
Reserve Tranche Position
The primary means of financing the International Monetary Fund is through members'
quotas. Each member of the IMF is assigned a quota, part of which is payable in SDRs or
specified usable currencies ("reserve assets"), and part in the member's own currency. The
difference between a member's quota and the IMF's holdings of its currency is a country's
Reserve Tranche Position (RTP).Reserve Tranche Position is accounted among a country's
Foreign Exchange Reserves.

INTERNATIONAL FINANCIAL INSTITUTIONS : THE IMF AND THE WORLD


BANK
Toward the end of the Second World War, in July 1944, representatives of the United States,
Great Britain, France, Russia, and 40 other countries met at Bretton Woods, a resort in New
Hampshire, to lay the foundation for the post-war international financial order. Such a new
system, they hoped, would prevent another worldwide economic cataclysm like the Great
Depression that had destabilized Europe and the United States in the 1930s and had
contributed to the rise of Fascism and the war.
Therefore, the United Nations Monetary and Financial Conference, as the Bretton Woods
conference was officially called, created the International Monetary Fund (the IMF) and the
World Bank to prevent economic crises and to rebuild economies shattered by the war.

WORLD BANK

The World Bank (WB) Group today consists of five closely associated institutions
propitiating the role of development in the member nations in different areas. The World
Bank is like a cooperative, made up of 189 member countries. These member countries, or
shareholders, are represented by a Board of Governors, who are the ultimate policymakers at
the World Bank. The term World Bank generally refers to the IBRD and IDA, whereas the
World Bank Group is used to refer to the institutions collectively.

1. IBRD
The mission statement of the IBRD states that it "aims to reduce
poverty in middle-income and creditworthy poorer countries by
promoting sustainable development, through loans, guarantees, and
non-lending-including analytical and advisory-services."
The International Bank for Reconstruction and Development is the
oldest of the WB institutions which started functioning (1945) in the
area of reconstruction of the war-ravaged regions (world war II) and
later for the development of the middle income and credit worthy
poorer economies of the world.
Human development was the main focus of the developmental lending
with a very low interest rate (1.55 per cent per annum) - the areas of
focus being agriculture, irrigation, urban development, health care,
family welfare, dairy development etc. It commenced lending for India
in 1949.

Supports long-term human and social development that private


creditors do not finance
Preserves borrowers' financial strength by providing support in times
of crisis, when poor people are most adversely affected
Promotes key policy and institutional reforms (such as safety net or
anti-corruption reforms)
Creates a favorable investment climate to catalyze the provision of
private capital
Facilitates access to financial markets often at more favorable terms
than members can achieve on their own
India's borrowing from IBRD - Fiscal 2016 is 2820 Millions next to
peru 2850 Millions.
2. IDA (A world Bank Group, The world bank's fund for the poorest)
The International Development Agency (IDA) which is also known as
the soft window of the WB was set up in 1960 with the basic aim of
developing infrastructural support among the member nations, long
term lending for the development of economic services.
Its loans, known as credits are extended mainly to economies with the
less than 895 dollars per capita income.
The credits are for a period of 35-40 years, interest free, except for a
small charge to cover administrative costs.
Repayment begins after a 10 year grace period.
3. IFC
The international finance corporation (IFC) was set up in 1956 which is also
known as the private arm of the WB.
It lends money to private sector companies of its member nations.
The interest rate charged is commercial but comparatively low.
It finances and provides for private-public ventures and projects in partnership
with private investors and, through its advisory work, helps governments of
the member nations to create conditions that stimulate the flow of both
domestic and foreign private savings and investment.
It focuses on promoting economic development by encouraging the growth of
productive enterprises and efficient capital markets in its member countries.
it participates in an investment only when it can make a special contribution
that complements the role of market investors (as a foreign financial
investor(FFI).
It also plays a catalytic role, stimulating and mobilising private investment in
the developing world by demonstrating that investments there too can be
preferable.

4. MIGA

The Multilateral Investment Guarantee Agency set up in 1988 encourages foreign


investment in developing economies by offering insurance (guarantees) to foreign
private investors against loss caused by non-commercial (i.e., political) risks, such as
currency transfer, expropriation, war and civil disturbance.
It also provides technical assistance to help countries disseminate information on
investment oppurtunities.

5. ICSID

The International Centre for Settlement of Investment Disputes set up in 1966 is an


investment dispute settlement body whose decisions are binding on the parties.
It was established under the 1966 Convention on Settlement of Investment
Disputes between states and nationals of other states. Though recourse to the
centre is voluntary, but once parties have agreed to arbitration, they cannot withdraw
their consent unilaterally.
The ICSID Convention is a multilateral treaty formulated by the Executive Directors
of the World Bank to further the Banks objective of promoting international
investment.
ICSID is an independent, depoliticized and effective dispute-settlement institution.
Its availability to investors and States helps to promote international investment by
providing confidence in the dispute resolution process.
It is also available for state-state disputes under investment treaties and free trade
agreements, and as an administrative registry.
ICSID provides for settlement of disputes by conciliation, arbitration or fact-finding.
It settles the investment disputes arising between the investing foreign companies and
the host countries where the investments have been done.
India is not its member. It is believed that being signatory to it encourages the foreign
investment flows into an economy, but risks independent sovereign decisions, too.
The World Bank established ICSID in 1966 to encourage both investors and
governments to undertake and receive foreign direct investment by providing a
neutral dispute resolution system. The ICSID provides arbitration services, which are
entered into on a voluntary basis, but once two parties agree to submit issue resolution
to ICSID, they are required to follow ICSID procedures until the verdict is rendered.
Furthermore, all member countries of ICSID are bound to recognize and enforce the
rulings that are made.

IMF

1. IMF and World Bank are popularly called the Bretton Woods' twins.
2. The International Monetary Fund (IMF) came up in 1944 whose Article came into
force on the December 27, 1945 with the main functions as
exchange rate regulation,
purchasing short term foreign currency liabilities of the member nations from
around the world,
allotting special drawing rights (SDRs) to the member nations and
the most important one as the bailor to the member economies in the function
of any BoP crisis.
3. The Main functions of the IMF are as given below :
to facilitate international monetary cooperation
to promote exchange rate stability and orderly exchange arrangements
to assist in the establishment of a multilateral system of payments and the
elimination of foreign exchange restrictions; and
to assist member countries by temporarily providing financial resources to
correct mal-adjustment in their balance of payments. (BoPs).
4. The Board of Governors of the IMF consists of one governor and one alternate
Governor from each member country. For India, Finance Minister is the ex-officio
governor while the RBI governor is the alternate governor on the board.

In simpler terms, the goals are to:


1) Facilitate the cooperation of countries on monetary policy, including providing
the necessary resources for both consultation and the establishment of
monetary policy in order to minimize the effects of international financial
crises.
2) Assist the liberalization of international trade by helping countries increase
their real incomes while lowering unemployment.
3) Help stabilize exchange rates between countries. Especially after the global
depression of the 1930s, it was considered vital to establish currencies that
could hold their value, serve as mediums of international exchange, and resist
any speculative attacks.
4) Maintain a multilateral system of payments that eliminates foreign exchange
restrictions. Countries are thus free to trade with each other without worrying
about the effects of interest rates and currency depreciation on their payments.
5) Provide a safeguard to members of the IMF against balance of payments
crises, i.e., when governments cannot balance the money they have with the
money they owe to other countries. IMF members can have the confidence to
adjust the imbalances in their national accounts without resorting to painful
measures that would hamper their prosperity, such as devaluing their currency
in relation to other countries'.
6) Try to reduce the effects of volatility in countries' balance of payments
accounts, the IMF helps assure that global trade and financial relationships can
continue at a steady rate without the risks of global depressions like that of the
1930s.
CONSUMER PRICE INDEX

Other than the WPI, India also calculates inflation at the consumer level, similar to all the
economies of the world. Depending upon the socio-economic differentiations among
consumers, India has four differing sets of CPI with some differentials in the basket of
commodities allotted to them.

At the national level, there are four Consumer Price Index (CPI) numbers. These are:
CPI for Industrial Workers (IW), CPI for Agricultural Labourers (AL), CPI for Rural
Labourers (RL) and CPI for Urban Non-Manual Employees (UNME). The base years of the
current series of CPI(IW), CPI(AL) and CPI(RL), and CPI(UNME) are 1982, 1986-87 and
1984-85, respectively. While the first three are compiled and released by the Labour Bureau
in the Ministry of Labour, the fourth one is released by the Central Statistical Organisation in
the Ministry of Statistics and Programme Implementation.

CPI-IW - The Consumer Price Index Numbers for Industrial Workers on base 1960=100 (old
series) was compiled for Industrial Workers relating to factories, mines and plantations. But
for the subsequent series of Index Numbers on base 1982=100 and 2001=100 the coverage of
the Industrial Workers were increased to seven sectors viz. (a) factories, b) mines, c)
plantations, d) railways, e) public motor transport undertakings, f) electricity generation and
distribution establishments, and g) ports and docks. A Working Class Family is defined as
one where one of the members worked as manual worker in one of the 7 sectors as listed
above and which derived one half or more of its income through manual work.

The current series of Consumer Price Index on base 2001=100 is compiled for 78 selected
centres in the country. The All-India Consumer Price Index for Industrial Workers is the
weighted average of these 78 centre indices. These centres have been selected on the basis of
industrial importance in the country in the first instance and then distributed among different
states in proportion to the industrial employment in the state subject to maximum allotment of
5 centres in a state to a sector.

Uses of CPI-IW:

I. The CPI (IW) indices are mainly used for regulation of Dearness allowance and
Wages of millions of Workers and Employees belonging to Central Government,
State Governments, Public and Private sector Establishments in the country.
II. CPI-IW serves as an indicator of retail price situation in the country. The rate of
inflation based on retail prices is measured through these indices.
III. These are also used for real wage calculation i.e. as deflators of money wages.
IV. These indices are used for determining the poverty line in the country.
V. These indices are also used for price adjustments in Business, Individual and Public
Works contracts.
VI. The interest rates charged by Banks and other financial institutions undergo changes
on the basis of inflation rates depicted by these indices
VII. These indices help in the formulation of General Economic Policy of the Government
particularly with reference to wages, prices and taxation.

All India General Index Numbers for Agricultural and Rural Labourers on base 1986-87
(General Index)

Description January 2017 February 2017 March 2017


Agricultural 870 869 866
Labourers
Rural Labourers 876 874 872

Wholesale Price Index (WPI) is based on the price prevailing in the wholesale markets or
the price at which bulk transactions are made.

Consumer Price Index (CPI) is based on the final prices of goods at the retail level. Both
these indices are the weighted averages of prices of a specified set of goods and services.
1. Data on Wholesale Price Index (WPI) is available every week, while data on
Consumer Price Index (CPI) is only available every month, so there is a time lag in
CPI data availability compared to WPI data availability, which can impact decision
making both for RBI and the Government of India, as the previous answer states.
2. In India, we do not have one CPI calculated per se. Earlier, there were 4 CPIs
calculated for 4 different sets of workers, and now we have three such CPIs, out of
which the most famous is CPI for Industrial Workers (CPI-IW). The others used
currently are CPI for agricultural laborers and CPI for rural laborers.
The argument used therefore is that there is no one CPI value which can be used for decision
making by either RBI or the Government of India.
1. According to our policy makers/decision makers at RBI and elsewhere, or so it seems,
WPI has a broader coverage compared to all the CPIs, in terms of the commodities
covered, quotations, larger number of non-agricultural products and tradeable items,
which are missing in the CPIs.
Also, interest rates which the RBI controls may not have much of a correlation with high
food prices and therefore decision makers may feel that since they cant target inflation
across major sections constituting the CPI, they would rather focus on WPI constituted of
goods on whose demand interest rates may have a more significant impact.
1. WPI is calculated on an all India basis, while CPI is calculated for specific centres in
India and then this is aggregated to an all India index.
Why CPI is better than WPI?
Conceptually, retail inflationprice rise driven by potential consumer demand and
available supplyis a better indicator of inflation for guiding monetary policy
decisions than WPI inflation.
WPI excludes prices of services such as education, healthcare, and rents. However,
services now account for nearly 60 per cent of GDP and a vast majority of these
services are not traded with other countries. Conversely, the new CPI measure assigns
nearly 36% weightage on services and includes price changes in housing, education,
healthcare, transport and communication, personal care and entertainment
WPI assigns nearly 15% and 10.7% weightage for the fuel group and metal and metal
products group, respectively.Any sharp movements in international prices of fuels and
metals, therefore, lead to sharp changes in WPI.CPI shows the consumer trends of the
common man
The consumer price index for the industrial workers (CPI-IW) has 260 items in its
basket with 2001 as the base year (the first base year was 1958-59). The data is collected
at 76 centres with one month's frequency and the index has a time lag of one month.
Basically, this index specifies the government employees (other than banks and
embassies personnel). The wages/salaries of the central governement employees are
revised on the basis of the changes occuring in this index, the dearness allowance (DA)
is announced twice a year. When the Pay Commission recommends pay revisions, the
base is the CPI -IW.

CPI-UNME

1. The consumer for index for the urban Non-manual employees has 1984-85 as the base
year and 146-365 commodities in the basket for which data is collected at 59 centres
in the country - data collection frequency is monthly with two weeks' time lag.
2. This price index has limited use and is basically used for determining dearness
allowances of employees of some foreign companies operating in India (i.e., airlines,
communications, banking, insurance, embassies and other financial services).
3. It is also uses under the Income Tax Act to determine capital gains and by the CSO
for deflating selected service sector's contribution to the GDP at factor cost and
current prices to calculate the corresponding figure at constant prices.
4. Presently, on the advice of its governing council, the NSSO is conducting a Family
Living Survey (FLS) to obtain the present consumption pattern of urban non-manual
employees for shifting the present base of CPI-UNME. The CSO is also examining
the possibility of constructing a consumer price index for the urban employees.
5. An urban non-manual employee is defined as one who derives 50 per cent or more of
his or her income from gainful employment on non-manual work in the urban non-
agricultural sector. The current CPI(UNME) series with base 1984-85, introduced in
November 1987, derives the weighting pattern from the family living survey
conducted during 1982-83 in 59 selected urban centres.

CPI-AL

1. The consumer price index for Agricultural labourers has 1986-87 as its base year with
260 commodities in its basket. The data is collected in 600 villages with a monthly
frequency and has three weeks time lag.
2. This index is used for revising minimum wages for agricultural labourers in different
states. As the consumption pattern of agricultural labourers has changed since 1986-
87( its base year), the Labour Bureau proposes to revise the existing base year of this
index. For the revision, the consumer expenditure data collected by the NSSO durinf
its 61st NSS Round 2004-2005 us proposed to be used.

CPI-RL

1. CPI-RL takes 1983 as the base year, data is collected at 600 villages on monthlt
frequency with three weeks time lag, its basket contains 260 commodities.
2. The agricultural and rural labourers in India create an overlap, i.e., the same labourers
work as the rural labourers once the farm sector has either low or no employment
scope. Probably, due to this reason this index was dropped by the government in
2001-02 but was revised again after the new government.

CPI AL/RL

1. A person is treated as an agricultural labourer if he or she follows one or more of the


agricultural occupations in the capacity of a labourer on hire, whether paid in cash or
kind or partly in cash and partly in kind. A rural labourer is defined as one who does
manual work in rural areas in agricultural and non-agricultural occupations in return
for wages in cash or kind, or partly in cash and partly in kind.
2. The source of weights for the current series of CPI(AL) and CPI(RL), with base 1986-
87, released since November 1995, is consumption expenditure data collected during
the NSS 38th Round of Consumer Expenditure Survey, 1983. For the purpose of
collection of consumer expenditure data for deriving weighting diagrams for
CPI(AL/RL) as a part of general consumer expenditure survey of NSSO, the rural
labour household is defined as one which derives its major income during the last 365
days from wage paid manual employment (rural labour), vis--vis wage paid non-
manual employment as also self-employment. From amongst the rural labour
households, those households which earn 50% or more of their total income (from
gainful occupation) during the last 365 days from wage paid manual labour in
agriculture are categorised as Agricultural Labour Households.
WTO
On 1 January 1995, the WTO replaced GATT, which had been in existence since 1947, as the
organization overseeing the multilateral trading system. The governments that had signed
GATT were officially known as GATT contracting parties. Upon signing the new WTO
agreements (which include the updated GATT, known as GATT 1994), they officially
became known as WTO members.

The list below is historical. It contains the 128 GATT signatories as at the end of 1994,
together with the dates they signed the agreement.

WTO AND INDIA

India is a founder member of both GATT and WTO. The WTO provides a rule based,
transparent and predictable multilateral trading system. The WTO rules envisage non-
discrimination in the form of National Treatment and Most Favoured Nation (MFN)
treatment to India's exports in the markets of other WTO members. National Treatment
ensures that India's products once imported into the territory of other WTO members would
not be discriminated vis-a-vis the domestic products in those countries. MFN treatment
principle ensures that members do not discriminate among various WTO members. If a
member country believes that the due benefits are not accruing to it because of trade meaures
by another WTO member, which are violative of WTO rules and discipline, it may file a
dispute under the Dispute Settlement Mechanism (DSM) of the WTO. There are also
contingency provisions built into WTO rules, enabling member countries to take care of
exigencies like balance of payment problems and situations like a surge in imports. In case of
unfair trade practices causing injury to the domestic producers, there are provisions to impose
Anti-Dumping or Countervailing duties as provided for in the Anti-Dumping Agreement and
the Subsidies and Countervailing Measures Agreement.

WTO MINISTERIAL CONFERENCES

The highest decision making body of the WTO is the Ministerial conference, which has to
meet at least once every two years. The ministerial conference can take decisions on all
matters under any of the multilateral trade agreements.

THE AGRICULTURE AGREEMENT - WTO - AGREEMENT ON AGRICULTURE

The objective of the Agriculture Agreement is to reform trade in the sector and to
make policies more market-oriented. This would improve predictability and security
for importing and exporting countries alike.
AA's goal was to provide a framework for the leading members of the WTO to make
changes in their domestic farm policies to facilitate more open trade.
The Agreement on Agriculture forms a part of the Final Act of the Uruguay Round of
Multilateral Trade Negotiations, which was signed by the member countries in April
1994 at Marrakesh, Morocco and came into force on 1st January, 1995. The WTO
Agreement on Agriculture together with individual countrys commitments to reduce
export subsidies, domestic support and import duties on agricultural products are
significant steps towards reforming agricultural trade between countries.
The core objective of AoA is to establish a fair and market oriented agricultural
trading system. Its implementation period was six years for developed countries and
nine for developing countries, starting with the date the agreement on Agriculture
came into effect January 1, 1995. The least developed countries are not required to
make any reductions.

THREE PILLARS

The Agreement is made up of three pillars: market access, export competition and domestic
support. All WTO members, except least developed countries (LDCs), were required to make
commitments in all these areas in order to liberalise agricultural trade. As can be seen in the
box below, developing countries were given a limited element of special and differential
treatment (S&DT).

The new rules and commitments apply to:

market access various trade restrictions confronting imports


domestic support subsidies and other programmes, including those that raise
or guarantee farmgate prices and farmers incomes
export subsidies and other methods used to make exports artificially competitive.

The agreement does allow governments to support their rural economies, but preferably
through policies that cause less distortion to trade. It also allows some flexibility in the way
commitments are implemented. Developing countries do not have to cut their subsidies or
lower their tariffs as much as developed countries, and they are given extra time to complete
their obligations. Least-developed countries dont have to do this at all. Special provisions
deal with the interests of countries that rely on imports for their food supplies, and the
concerns of least-developed economies.

Components of AoA

Developed Countries Developing Countries


6 years : 1995- 2000 10 years : 1995-2004
Market access
Average tariff cut for all -36% -24%
agricultural products
Minimum cut per product -15% -10%
Domestic Support
Total AMS cuts for sector -20% -13%
(base period - 1986-88)
Exports
Value of subsidies -36% -24%
Subsidised quantities (base -21% -14%
period 1986-90

Least developed countries do not have to make commitments to reduce tariffs or subsidies.

MARKET ACCESS (articles 4 and 5 and annex 5).

Market access includes

1. Tariffication,

2. Tariff reduction

3. Access opportunities.

AoA prohibited the use of non-tariff-barriers (NTBs) like quotas and import restrictions for
agricultural products and introduced Tariffication. Tariffication required that all NTBs on
the import of an agricultural product would have to be replaced by a single bound tariff rate
so that the resulting protection would be equivalent to the nominal protection in the base
period. No country was allowed to increase tariff rates beyond the bound rate. Tariffication
led to the concern that it could result in high bound tariffs which, if applied, could be
prohibitive for any trade to take place. This gave rise to the concept of 'minimum market
access', whereby access WTO members were required to maintain current import access
opportunities at a certain minimum level. This was achieved through the tariff rate quota
(TRQ), which is a two-level tariff with the rate, charged depending on the volume of imports.
A lower tariff is charged on imports to ensure minimum market access or the quota volume; a
higher tariff is charged on imports in excess of the quota volume. By 2002, almost all
quantitative restrictions on agricultural imports had been abolished. Under normal
circumstances, an imported product is expected to have free entry into the importing country.
However, a member is allowed to impose a tariff i.e., customs duty on the imported product
at the time when it enters the importing country. Tariffs usually serve the purpose of getting
revenue for the government and in the case of developing counties it forms an important
source of income. Tariffs are used for the protection of the local industry by making domestic
products cheaper for a developing country, protecting its domestic produce and farmers. In
agriculture, 100 percent of products now have bound tariffs.

The most important commitments are:

Developed and developing countries to convert all non-tariff barriers into simple tariffs (a
process known as tariffication).

All tariffs to be bound (i.e. cannot be increased above a certain limit).

Developed countries to reduce import tariffs by 36% (across the board) over a six year
period with a minimum 15% tariff reduction for any one product.

Developing countries to reduce import tariffs by 24% (across the board) over a ten year
period with a minimum 10% tariff reduction for any one product.
EXPORT COMPETITION (articles 8,9,10 and 11).

The export subsidy discipline requires that export subsidies be subjected to reduction and
limiting both in value and quantity. It establishes ceiling on the value as well as volume of
subsidized exports. Limits are determined on the basis of the support extended during 1986-
88 annual average The commitments are:

For developed countries, the value and volume of export subsidies to be reduced by 36%
and 24% respectively from the base period 1986- 1990 over a six year period.

For developing countries, the value and volume of export subsidies to be reduced by 24%
and 10% respectively from the base period 1986- 1990 over a ten year period.

DOMESTIC SUPPORT (article 6 and annexes 2, 3 and 4).

All forms of domestic support are subject to rules. The WTO classifies domestic subsidies
into three categories known as the Amber, Blue and Green Boxes (see Box 2). Only the
Amber Box is subject to reduction commitments as follows:

For developed countries, a 20% reduction in Total AMS (Amber Box) over six years
commencing 1995 from a base period 1986-1988.

For developing countries, a 13% reduction in Total AMS (Amber Box) over ten years
commencing 1995 from a base period 1986-1988

DIFFERENT BOXES (DOMESTIC SUPPORT) - WTO DOMESTIC SUBSIDY


BOXES

The agricultural subsidies, in the WTO terminology have in general been identified by 'boxes'
which have been given the colours of the traffic lights -

green box (means permitted)


amber box (means slow down i.e., to be reduced)
red box (means forbidden)

The WTO provisions on agriculture has nothing like red box subsidies, although subsidies
exceeding the reduction commitment levels is prohibited in the 'amber box' . The 'blue box'
subsidies are tied to programmes that limit the level of production. There is also a provision
of some exemption for the developing countries sometimes called the 'S&D box'.1

1
article 6.2, AoA, WTO, 1994 - In accordance with the Mid-Term Review Agreement that government measures
of assistance, whether direct or indirect, to encourage agricultural and rural development are an integral part of
the development programmes of developing countries, investment subsidies which are generally available to
agriculture in developing country Members and agricultural input subsidies generally available to low-income or
resource-poor producers in developing country Members shall be exempt from domestic support reduction
commitments that would otherwise be applicable to such measures, as shall domestic support to producers in
developing country Members to encourage diversification from growing illicit narcotic crops. Domestic support
meeting the criteria of this paragraph shall not be required to be included in a Members calculation of its
Current Total AMS.
AMBER BOX

All subsidies which are supposed to distort production and trade fall into the amber box, ie.,
all the agricultural subsidies except those which fall into the blue and green boxes.2 These
include government policies of minimum support prices (as MSP in India) for agricultural
products or any help directly related to production quantities ( a power, fertilisers, pesticides,
irrigation, etc).

Under the WTO provisions, these subsidies are subject to reduction commitment to
their minimum level - to 5 percent and 10 percent for the developed and the developing
countries, respectively, of their total value of agricultural outputs, per annum accordingly. It
means, the subsidies directly related to production promotion above the allowed level
(which fall in either the blue box or green box) must be reduced by the countries to the
prescribed levels.

Amber Box: all domestic subsidies such as market price support - that are considered to
distort production and trade. Subsidies in this category are expressed in terms of a Total
Aggregate Measurement of Support (Total AMS) which includes all supports in one single
figure. Amber Box subsidies are subject to WTO reduction commitments.

DE-MINIMIS PROVISION

Under this provision developed countries are allowed to maintain trade distorting subsidies or
Amber box subsidies to level of 5% of total value of agricultural output. For developing
countries this figure was 10%. So far Indias subsidies are below this limit, but it is growing
consistently. This is because MSP are always revised upward whereas Market Prices have
fluctuating trends. In recent times when crash in international market prices of many crops is
seen, government doesnt have much option to reduce MSP drastically. By this analogy
Indias amber box subsidies are likely to cross 10% level allowed by de Minimis provision.

de minimis - Minimal amounts of domestic support that are allowed even though they
distort trade up to 5% of the value of production for developed countries, 10% for
developing.

BLUE BOX

This is the amber box with conditions. The conditions are designed to reduce distortions. Any
subsidy that would normally be in the amber box, is placed in the blue box if it requires
farmers to go for a certain production level.3 These subsidies are nothing but certain direct
payments (i.e, direct set aside payments) made to farmers by the government in the form of
assistance programmes to encourage agriculture, rural development etc.

certain direct payments to farmers where the farmers are required to limit production
(sometimes called blue box measures), certain government assistance programmes to
encourage agricultural and rural development in developing countries, and other support on a

2
Article 6 , AOA, WTO
3
Article 6, Para 5
small scale (de minimis) when compared with the total value of the product or products
supported (5% or less in the case of developed countries and 10% or less for developing
countries).

Blue Box: subsidy payments that are directly linked to acreage or animal numbers, but under
schemes which also limit production by imposing production quotas or requiring farmers to
set-aside part of their land. These are deemed by WTO rules to be partially decoupled from
production and are not subject to WTO reduction commitments. In the EU, they are
commonly known as direct payments.

GREEN BOX

The agricultural subsidies which cause minimal or no distortions to trade are put under the
green box.4 They must not involve price support.

This box basically includes all forms of government expenses, which are not targeted
at a particular product, and all direct income support programmes to farmers, which are not
related to current levels of production or prices. This is a very wide box and includes all
government subsidies like public storage for food security, pest and disease control, research
and extension and some direct payments to farmers that do not stimulate prodution like
restructuring of agriculture, environmental protection, regional development, crop and
income insurance, etc.

The green box subisidies are allowed without limits provided that comply with the
policy specific criteria. It means, this box is exempt from the calculation under subsidies
under the WTO provisions because the subsidies under it are not meant to promote
production thus do not distort trade, That is why this box is called 'production neutral box'.

Measures with minimal impact on trade can be used freely they are in a green box
(green as in traffic lights). They include government services such as research, disease
control, infrastructure and food security. They also include payments made directly to
farmers that do not stimulate production, such as certain forms of direct income support,
assistance to help farmers restructure agriculture, and direct payments under environmental
and regional assistance programmes.

Green Box: subsidies that are deemed not to distort trade, or at most cause minimal distortion
and are not subject to WTO reduction commitments.2 For the EU and US one of the most
important allowable subsidies in this category is decoupled support paid directly to

4
Annexure 2, AOA , Para 1 - 1. Domestic support measures for which exemption from the reduction
commitments is claimed shall meet the fundamental requirement that they have no, or at most minimal, trade-
distorting effects or effects on production. Accordingly, all measures for which exemption is claimed shall
conform to the following basic criteria:

(a) the support in question shall be provided through a publicly-funded government programme (including
government revenue foregone) not involving transfers from consumers; and,
(b) the support in question shall not have the effect of providing price support to producers; plus policy-
specific criteria and conditions as set out below.
producers. Such support should not relate to current production levels or prices. It can also be
given on condition that no production shall be required in order to receive such payments

S & D Box

The WTO provisions have defined another box i.e., the Social and Development Box which
allows the developing countries for some subsidies to the agriculture sector under certain
conditions, These conditions revolve around human development issues such as poverty,
minimum social welfare, health support, etc., specially for the segment of population living
below the poverty line, Developing countries can forward such subsidies to the extent of less
than 5 percent of their total agricultural output

IMPLICATION OF AGREEMENT ON AGRICULTURE FOR INDIA

The Agreement on Agriculture contains provisions in 3 broad areas of trade and agriculture
policies:

market access, export subsidies and domestic support.

Market access for agricultural products is to be governed by a 'tariffs only' regime. That is to
say, the agreement states that there can be no restrictions on farm trade except through tariffs.
This means that non tariff barriers such as quantitative restrictions on imports (i.e., quotas,
import restrictions through permits, import licensing etc.) as were in existence before the
Agreement came into being, were to be replaced by tariffs on imports to provide the same
level of protection and then were to be followed by progressive reduction of tariff levels.
Tariffs resulting from this "tariffication process" as well as other tariffs are to be reduced by a
simple average of 36 per cent over 6 years in the case of developed countries and 24 per cent
over 10 years in the case of developing countries. However, developing countries like India
who had not converted their quantitative restrictions into tariffs, were allowed to have ceiling
bindings which were not subjected to these reduction commitments.

India had bound its tariffs at 100% for primary products, 150% for processed products
and 300% for edible oils, except for certain items (comprising about 119 tariff lines), which
were historically bound at a lower level in the earlier negotiations. Out of these low bound
tariff lines, bindings on 15 tariff lines which included skimmed milk powder, spelt wheat,
corn, paddy, rice, maize, millet, sorghum, rape, colza and mustard oil, fresh grapes etc. were
successfully negotiated under GATT Article XXVIII in December 1999 and the binding
levels were suitably revised upward to provide adequate protection to the domestic producers.
India has also not taken any commitment to provide minimum market access
opportunities which other countries who had tariffied their QRs had to undertake to the extent
of 3% of its domestic consumption going upto 5%, at the end of the implementation period.
Though India is not entitled to use the Special Safeguard Mechanism of the Agreement,
which can be used only by countries which had tariffied, yet it can take safeguard action
under the WTO Agreement on Safeguards if there is a surge in imports causing serious injury
or if there is a threat of serious injury to the domestic producers.
Domestic Support measures, according to the Agreement, are meant to identify acceptable
measures of support to farmers and curtailing unacceptable trade distorting support to
farmers. These measures are targetted largely at developed countries where the levels of
domestic agricultural support had risen to extremely high levels.

Domestic support is divided into two categories viz.,

(a) support with no, or minimal, distortive effect on trade (often referred to as "Green Box"
and "Blue Box" measures) and

(b) trade distorting support (often referred to as "Amber Box" measures).

The trade distorting domestic support is measured in terms of what is called the "Total
Aggregate Measurement of Support" (Total AMS), which is expressed as a percentage of the
total value of agricultural output and includes both product specific and non product specific
support. The Agreement on Agriculture stipulates a reduction commitment of total AMS by
20 per cent for developed countries in 6 years (1995-2000) and by 131/ 3 per cent by
developing countries in 10 years (1995-2004), taking 1986-88 as the base period. However,
domestic support given to the agricultural sector upto 10% of the total value of agricultural
produce in developing countries and 5% in developed countries is allowed. In other words,
AMS within this limit is not subject to any reduction commitment.

In India the product specific support is negative, while the non product specific support i.e.,
subsidies on agricultural inputs, such as, power, irrigation, fertilisers etc., is well below the
permissible level of 10% of the value of agricultural output. Therefore, India is under no
obligation to reduce domestic support currently extended to the agricultural sector.

Disciplines in the area of Export Subsidies required developed countries to reduce, over a
period of 6 years, the base period (1986-90) volume of subsidised exports by 21 per cent and
the corresponding budgetary outlays for export subsidies by 36 per cent. For developing
countries these reductions are 14 per cent in volume terms and 24 per cent in budgetary
outlays over a period of 10 years.

Export subsidies of the kind listed in the Agreement on Agriculture, which attract reduction
commitments, are not extended in India. Also, developing countries are free to provide
certain subsidies, such as subsiding of export marketing costs, internal and international
transport and freight charges etc. India is making use of these subsidies in certain schemes of
Agricultural & Processed Food Products Export Development Authority (APEDA),
especially for facilitating export of horticulture products.

SPECIAL AND DIFFERENTIAL TREATMENT FOR DEVELOPING COUNTRIES

During the ongoing negotiations, some developing countries, including India, have sought a
special safeguard mechanism (SSM) to be used by developing countries for addressing
situations of import surges or swings in international prices of agricultural products. Apart
from additional duties, these countries have sought the flexibility to impose quantitative
restrictions under the special safeguard mechanism.
Under AoA, developing countries enjoy S&D in three main areas: market access, domestic
support and export subsidies. In all three areas, developing countries are allowed a ten-year
(1995-2004) implementation period as compared to five years (1995-2000) for developed
countries. The reduction commitments of developing countries in these areas have been about
two-thirds that of developed countries.

TRADE FACILITATION AGREEMENT (TFA)

The Trade Facilitation Agreement basically aimed at -

1. Greater transparency and Simplification of customs procedures


2. Use of electronic payments and risk management techniques
3. Faster clearances at ports.

Trade facilitation was put on the agenda in the Bali Ministerial conference during 3 to 7
December 2013 mainly by the developed countries.

INTELLECTUAL PROPERTY - PROTECTION AND ENFORCEMENT

Types of intellectual property

The Agreement on TradeRelated Aspects of Intellectual Property Rights (TRIPS) is an


international agreement administered by the World Trade Organization (WTO) that sets
down minimum standards for many forms of intellectual property (IP) regulation as applied
to nationals of other WTO Members. It was negotiated at the end of the Uruguay Round of
the General Agreement on Tariffs and Trade (GATT) in 1994.

The areas covered by the TRIPS Agreement

1. Copyright and related rights


2. Trademarks, including service marks
3. Geographical indications
4. Industrial designs
5. Patents
6. Layout-designs (topographies) of integrated circuits
7. Undisclosed information, including trade secrets

The WTOs intellectual property agreement amounts to rules for trade and investment in
ideas and creativity. The rules state how copyrights, patents, trademarks, geographical names
used to identify products, industrial designs, integrated circuit layout-designs and undisclosed
information such as trade secrets intellectual property should be protected when trade
is involved.

The areas of intellectual property that it covers are: copyright and related rights (i.e. the rights
of performers, producers of sound recordings and broadcasting
organizations); trademarks including service marks; geographical indications including
appellations of origin; industrial designs; patents including the protection of new varieties of
plants; the layout-designs of integrated circuits; and undisclosed information including trade
secrets and test data.

The three main features of the Agreement are:

Standards. In respect of each of the main areas of intellectual property covered by


the TRIPS Agreement, the Agreement sets out the minimum standards of
protection to be provided by each Member. Each of the main elements of
protection is defined, namely the subject-matter to be protected, the rights to be
conferred and permissible exceptions to those rights, and the minimum duration of
protection. The Agreement sets these standards by requiring, first, that the
substantive obligations of the main conventions of the WIPO, the Paris
Convention for the Protection of Industrial Property (Paris Convention) and the
Berne Convention for the Protection of Literary and Artistic Works (Berne
Convention) in their most recent versions, must be complied with. With the
exception of the provisions of the Berne Convention on moral rights, all the main
substantive provisions of these conventions are incorporated by reference and thus
become obligations under the TRIPS Agreement between TRIPS Member
countries. The relevant provisions are to be found in Articles 2.1 and 9.1 of the
TRIPS Agreement, which relate, respectively, to the Paris Convention and to the
Berne Convention. Secondly, the TRIPS Agreement adds a substantial number of
additional obligations on matters where the pre-existing conventions are silent or
were seen as being inadequate. The TRIPS Agreement is thus sometimes referred
to as a Berne and Paris-plus agreement.

Enforcement. The second main set of provisions deals with domestic procedures
and remedies for the enforcement of intellectual property rights. The Agreement
lays down certain general principles applicable to all IPR enforcement procedures.
In addition, it contains provisions on civil and administrative procedures and
remedies, provisional measures, special requirements related to border measures
and criminal procedures, which specify, in a certain amount of detail, the
procedures and remedies that must be available so that right holders can
effectively enforce their rights.

Dispute settlement. The Agreement makes disputes between WTO Members


about the respect of the TRIPS obligations subject to the WTO's dispute settlement
procedures.

Ideas and knowledge are an increasingly important part of trade. Most of the value of new
medicines and other high technology products lies in the amount of invention, innovation,
research, design and testing involved. Films, music recordings, books, computer software and
on-line services are bought and sold because of the information and creativity they contain,
not usually because of the plastic, metal or paper used to make them. Many products that
used to be traded as low-technology goods or commodities now contain a higher proportion
of invention and design in their value for example brandnamed clothing or new varieties
of plants.

Creators can be given the right to prevent others from using their inventions, designs or other
creations and to use that right to negotiate payment in return for others using them. These
are intellectual property rights. They take a number of forms. For example books, paintings
and films come under copyright; inventions can be patented; brandnames and product logos
can be registered as trademarks; and so on. Governments and parliaments have given creators
these rights as an incentive to produce ideas that will benefit society as a whole.

The extent of protection and enforcement of these rights varied widely around the world; and
as intellectual property became more important in trade, these differences became a source of
tension in international economic relations. New internationally-agreed trade rules for
intellectual property rights were seen as a way to introduce more order and predictability, and
for disputes to be settled more systematically.

The Uruguay Round achieved that. The WTOs TRIPS Agreement is an attempt to narrow
the gaps in the way these rights are protected around the world, and to bring them under
common international rules. It establishes minimum levels of protection that each
government has to give to the intellectual property of fellow WTO members. In doing so, it
strikes a balance between the long term benefits and possible short term costs to society.
Society benefits in the long term when intellectual property protection encourages creation
and invention, especially when the period of protection expires and the creations and
inventions enter the public domain. Governments are allowed to reduce any short term costs
through various exceptions, for example to tackle public health problems. And, when there
are trade disputes over intellectual property rights, the WTOs dispute settlement system is
now available.

The agreement covers five broad issues:


how basic principles of the trading system and other international intellectual property
agreements should be applied
how to give adequate protection to intellectual property rights
how countries should enforce those rights adequately in their own territories
how to settle disputes on intellectual property between members of the WTO
special transitio

Copyright

The TRIPS agreement ensures that computer programs will be protected as literary works
under the Berne Convention and outlines how databases should be protected.

It also expands international copyright rules to cover rental rights. Authors of computer
programs and producers of sound recordings must have the right to prohibit the commercial
rental of their works to the public. A similar exclusive right applies to films where
commercial rental has led to widespread copying, affecting copyright-owners potential
earnings from their films.

The agreement says performers must also have the right to prevent unauthorized recording,
reproduction and broadcast of live performances (bootlegging) for no less than 50 years.
Producers of sound recordings must have the right to prevent the unauthorized reproduction
of recordings for a period of 50 years

Trademarks

The agreement defines what types of signs must be eligible for protection as trademarks, and
what the minimum rights conferred on their owners must be. It says that service marks must
be protected in the same way as trademarks used for goods. Marks that have become well-
known in a particular country enjoy additional protection.

Geographical indications

A place name is sometimes used to identify a product. This geographical indication does
not only say where the product was made. More importantly, it identifies the products
special characteristics, which are the result of the products origins.

Well-known examples include Champagne, Scotch, Tequila, and Roquefort cheese.


Wine and spirits makers are particularly concerned about the use of place-names to identify
products, and the TRIPS Agreement contains special provisions for these products. But the
issue is also important for other types of goods.

Using the place name when the product was made elsewhere or when it does not have the
usual characteristics can mislead consumers, and it can lead to unfair competition. The
TRIPS Agreement says countries have to prevent this misuse of place names.

For wines and spirits, the agreement provides higher levels of protection, i.e. even where
there is no danger of the public being misled.
Some exceptions are allowed, for example if the name is already protected as a trademark or
if it has become a generic term. For example, cheddar now refers to a particular type of
cheese not necessarily made in Cheddar, in the UK. But any country wanting to make an
exception for these reasons must be willing to negotiate with the country which wants to
protect the geographical indication in question.

The agreement provides for further negotiations in the WTO to establish a multilateral system
of notification and registration of geographical indications for wines. These are now part of
the Doha Development Agenda and they include spirits. Also debated in the WTO is whether
to negotiate extending this higher level of protection beyond wines and spirits.

Industrial designs

Under the TRIPS Agreement, industrial designs must be protected for at least 10 years.
Owners of protected designs must be able to prevent the manufacture, sale or importation of
articles bearing or embodying a design which is a copy of the protected design.

Patents

The agreement says patent protection must be available for inventions for at least 20 years.
Patent protection must be available for both products and processes, in almost all fields of
technology. Governments can refuse to issue a patent for an invention if its commercial
exploitation is prohibited for reasons of public order or morality. They can also exclude
diagnostic, therapeutic and surgical methods, plants and animals (other than
microorganisms), and biological processes for the production of plants or animals (other than
microbiological processes).

Plant varieties, however, must be protectable by patents or by a special system (such as the
breeders rights provided in the conventions of UPOV the International Union for the
Protection of New Varieties of Plants).

The agreement describes the minimum rights that a patent owner must enjoy. But it also
allows certain exceptions. A patent owner could abuse his rights, for example by failing to
supply the product on the market. To deal with that possibility, the agreement says
governments can issue compulsory licences, allowing a competitor to produce the product
or use the process under licence. But this can only be done under certain conditions aimed at
safeguarding the legitimate interests of the patent-holder.

If a patent is issued for a production process, then the rights must extend to the product
directly obtained from the process. Under certain conditions alleged infringers may be
ordered by a court to prove that they have not used the patented process.

An issue that has arisen recently is how to ensure patent protection for pharmaceutical
products does not prevent people in poor countries from having access to medicines while
at the same time maintaining the patent systems role in providing incentives for research and
development into new medicines. Flexibilities such as compulsory licensing are written into
the TRIPS Agreement, but some governments were unsure of how these would be
interpreted, and how far their right to use them would be respected.
A large part of this was settled when WTO ministers issued a special declaration at the Doha
Ministerial Conference in November 2001. They agreed that the TRIPS Agreement does not
and should not prevent members from taking measures to protect public health. They
underscored countries ability to use the flexibilities that are built into the TRIPS Agreement.
And they agreed to extend exemptions on pharmaceutical patent protection for least-
developed countries until 2016. On one remaining question, they assigned further work to the
TRIPS Council to sort out how to provide extra flexibility, so that countries unable to
produce pharmaceuticals domestically can import patented drugs made under compulsory
licensing. A waiver providing this flexibility was agreed on 30 August 2003.

Integrated circuits layout designs

The basis for protecting integrated circuit designs (topographies) in the TRIPS agreement is
the Washington Treaty on Intellectual Property in Respect of Integrated Circuits, which
comes under the World Intellectual Property Organization. This was adopted in 1989 but has
not yet entered into force. The TRIPS agreement adds a number of provisions: for example,
protection must be available for at least 10 years.

Undisclosed information and trade secrets

Trade secrets and other types of undisclosed information which have commercial value
must be protected against breach of confidence and other acts contrary to honest commercial
practices. But reasonable steps must have been taken to keep the information secret. Test data
submitted to governments in order to obtain marketing approval for new pharmaceutical or
agricultural chemicals must also be protected against unfair commercial use.

Intellectual property rights are customarily divided into two main areas:

(i) Copyright and rights related to copyright.

The rights of authors of literary and artistic works (such as books and other writings, musical
compositions, paintings, sculpture, computer programs and films) are protected by copyright,
for a minimum period of 50 years after the death of the author.

Also protected through copyright and related (sometimes referred to as neighbouring)


rights are the rights of performers (e.g. actors, singers and musicians), producers of
phonograms (sound recordings) and broadcasting organizations. The main social purpose of
protection of copyright and related rights is to encourage and reward creative work.

(ii) Industrial property.

Industrial property can usefully be divided into two main areas:

One area can be characterized as the protection of distinctive signs, in particular


trademarks (which distinguish the goods or services of one undertaking from those
of other undertakings) and geographical indications (which identify a good as
originating in a place where a given characteristic of the good is essentially
attributable to its geographical origin).

The protection of such distinctive signs aims to stimulate and ensure fair
competition and to protect consumers, by enabling them to make informed choices
between various goods and services. The protection may last indefinitely,
provided the sign in question continues to be distinctive.

Other types of industrial property are protected primarily to stimulate innovation,


design and the creation of technology. In this category fall inventions (protected
by patents), industrial designs and trade secrets.

The social purpose is to provide protection for the results of investment in the
development of new technology, thus giving the incentive and means to finance
research and development activities.

A functioning intellectual property regime should also facilitate the transfer of


technology in the form of foreign direct investment, joint ventures and licensing.

The protection is usually given for a finite term (typically 20 years in the case of
patents).

While the basic social objectives of intellectual property protection are as outlined above, it
should also be noted that the exclusive rights given are generally subject to a number of
limitations and exceptions, aimed at fine-tuning the balance that has to be found between the
legitimate interests of right holders and of users.

DISPUTE SETTLEMENT

The WTOs procedure for resolving trade quarrels under the Dispute Settlement
Understanding is vital for enforcing the rules and therefore for ensuring that trade flows
smoothly. Countries bring disputes to the WTO if they think their rights under the agreements
are being infringed. Judgements by specially-appointed independent experts are based on
interpretations of the agreements and individual countries commitments.

The system encourages countries to settle their differences through consultation. Failing that,
they can follow a carefully mapped out, stage-by-stage procedure that includes the possibility
of a ruling by a panel of experts, and the chance to appeal the ruling on legal grounds.
Confidence in the system is borne out by the number of cases brought to the WTO around
300 cases in eight years compared to the 300 disputes dealt with during the entire life of
GATT (194794).

AGREEMENT ON TRADE RELATED INVESTMENT MEASURES

The Trade-Related Investment Measures (TRIMs) Agreement applies only to measures that
affect trade in goods. It recognizes that certain measures can restrict and distort trade, and
states that no member shall apply any measure that discriminates against foreigners or foreign
products (i.e. violates national treatment principles in GATT). It also outlaws investment
measures that lead to restrictions in quantities (violating another principle in GATT). An
illustrative list of TRIMs agreed to be inconsistent with these GATT articles is appended to
the agreement. The list includes measures which require particular levels of local
procurement by an enterprise (local content requirements). It also discourages measures
which limit a companys imports or set targets for the company to export (trade balancing
requirements).

Under the agreement, countries must inform fellow-members through the WTO of all
investment measures that do not conform with the agreement. Developed countries had to
eliminate these in two years (by the end of 1996); developing countries had five years (to the
end of 1999); and least-developed countries seven. In July 2001, the Goods Council agreed to
extend this transition period for a number of requesting developing countries.

The agreement establishes a Committee on TRIMs to monitor the implementation of these


commitments. The agreement also says that WTO members should consider, by 1 January
2000, whether there should also be provisions on investment policy and competition policy.
This discussion is now part of the Doha Development Agenda.

This Agreement, negotiated during the Uruguay Round, applies only to measures that affect
trade in goods. Recognizing that certain investment measures can have trade-restrictive and
distorting effects, it states that no Member shall apply a measure that is prohibited by the
provisions of GATT Article III (national treatment) or Article XI (quantitative restrictions).

PRINCIPLES OF THE TRADING SYSTEM

1. TRADE WITHOUT DISCRIMINATION

- Most-favoured-nation (MFN): treating other people equally Under the WTO agreements,
countries cannot normally discriminate between their trading partners. Grant someone a
special favour (such as a lower customs duty rate for one of their products) and you have to
do the same for all other WTO members.

This principle is known as most-favoured-nation (MFN) treatment (see box). It is so


important that it is the first article of the General Agreement on Tariffs and Trade (GATT),
which governs trade in goods. MFN is also a priority in the General Agreement on Trade in
Services (GATS) (Article 2) and the Agreement on Trade-Related Aspects of Intellectual
Property Rights (TRIPS)(Article 4), although in each agreement the principle is handled
slightly differently. Together, those three agreements cover all three main areas of trade
handled by the WTO.

Some exceptions are allowed. For example, countries can set up a free trade agreement that
applies only to goods traded within the group discriminating against goods from outside.
Or they can give developing countries special access to their markets. Or a country can raise
barriers against products that are considered to be traded unfairly from specific countries.
And in services, countries are allowed, in limited circumstances, to discriminate. But the
agreements only permit these exceptions under strict conditions. In general, MFN means that
every time a country lowers a trade barrier or opens up a market, it has to do so for the same
goods or services from all its trading partners whether rich or poor, weak or strong.

2. National treatment: Treating foreigners and locals equally Imported and locally-
produced goods should be treated equally at least after the foreign goods have entered the
market. The same should apply to foreign and domestic services, and to foreign and local
trademarks, copyrights and patents. This principle of national treatment (giving others the
same treatment as ones own nationals) is also found in all the three main WTO agreements
(Article 3 of GATT, Article 17 of GATS and Article 3 of TRIPS), although once again the
principle is handled slightly differently in each of these.

National treatment only applies once a product, service or item of intellectual property has
entered the market. Therefore, charging customs duty on an import is not a violation of
national treatment even if locally-produced products are not charged an equivalent tax.

2.Freer trade: gradually, through negotiation

Lowering trade barriers is one of the most obvious means of encouraging trade. The barriers
concerned include customs duties (or tariffs) and measures such as import bans or quotas that
restrict quantities selectively. From time to time other issues such as red tape and exchange
rate policies have also been discussed.

3. Predictability: through binding and transparency

Sometimes, promising not to raise a trade barrier can be as important as lowering one,
because the promise gives businesses a clearer view of their future opportunities. With
stability and predictability, investment is encouraged, jobs are created and consumers can
fully enjoy the benefits of competition choice and lower prices. The multilateral trading
system is an attempt by governments to make the business environment stable and
predictable.

4. Promoting fair competition

The WTO is sometimes described as a free trade institution, but that is not entirely
accurate. The system does allow tariffs and, in limited circumstances, other forms of
protection. More accurately, it is a system of rules dedicated to open, fair and undistorted
competition.

The rules on non-discrimination MFN and national treatment are designed to secure
fair conditions of trade. So too are those on dumping (exporting at below cost to gain market
share) and subsidies. The issues are complex, and the rules try to establish what is fair or
unfair, and how governments can respond, in particular by charging additional import duties
calculated to compensate for damage caused by unfair trade.

Many of the other WTO agreements aim to support fair competition: in agriculture,
intellectual property, services, for example. The agreement on government procurement (a
plurilateral agreement because it is signed by only a few WTO members) extends
competition rules to purchases by thousands of government entities in many countries. And
so on.

The principles

The trading system should be ...

1. without discrimination a country should not discriminate between its trading


partners (giving them equally most-favoured-nation or MFN status); and it should
not discriminate between its own and foreign products, services or nationals (giving
them national treatment);
2. freer barriers coming down through negotiation;
3. predictable foreign companies, investors and governments should be confident
that trade barriers (including tariffs and non-tariff barriers) should not be raised
arbitrarily; tariff rates and market-opening commitments are bound in the WTO;
4. more competitive discouraging unfair practices such as export subsidies and
dumping products at below cost to gain market share;
5. more beneficial for less developed countries giving them more time to adjust,
greater flexibility, and special privileges.

Tariff Quotas - lower tariff rates for specified quantities, higher (sometimes much higher)
rates for quantities that exceed the quota. The newly committed tariffs and tariff quotas,
covering all agricultural products, took effect in 1995. Uruguay Round participants agreed
that developed countries would cut the tariffs (the higher out-of-quota rates in the case of
tariff-quotas) by an average of 36%, in equal steps over six years. Developing countries
would make 24% cuts over 10 years.

A tariff-quota

This is what a tariff-quota might look like

Imports entering under the tariff-quota (up to 1,000 tons) are generally charged 10%. Imports
entering outside the tariff-quota are charged 80%. Under the Uruguay Round agreement, the
1,000 tons would be based on actual imports in the base period or an agreed minimum
access formula.

Tariff quotas are also called tariff-rate quotas.

AGREEMENT ON APPLICATION OF SANITARY AND PHYTOSANITARY


MEASURES
A separate agreement on food safety and animal and plant health standards (the Sanitary and
Phytosanitary Measures Agreement or SPS) sets out the basic rules that allows countries to
set their own standards. But it also says regulations must be based on science. They should be
applied only to the extent necessary to protect human, animal or plant life or health. And they
should not arbitrarily or unjustifiably discriminate between countries where identical or
similar conditions prevail.

Member countries are encouraged to use international standards, guidelines and


recommendations where they exist. When they do, they are unlikely to be challenged legally
in a WTO dispute. However, members may use measures which result in higher standards if
there is scientific justification. They can also set higher standards based on appropriate
assessment of risks so long as the approach is consistent, not arbitrary. And they can to some
extent apply the precautionary principle, a kind of safety first approach to deal with
scientific uncertainty. Article 5.7 of the SPS Agreement allows temporary precautionary
measures.

The agreement still allows countries to use different standards and different methods of
inspecting products. So how can an exporting country be sure the practices it applies to its
products are acceptable in an importing country? If an exporting country can demonstrate that
the measures it applies to its exports achieve the same level of health protection as in the
importing country, then the importing country is expected to accept the exporting countrys
standards and methods.

The agreement includes provisions on control, inspection and approval procedures.


Governments must provide advance notice of new or changed sanitary and phytosanitary
regulations, and establish a national enquiry point to provide information. The agreement
complements that on technical barriers to trade.

The SPS Agreement encourages WTO members to base their regulations on the health and
safety standards developed by the three relevant international expert bodies, namely

1. the Codex Alimentarius Commission (for food safety),


2. the International Plant Protection Convention (for plant health) and
3. the World Organisation for Animal Health (for animal health and animal diseases
transmittable to humans).

WTO members who want to impose more stringent requirements must be able to justify these
measures based on a scientific assessment of health risks. The SPS Agreement aims to
achieve a balance between the right of WTO members to implement legitimate health
protection policies and the goal of allowing the smooth flow of goods across international
borders without unnecessary restrictions. The SPS Committee provides a forum for the
exchange of information and gives WTO members the opportunity to resolve specific trade
concerns. Nearly half of the concerns raised in the Committee have subsequently been
completely or partially resolved among the members concerned.
For the purposes of the SPS Agreement, sanitary and phytosanitary measures are defined as
any measures applied:

to protect human or animal life from risks arising from additives,


contaminants, toxins or disease-causing organisms in their food;
to protect human life from plant- or animal-carried diseases;
to protect animal or plant life from pests, diseases, or disease-causing
organisms;
to prevent or limit other damage to a country from the entry, establishment
or spread of pests.

WTO AND GOVERNMENT PROCUREMENT

Government procurement accounts for 10-15 per cent of the GDP of an economy on average.
It constitutes a significant market and an important aspect of international trade. The WTO's
work on government procurement aims to promote transparency, integrity and competition in
this market.

MAIN MINISTERIAL MEETS AND TERMS

1. WASHINGTON TREATY - The Washington Treaty was adopted in 1989 and


provides protection for the layout designs (topographies) of integrated circuits.
2. BERNE CONVENTION - A treaty, administered by WIPO, for the protection of the
rights of authors in their literary and artistic works
3. LISBON AGREEMENT - Treaty, administered by WIPO, for the protection of
geographical indications and their international registration.
4. MADRID AGREEMENT - Treaty, administered by WIPO, for the repression of
false or deceptive indications of source on goods.
5. MAIL BOX - In intellectual property, refers to the requirement of the TRIPS
Agreement applying to WTO members which do not yet provide product patent
protection for pharmaceuticals and for agricultural chemicals. Since 1 January 1995,
when the WTO agreements entered into force, these countries have to establish a
means by which applications of patents for these products can be filed. (An additional
requirement says they must also put in place a system for granting exclusive
marketing rights for the products whose patent applications have been filed.)
6. NAMA - Non-agricultural market access: broadly covers industrial, fisheries and
forestry products.
7. PARIS CONVENTION - Treaty, administered by the World Intellectual Property
Organization (WIPO), for the protection of industrial intellectual property, i.e.
patents, utility models, industrial designs, etc.
8. PRICE UNDERTAKING - Undertaking by an exporter to raise the export price of
the product to avoid the possibility of an anti-dumping duty.
9. ROME CONVENTION - Treaty, administered by the World Intellectual Property
Organization (WIPO), United Nations Educational, Scientific and Cultural
Organization (UNESCO) and International Labour Organization (ILO), for the
protection of the works of performers, broadcasting organizations and producers of
phonograms.
10. SANITARY AND PHYTOSANITARY MEASURES (SPS) - Measures dealing
with food safety and animal and plant health.
sanitary: for human and animal health.
phytosanitary: for plants and plant products
11. SINGAPORE ISSUES - Four issues introduced to the WTO agenda at the December
1996 Ministerial Conference in Singapore: trade and investment, trade and
competition policy, transparency in government procurement, and trade facilitation.
12. SQUARE BRACKETS - In official drafts, square brackets indicate text that has not
been agreed and is still under discussion.
13. TARIFF QUOTA - When quantities inside a quota are charged lower import duty
rates, than those outside (which can be high).
14. TRADE FACILITATION - Removing obstacles to the movement of goods across
borders (e.g. simplification of customs procedures).
15. PARALLEL IMPORTS - When a product made legally (i.e. not pirated) abroad is
imported without the permission of the intellectual property right-holder (e.g. the
trademark or patent owner). Some countries allow this, others do not.
16. TARIFF PEAKS - Relatively high tariffs, usually on sensitive products, amidst
generally low tariff levels. For industrialized countries, tariffs of 15% and above are
generally recognized as tariff peaks.
17. TARIFF ESCALATION - Higher import duties on semi-processed products than on
raw materials, and higher still on finished products. This practice protects domestic
processing industries and discourages the development of processing activity in the
countries where raw materials originate.
18. TARIFF BINDING - Commitment not to increase a rate of duty beyond an agreed
level. Once a rate of duty is bound, it may not be raised without compensating the
affected parties.
19. PRECAUTIONARY PRINCIPLE - Member countries are encouraged to use
international standards, guidelines and recommendations where they exist. When they
do, they are unlikely to be challenged legally in a WTO dispute. However, members
may use measures which result in higher standards if there is scientific justification.
They can also set higher standards based on appropriate assessment of risks so long as
the approach is consistent, not arbitrary. And they can to some extent apply the
precautionary principle, a kind of safety first approach to deal with scientific
uncertainty. Article 5.7 of the SPS Agreement allows temporary precautionary
measures.

SINGAPORE ISSUES - 1996

The Singapore issues term refers to areas of

1. trade and investment;

2. trade and competition policy;


3. trade facilitation; and

4. transparency in government procurement,

These four issues have collectively come to be known as the Singapore issues in the context
of the WTO, because it was at the first ministerial conference of the WTO in Singapore in
1996 that they were first brought up as possible areas on which the multilateral body could
initiate negotiations. As it can be inferred from these four areas, only trade facilitation is
directly related to trade, while other three are only indirectly related (if not unrelated) to
trade. Developed countries wanted to include all these areas in negotiations. In contrast,
developed countries wanted implementation of outcomes of Uruguay round. Hence, from
very beginning of WTO deliberations, contradictions of interests of both developed and
developing world came to surface, which continues till date. Further, The USA and Norway
were behind the push for bringing in labour standards in the WTO, but developing countries
were able to get the meeting to agree that the International Labour Organisation is the
competent body to do such work.

What was Indias stand?

On issues like investment and competition policy, India feels that having a multilateral
agreement would be a serious impingement on the sovereign rights of countries. To an extent,
of course, this is inherent in any multilateral treaty, but Investment is seen as an area in which
ceding sovereign rights would leave governments, particularly developing country
governments, with too little room for maneuver in directing investments into areas of national
priority. These are concerns that many other developing countries also share. In addition, on
the specific issue of competition policy as applicable to hardcore cartels,

India has pointed out that there is no clarity on whether these would include export cartels.
The Organisation of Petroleum Exporting Countries (OPEC) is perhaps the best known
example of an export cartel that rigs prices by fixing production ceilings. On the issue of
transparency in government procurement, the Indian position is that while the principle is
entirely acceptable, there cannot be a universal determination of what constitutes transparent
procedures. On trade facilitation, India has argued that once again while the idea is
unexceptionable, developing countries may not have the resources by way of technology,
or otherwise to bring their procedures in line with those in the developed world over the
short to medium term.

Highlights of Nairobi outcomes:

1. There was a commitment to completely eliminate subsidies for farm exports Under the
decision, developed members have committed to remove export subsidies immediately,
except for a handful of agriculture products, and developing countries will do so by 2018.
Developing members will keep the flexibility to cover marketing and transport costs for
agriculture exports until the end of 2023, and the poorest and food importing countries would
enjoy additional time to cut export subsidies.
2. Ministers also adopted a Ministerial Decision on Public Stockholding for Food Security
Purposes. The decision commits members to engage constructively in finding a permanent
solution to this issue. Under the Bali Ministerial Decision of 2013, developing countries are
allowed to continue food stockpile programmes, which are otherwise in risk of breaching the
WTOs domestic subsidy cap, until a permanent solution is found by the 11th Ministerial
Conference in 2017.

3. A Ministerial Decision on a Special Safeguard Mechanism (SSM) for Developing


Countries recognizes that developing members will have the right to temporarily increase
tariffs in face of import surges by using an SSM. Members will continue to negotiate the
mechanism in dedicated sessions of the Agriculture Committee. (This means issue is not
closed and still under negotiation).

4. There were other decisions of particular interests of least developing Countries. One of
them is Preferential Rules of Origin. It entails that Made in LDC products will get
unrestricted access to markets of non LDCs.

5. There was affirmation that Regional Trade Agreements (RTAs) remain complementary to,
not a substitute for, the multilateral trading system (WTO).

6. Ministers acknowledged that members have different views on how to address the future
of the Doha Round negotiations but noted the strong commitment of all Members to
advance negotiations on the remaining Doha issues.
BALANCE OF PAYMENTS

The balance of payments (henceforth BOP) is a consolidated account of the receipts and
pay-ments from and to other countries arising out of all economic transactions during the
course of a year.

Current account balance + Capital account balance + Reserve Balance = BoP

(X M) + (CI CO) + FOREX = BOP

X is exports,

M is imports,

CI is capital inflows,

CO is capital outflows,

FOREX is foreign exchange reserve balance.


Components of BoP are

CURRENCY CONVERTIBILITY

Currency convertibility means currency of a country can be freely converted into foreign
exchange at market determined rate of exchange ,i.e the rate determined by demand and
supply of currency of different countries. In India there are some dealers whose job is
facilitating the services of exchanging the currency of one country into another. Mostly these
are commercial banks who act as dealers of exchange. Convertibility of currency allows you
to go there and convert your Indian rupees into whatever currency you wanted. Capital
account convertibility (CAC) refers to the freedom of converting local financial assets into
foreign financial assetsand vice versa at market determined rates of exchange. It refers to the
elimination of restraints on international flows on a country s capital account, facilitating full
currency convertibility and opening of the financial system.

Currency convertibility is of two types as follows :

(1)Current account convertibility

(2)Capital account convertibility

CURRENT ACCOUNT

It has two meanings - one is related to the banking sector and the other to the external sector.

1. In the banking industry, a business firms bank account is known as current account.
The account is in the name of a firm run by authorised person or persons in which no
interest is paid by the bank on the deposits. Every withdrawal from the account taks
place by cheques with limitations on the number of deposits and withdrawals in a
single day. The overdraft facility or the cash-cum-credit (c/c account) facility to
business firms is offered by the banks on this account only.
2. In the external sector, it refers to the account maintained by every government of the
world in which every kind of current transactions is shown - basically this account is
maintained by the central banking body of the economy on behalf of the government.
Current transactions of an economy in foreign currency all over the world are -
exports, import, interest payments, private remittances and transfers.
All transactions are shown as either, inflow or outflow (Credit or debit). At the end of
the year, the current account might be positive or negative. The positive one is known
as a surplus current account, and the negative one is known as a deficit current
account. India had surplus current accounts for three consecutive years (2000 to
2003)- the only such period in Indian economic history.

CAPITAL ACCOUNT

Every government of the world maintains a capital account, which shows the capital kind of
transactions of the economy with outside economies. Every transaction in foreign currency
(inflow or outflow) considered as capital is shown in this account -
external lending and borrowing
foreign currency deposits of bank
external bonds issued by the govt of india
FDI
PIS and
Security market investment of the QFIs (Qualified Foreign investors) (Rupee is fully
convertible in this case).

There is no deficit or surplus in this account like the current account.


CONVERTIBILITY

An economy might allow its currency full or partial convertibility in the current account and
capital accounts. If domestic currency is allowed to convert into foreign currency for all
current account purposes, it is a case of full current account convertibility. Similarly, in cases
of capital outflow, if the domestic currency is allowed to convert into foreign currency, it is a
case of full capital account convertibility. If the situation is of partial convertibility, then the
portion allowed by the government can be converted into foreign currency for current and
capital purposes. It should always be kept in mind that the issue of currency convertibility is
concerned with foreign currency outflow only.

CONVERTIBILITY IN INDIA

Current Account - Current Account is fully convertible (operationalised on August 19,


1994). It means that the full amount of the foreign exchange required by someone for current
purposes will be made available to him at official exchange rate and there could be an
unprohibited outflow of foreign exchange. India was obliged to do so as per Article VIII of
the IMF which prohibits any exchange restrictions on current international transactions. India
was under pre-conditions of the IMF since 1991.

Capital Account - After the recommendations of the S.S.Tarapore committee (1997) on


capital account convertibility, India has been moving in the direction of allowing full
convertibility in this account, but with required precautions. India is still a country of partial
convertibility (40:60) in the capital account.

LERMS - India announced the Liberalised Exchange Rate Mechanism System (LERMS) in
the Union Budget 1992-93 and in March 1993 it was operationalised. India delinked its
currency from the fixed currency system and moved into the era of floating exchange rate
system under it. Indian form of exchange rate is known as the 'dual exchange rate', one
exchange rate of rupee is official and the other is market-driven. The market driven exchange
rate shows the actual tendencies of the foreign currency demand and supply in the economy
vis-a-vis the domestic currency. It is the market driven exchange rate which affects the
official rate and not the other way around.

NEER - The Nominal Effective Exchange Rate (NEER) of the rupee is a weighted average
of exchange rates before the currencies of India's major trading partners.

REER - When the weight of inflation is adjusted with the NEER, we get the Real Effective
Exchange Rate(REER) of the Rupee. Since inflation has been on the higher side REER of the
rupee is more than NEER.

EFF - The extended fund facility(EFF) is a service provided by the IMF to its member
countries which authorises them to raise any amount of foreign exchange from it to fulfil
their BoP crisis, but on the conditions of structural reforms in the economy put by the body. It
is the first agreement of its kind. India had signed this agreement with the IMF in the
financial year 1981-82.
IMF CONDITIONS ON INDIA

The BoP crisis of the early 1990s made India borrow from the IMF which came on some
conditions. The medium term loan to India was given for the restructuring of the economy on
the following conditions:

1. Devaluation of rupee by 22 %
2. Drastic custom cut to a peak duty of 30 percent from the erstwhile level of 130
percent for all goods.
3. Excise duty to be increases by 20 percent to neutralise the loss of revenue due to
custom cut.
4. Government expenditure to be cut by 10% per annum (the burden of salaries,
pensions, subsidies, etc.).

CROWDING OUT EFFECT

A concept of public finance which means an increase in the government expenditure which
has an effect of reducing the private sector expenditure.

CURRENT ACCOUNT CONVERTIBILITY Vs CAPITAL ACCOUNT


CONVERTIBILITY

Capital Account Convertibility means that rupee can now be freely convertible into any
foreign currencies for the acquisition of assets like shares, properties and assets abroad.
Further, the banks can accept deposits in any currency.

Currency convertibility means the freedom to convert one currency into other internationally
accepted currencies, wherein the exporters and importers were allowed a free conversion of a
rupee.But still, none was allowed to purchase any assets abroad.

So if a foreigner buys a building in India, and after 5 yrs its selling price rises so sells it at
five times the cost he collected, now he has rupees in hand, can he easily convert these rupees
into yen easily?

Considering that exchange rate is better in terms of INR-JPY, the foreigner would want to
convert the currency into yen..and this can be done if complete capital a/c convertibility takes
place.

Remittance to foreign countries from India is restricted by RBI. for import of machines you
are remitting abroad means it is capital account convertibility. if you remit money to your son
or relative living abroad means current account convertibility.

Capital account convertibility

It means the freedom to convert local financial assets into foreign financial assets and vice
versa at market determined rates of exchange. It refers to the removal of restraints on
international flows on a countrys capital account, enabling full currency convertibility and
the opening of the financial system. Capital account convertibility is considered to be one of
the major features of a developed economy. It helps attract foreign investment.At the same
time, capital account convertibility makes it easier for domestic companies to tap foreign
markets. It is sometimes referred to as Capital Asset Liberation.

Capital account convertibility (CAC) refers to the freedom of converting local financial assets
into foreign financial assets and vice versa at market determined rates of exchange. It refers
to the elimination of restraints on international flows on a country s capital account,
facilitating full currency convertibility and opening of the financial system.

BENEFITS

1. The most obvious argument is that all developed countries are capital account
convertible; hence this is an inevitable destiny of the developing countries in their
path to development.
2. Free global capital flows bring about better and more efficient allocation of the global
pool of savings to the more productive uses. From the developing countrys
viewpoint, free access to global capital markets increases available investible
resources which augments domestic savings, reduces marginal cost of capital,
accelerates investment and growth.
3. According to Stanley Fischer, ....open capital accounts support the multilateral
trading systems by broadening the channels through which countries can finance trade
and investment.
4. Open capital accounts facilitate portfolio diversification by investors in developed as
well as developing countries.
5. Because the feasibility of capital account convertibility rests on sound
macroeconomic policy, it creates a sort of commitment for the country concerned to
ensure better macroeconomic management, lest it is punished by the investors. As
Rudiger Dornbusch puts it, The capital market fulfils an important supervisory
function over economic policy

6. The first and foremost advantage of capital account convertibility is that it helps the
currency of the country because due to capital convertibility being implemented
foreign investors feel free to invest in the country resulting in glut of foreign currency
flowing into the country and due to foreign currency inflows the currency of the
country appreciate against the foreign currencies. Hence as far currency is concerned
capital account convertibility initially is a boon and indirectly helps the imports of the
country getting cheaper because appreciation in currency results in imports of the
country getting cheaper.

7. Another advantage of capital account convertibility is that it helps in increasing the


confidence of the foreign investors as they can freely buy and sell assets and also
convert the domestic currency into foreign currency anytime they want which results
in an improved outlook for the economy of the country by the foreign investors.

DIS-ADVANTAGES
1. It is recognised that capital flows are sensitive to macroeconomic conditions. Any
deterioration in fiscal conditions, inflation management, balance of payments, or any
other macroeconomic shock may cause a cessation or reversal of capital flows
2. Capital flows, inasmuch as they result essentially from trade in financial assets, are
prone to volatilities derived from information asymmetries, herd behaviour, panics
etc., which may be far divested from the fundamental macroeconomic strengths. I
resist the temptation to tangentially sail into a discussion on the vagaries of the
financial markets. Suffice to quote Keyness famous words: when capital
development of a country becomes a by-product of the activities of a casino, the job is
likely to be ill done.
3. As a consequence of impossible trinity, an open capital account demands a complete
let go of the exchange rate management and volatile capital flows and can therefore
lead to extreme volatility in the exchange rate and large departures from its
equilibrium value.

Current account convertibility

Current account convertibility allows free inflows and outflows for all purposes other than for
capital purposes such as investments and loans. In other words, it allows residents to make
and receive trade-related payments receive dollars (or any other foreign currency) for
export of goods and services and pay dollars for import of goods and services, make sundry
remittances, access foreign currency for travel, studies abroad, medical treatment and gifts,
etc.

Advantages of Current account convertibility:

(1) Facility to send the foreign earnings to India freely :

Current account convertibility allows you to receive and convert the earnings sent by your
family members working in abroad without going under a complex procedure as earlier.

(2) Flourish the international trade :

Current account convertibility leads to smoother exchange of foreign exchange into domestic
currency and vice versa. This helps in integrating the trade activities among different
countries of the world. It enhances the international trade relations between the countries by
removing the exchange barriers.

(3) Imports and exports can be done at fair rates determined by the market :

Earlier when there was no free current account convertibility one needs to surrender either
some portion of their foreign exchange receipt or should convert it in to Indian rupees at the
rates determined by RBI. Usually the rate determined used to be less than the rate determined
by the market. Hence current account convertibility allows you to convert your foreign
exchange at the rates determined by the market which is more fair than pre determined rates.

FDI - FOREIGN DIRECT INVESTMENT


Foreign direct investment (FDI) is an investment made by a company or individual in one
country in business interests in another country, in the form of either establishing business
operations or acquiring business assets in the other country, such as ownership or controlling
interest in a foreign company. Foreign direct investments are distinguished from portfolio
investments in which an investor merely purchases equities of foreign-based companies. The
key feature of foreign direct investment is that it is an investment made that establishes either
effective control of, or at least substantial influence over, the decision making of a foreign
business.

India has become one of the largest recipients of foreign direct investment on account of
reform measures taken by the government, the Economic Survey for 2016-17

The government has liberalised and simplified the foreign direct investment (FDI) policy in
sectors like defence, railway infrastructure, construction and pharmaceuticals.

It said many new initiatives have been taken up to facilitate investment and ease of doing
business in the country such as Make-in-India, Invest India, Start Up India and e-biz Mission
Mode Project.

Methods of Foreign Direct Investment

Foreign direct investments can be made in a variety of ways, including the opening of a
subsidiary or associate company in a foreign country, acquiring a controlling interest in an
existing foreign company, or by means of a merger or joint venture with a foreign company.

The threshold for a foreign direct investment that establishes a controlling interest, per
guidelines established by the Organization of Economic Cooperation and Development
(OECD), is a minimum 10% ownership stake in a foreign-based company, typically
represented for the investor acquiring 10% or more of the ordinary shares or voting shares of
a foreign company. However, that definition is flexible, as there are instances where effective
controlling interest in a firm can be established with less than 10% of the company's voting
shares.

Foreign direct investments are commonly categorized as being horizontal, vertical or


conglomerate in nature. A horizontal direct investment refers to the investor establishing the
same type of business operation in a foreign country as it operates in its home country, for
example, a cell phone provider based in the United States opening up stores in China. A
vertical investment is one in which different but related business activities from the investor's
main business are established or acquired in a foreign country, such as when a manufacturing
company acquires an interest in a foreign company that supplies parts or raw materials
required for the manufacturing company to make its products. A conglomerate type of
foreign direct investment is one where a company or individual makes a foreign investment
in a business that is unrelated to its existing business in its home country. Since this type of
investment involves entering an industry the investor has no previous experience in, it often
takes the form of a joint venture with a foreign company already operating in the industry.
FOREIGN PORTFOLIO INVESTMENT

Foreign portfolio investment (FPI) consists of securities and other financial assets passively
held by foreign investors. It does not provide the investor with direct ownership of financial
assets and is relatively liquid depending on the volatility of the market. Foreign portfolio
investment differs from foreign direct investment (FDI), in which a domestic company runs a
foreign firm, because although FDI allows a company to maintain better control over the firm
held abroad, it may face more difficulty selling the firm at a premium price in the future.

FPI is part of a countrys capital account and shown on its balance of payments (BOP). The
BOP measures the amount of money flowing from one country to other countries over one
monetary year. It includes the countrys capital investments, monetary transfers, and the
number of exports and imports of goods and services.

Foreign Portfolio Investment (FPI) is investment by non-residents in Indian securities


including shares, government bonds, corporate bonds, convertible securities, infrastructure
securities etc. The class of investors who make investment in these securities are known as
Foreign Portfolio Investors.

SEBI has recently stipulated the criteria for Foreign Portfolio Investment. According to this,
any equity investment by non-residents which is less than or equal to 10% of capital in a
company is portfolio investment. While above this the investment will be counted as Foreign
Direct Investment (FDI).

Investment by a foreign portfolio investor cannot exceed 10 per cent of the paid up
capital of the Indian company. All FPI taken together cannot acquire more than 24 per cent of
the paid up capital of an Indian Company. As per SEBI regulations, FPIs are not allowed to
invest in unlisted shares and investment in unlisted entities will be treated as FDI.

Who are Foreign Portfolio Investors?

Foreign Portfolio Investors includes investment groups of Foreign Institutional


Investors (FIIs), Qualified Foreign Investors (QFIs) (Qualified Foreign Investors) and
subaccounts etc. NRIs doesnt comes under FPI.

After the new SEBI guidelines, the RBI stipulated that Foreign Portfolio Investors
include Asset Management Companies, Banks, Pension Funds, Mutual Funds, and
Investment Trusts as Nominee Companies, Incorporated / Institutional Portfolio Managers or
their Power of Attorney holders, University Funds, Endowment Foundations, Charitable
Trusts and Charitable Societies etc. Sovereign Wealth Funds are also regulated as FIIs.

Who is a Foreign Institutional Investor?

FII is an institution like a mutual fund, insurance company, pension fund etc.
According to SEBI, an FII is an institution established or incorporated outside India which
proposes to make investments in India in securities. FII is an institution who is registered
under the Securities and Exchange Board of India (Foreign Institutional Investors)
Regulations, 1995. FIIs comprised of a pension fund, a mutual fund, investment trust,
insurance company or a reinsurance company.

Who is a Qualified Foreign Investor?

QFI is an individual, group or association which is a resident in a foreign country. The


QFI should compliant with the Financial Action Task Force standard and should be a
signatory to the International Organisation of Securities Commission.

In order to harmonize the various available routes for foreign portfolio investment in India,
the Indian securities market regulator i.e. Securities Exchange Board of India (SEBI) has
introduced a new class of foreign investors in India known as the Foreign Portfolio Investors
(FPIs). This class has been formed by merging the existing classes of investors through
which portfolio investments were previously made in India namely, the Foreign Institutional
Investors.(FIIs), Qualified Foreign Investors (QFIs) and sub-accounts of the FIIs.
Previously portfolio investment was governed under different laws i.e. the SEBI (Foreign
Institutional Investors) Regulations, 1995 (FII Regulations) for FIIs and their subaccounts
and SEBI circulars dated August 09, 2011 and January 13, 2012 governing QFIs, which are
now repealed under the SEBI (Foreign Portfolio Investors) Regulations (FPI Regulations)
that govern FPIs. SEBI has, thus, intended to simplify the overall operation of making foreign
portfolio investments in India.

Essentially, foreign portfolio investment entails buying of securities, traded in another


country, which are highly liquid in nature and, therefore, allow investors to make quick
money through their frequent buying and selling. Such securities may include instruments
like stocks and bonds, and unlike shares, they do not give managerial control to the investor
in a company. To govern FPIs, SEBI introduced the FPI Regulations by a notification dated
January 7, 2014. In this newsletter, we will discuss the legal framework that will govern FPIs,
how FPIs will be taxed and the effect of this new regime on foreign portfolio investment in
India.

FOREIGN INSTITUTIONAL INVESTORS

Private Equity Funds


Partnership / Proprietorship Firm
Others

Foreign Institutional Investor (FII) means an institution established or incorporated outside


India which proposes to make investment in securities in India. They are registered as FIIs in
accordance with Section 2 (f) of the SEBI (FII) Regulations 1995. FIIs are allowed to
subscribe to new securities or trade in already issued securities. This is just one form of
foreign investments in India, as may be seen here:
However, FII as a category does not exist now. It was decided to create a new investor class
called "Foreign Portfolio Investor" (FPI) by merging the existing three investor classes viz.
FIIs, Sub Accounts and Qualified Foreign Investors. Accordingly, SEBI (Foreign Portfolio
Investors) Regulations, 2014 were notified on January 07, 2014 followed by certain other
enabling notifications by Ministry of Finance and RBI. In order to ensure the seamless
transition from FII regime to FPI regime, it was decided to commence the FPI regime with
effect from June 1, 2014 so that the requisites systems and procedures are in place before
migration to the new FPI regime.

With the new FPI regime, which has commenced from 1 June 2014, it has now been decided
to dispense with the mandatory requirement of direct registration with SEBI and a risk based
verification approach has been adopted to smoothen the entry of foreign investors into the
Indian securities market.

FPIs have been made equivalent to FIIs from the tax perspective, vide central government
notification dated 22nd January 2014.

FII Vs FDI: International standards and Indian definition


According to IMF and OECD definitions, the acquisition of at least ten percent of the
ordinary shares or voting power in a public or private enterprise by non-resident investors
makes it eligible to be categorized as foreign direct investment (FDI). (see OECD benchmark
definition) In India, a particular FII is allowed to invest upto 10% of the paid up capital of a
company, which implies that any investment above 10% will be construed as FDI, though
officially such a definition did not exist. It may be noted that there is no minimum amount of
capital to be brought in by the foreign direct investor to get the same categorised as FDI.

Given this backdrop, in the Union Budget 2013-14, announced on 28 February 2013, vide
para 95, Honourable FM announced his intention to go by the internationally accepted
definition for FIIs and FDIs, as stated below:

"In order to remove the ambiguity that prevails on what is Foreign Direct Investment (FDI)
and what is Foreign Institutional Investment (FII), it is proposed to follow the international
practice and lay down a broad principle that, where an investor has a stake of 10 percent or
less in a company, it will be treated as FII and, where an investor has a stake of more than 10
percent, it will be treated as FDI. A committee will be constituted to examine the application
of the principle and to work out the details expeditiously."
Meanwhile, to rationalize/harmonize various foreign portfolio investment windows and to
simplify procedures, SEBI had formed a Committee on Rationalization of Investment
Routes and Monitoring of Foreign Portfolio Investments under the chairmanship of Shri K.
M. Chandrasekhar, former Cabinet Secretary. The Committee submitted its report on June 12,
2013.

In accordance with the budget announcement, a committee has been constituted under the
chairmanship of Secy (DEA), to examine and work out the details of the application of the
principle followed internationally for defining FDI and FII. The committee submitted its
report in June 2014. Based on the Committee recommendations and subsequent to the issue
of SEBI (FPI) Regulations, 2014, any investment beyond 10% in a company is termed as
FDI. Further, any investment in an unlisted entity, even if it is only one or two percentage of
the paid up capital will also be treated as FDI. An FPI is not allowed to invest in the equity of
unlisted companies, while they can invest in the listed companies or to-be listed companies
(i.e., at the time of IPO) through the stock exchange.

In India, FDI and FII are defined in Schedule 1 and 2 respectively of the Foreign Exchange
Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations
2000.

Who can get registered as FII?


Following foreign entities / funds are eligible to get registered as FII:

1. Pension Funds
2. Mutual Funds
3. Investment Trusts
4. Banks
5. Insurance Companies / Reinsurance Company
6. Foreign Central Banks
7. Foreign Governmental Agencies
8. Sovereign Wealth Funds
9. International/ Multilateral organization/ agency
10. University Funds (Serving public interests)
11. Endowments (Serving public interests)
12. Foundations (Serving public interests)
13. Charitable Trusts / Charitable Societies (Serving public interests)

FDI VS FII
Here are the some contrasts between FDI and FII.
Meaning:
When any organization in one nation makes an investment in any organization in abroad, it is
mostly called as foreign direct investment or FDI.
When any organization in abroad make investment in the market related to stock of a nation
then this investor is called foreign institutional investor or FII.
Brings:
Foreign direct investment brings long term capital in the company where investment is made
by other company.
Foreign institutional investor brings short or long term capital in the nation.
Access or leave:
Foreign direct investment does not give an easy access or exit to the stock market. FII gives
an easier access to stock market and also allow an investor to leave the stock market.
Transfer:
In foreign direct investment, transfer of technologies, funds, strategies or resources is done.
In FII, only funds are transferred through this institution.
Economic growth:
Foreign direct investment helps to increase the job opportunities in the country which leads to
increase in living standard of people, also develops the infrastructure of the investee country
and all of this helps in the economic growth so FDI plays its role in economic growth of the
country. Foreign institutional investor does not play any part in the economic growth of
country.
Making money:
Foreign direct investment does not give an easy way in making money quickly as it includes
complex procedures.
FII allows the investor to make money quickly from the stock market.
Results:
By having foreign direct investment, there is the increase in productivity, job opportunities
and eventually it helps to increase the economic growth of the country.
The main consequence of FII is that there is an increase in capital of country.
Target:
Foreign direct investment targets any specific company for investment.
FII never targets any specific company.
Control:
Through FDI, there is the administration control in company.
FII does not help to get such kind of control in company.

KEY DIFFERENCES BETWEEN FDI AND FII

The significant differences between FDI and FII are explained below:

1. Foreign Direct Investment or FDI is defined as the investment made by a company in


the company situated outside the country. Foreign Institutional Investor or FII is when
investors, most commonly in the form of institutions that invest in the countrys
financial market.

2. FII is a way to to make quick money, the entry and exit to the stock market are very
easy. On the other hand, the entry and exit are not easy in FDI.
3. FDI brings long-term capital in the investee company whereas FII may bring long or
short term capital in the country.

4. In the case of FDI, there is the transfer of funds, resources, technology, strategies,
know-how. Conversely, FII involves the transfer of funds only.

5. FDI increases job opportunities, infrastructural development in the investee country


and thus leads to economic growth, which is not in the case of FII.

6. FDI results in the increase in the countrys productivity. As opposed to FII that results
in the increase in the countrys capital.

7. FDI targets a particular company, but FII does not target a particular company.

8. FDI obtains management control in the company. However, FII does not enable such
control.
BASIS FOR
FDI FII
COMPARISON

Meaning When a company situated in one FII is when foreign


country makes an investment in a companies make
company situated abroad, it is investments in the stock
known as FDI. market of a country.

Entry and Exit Difficult Easy

What it brings? Long term capital Long/Short term capital

Transfer of Funds, resources, technology, Funds only.


strategies, know-how etc.

Economic Growth Yes No

Consequences Increase in country's Gross Increase in capital of the


Domestic Product (GDP). country.

Target Specific Company No such target, investment


flows into the financial
market.

Control over a Yes No


company
FDI Fll

FDI is when foreign company FII is when a foreign company


brings capital into a country or an buys equity in a company through
economy to set up a production or the stock markets. Therefore, in
1
some other facility. FDI gives the this case, FII would not give the
foreign company some control in foreign company any control in
the operations of the company the company

FDI involves in the direct FII is a short term investment


2 production activity & also of mostly in the financial markets &
medium to long term nature it consist of FII

It enables a degree of control in the It does not involve obtaining a


3
company degree of control in a company

4 FDI brings-long term capital FII brings short-term capital

CAPITAL FLIGHT

Capital flight is the movement of capital from one country to another, or sometimes from one
investment sector to another, to capitalize on returns or mitigate risk.

Capital flight denotes large scale outflow of capital (investment etc.) from an economy. Such
a mass movement or exodus of money mainly invested in a countrys financial markets occur
either due to some undesirable development in the domestic economy or due to some positive
development in other economies.

Usually capital flight occurs in developing countries who accepts huge amount of foreign
capital to promote domestic investment.

Cause of capital flight

Both domestic (push) and external (pull) factors may create capital flight. The term flight is
obviously used from the angle of the host developing economy like India which holds such
capital (in the form of foreign investment mostly).

An example for (push) is the increase in interest rate by the US Fed may make high returns
for US financial assets. Increase in US interest rate implies more interest rate in US banks.
Here the US investors who have invested in India may find that US is also attractive now
because of the rate of interest hike there.
Another reason (pull) is the trouble in the domestic economy. an example here is the East
Asian crisis of 1997 where failure of many East Asian banks triggered mass withdrawal of
foreign deposits.

Impact of capital flight

On the impact side, because of capital flight, foreign currencies may become scarce in
domestic foreign exchange market. Such a situation will cause depreciation of the domestic
currency. it will reduce money available for domestic investment. If the capital flight is big
macroeconomic crisis may appear.

CROWDING OUT EFFECT

A situation when increased interest rates lead to a reduction in private investment spending
such that it dampens the initial increase of total investment spending is called crowding out
effect.

Sometimes, government adopts an expansionary fiscal policy stance and increases its
spending to boost the economic activity. This leads to an increase in interest rates. Increased
interest rates affect private investment decisions. A high magnitude of the crowding out effect
may even lead to lesser income in the economy.

With higher interest rates, the cost for funds to be invested increases and affects their
accessibility to debt financing mechanisms. This leads to lesser investment ultimately and
crowds out the impact of the initial rise in the total investment spending. Usually the initial
increase in government spending is funded using higher taxes or borrowing on part of the
government.
BUDGET

An annual financial statement of income and expenditure is generally used for a govenrment,
but it could be a firm , company, corporation etc. This word had his origin from french word
'Bugeut' in mid 18th century meaning a leather bag out of which the financial statement was
brought out and presented in the parliament. The constitution of India has a provision
(Art.112) for such a document called Annual Financial statement to be presented in the
parliament before the commencement of every new fiscal year - popular as the union budget.

REVENUE BUDGET

The part of the Budget which deals with the income and expenditure of revenue by the
government. This presents the annual financial statement of the total revenue receipts and the
total revenue expenditure - if the balance emerges to be positive it is a revenue surplus
budget, and if it comes out to be negative, it is a revenue deficit budget.

CAPITAL BUDGET

The part of the Budget which deals with the receipts and expenditures of the capital by the
government. This shows the means by which the capital is managed and the areas where
capital is spent.

REVENUE

Every form of money generation in the nature of income, earnings are revenue for a firm or a
government which do not increase financial liabilities of the government i.e., the tax incomes,
non-tax incomes along with foreign grants.

NON-REVENUE

Every form of money generation which is not income or earnings for a firm or a government
(i.e., money raised via borrowings) is considered a non-revenue source if they increase
financial liabilities.

RECEIPTS

Every receiving or accrual of money to a government by revenue and non revenue sources is
a receipt. Their sum is called total receipts. It includes all incomes as well as non-income
accruals of a government.

REVENUE RECEIPTS

Revenue receipts of a government are of two kinds - Tax Revenue Receipts and Non-tax
Revenue Receipts - consisting of the following income receipts in India :

1. TAX REVENUE RECEIPTS

This includes all money earned by the government via the different taxes the government
collects i.e., all direct and indirect tax collections
2. NON-TAX REVENUE RECEIPTS

This includes all money earned by the government from sources other than taxes. In India
they are

1. Profits and dividends which the government gets from its public sector undertakings
(PSU).
2. Interests received by the government out of all loans forwarded by it, be it inside the
country (i.e., internal lending) or outside the country (i.e., external lending). It means
this income might be in both domestic and foreign currencies.
3. Fiscal services also generate incomes for the government i.e., currency printing,
stamp printing , coinage and medals minting etc.,
4. General services also earn money for the government as the power distribution,
irrigation, banking, insurance, community services etc.
5. Fees, Penalties and Fines received by the government.
6. Grants which the governments receives - it is always external in the case of the
central government and internal in the case of state governments.

CAPITAL RECEIPTS

All non -revenue receipts of a government are known as capital receipts. Such receipts are for
investment purposes and supposed to be spent on plan-development by a government. But the
receipts might need their diversion to meet other needs to take care of the rising revenue
expenditure of a government as the case had been with India. The capital receipts in India
include the following capital kind of accruals to the government :

1. Loan Recovery - This is one source of capital receipts. The money the government
had lent out in the past in India and abroad their capital comes back to the government
when the borrowers repay them as capital receipts. The interest which come to the
government on such loans are part of the revenue receipts.
2. Borrowings by the government - This includes all long term loans raised by the
government inside the country ,internal borrowings and outside the country, external
borrowings. Internal borrowings might include the borrowings from the RBI, Indian
banks, financial institutions etc. Similarly external borrowings might include the loans
from the World Bank, the IMF, foreign banks, foreign governments, foreign financial
institutions etc.
3. Other receipts by the Governments - This include many long term capital accruals to
the government through the Provident Fund (PF), Postal Deposits, various small
saving scheme and the government bonds sold to the public (Kisan Vikas Patra, Indira
Vikas Patra, Market stabilisation Bond etc.) Such receipts are nothing but a kind of
loan on which the government needs to pay interests on their maturities. But they play
a role in capital raising process by the government.

DIFFERENT TYPES OF DEFICIT


1. REVENUE DEFICIT - If the balance of total revenue receipts and total expenditure
turns out to be negative it is known as revenue deficit, a new fiscal terminology used
since the fiscal 1997-98 in India. This shows that the government's Revenue budget is
running in losses and the government is earning less revenue and spending more
revenues - incurring a deficit.
2.