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Approach – Answer: General Studies Mains Mock Test 1223 (2019)

1. Explaining the need and objectives of land reforms in India, assess the steps taken by the government
in this regard.
Approach:
 List the need and objectives of land reforms in India.
 Assess the various land reform policies that came to be implemented since independence.
 Conclude by assessing the steps taken in this regard.
Answer:
In a narrow sense, land reform means the distribution of surplus land to small farmers and landless
tillers, accrued as a result of the implementation of the ceiling on agricultural holdings. More broadly, it
includes regulation of ownership, operation, leasing, sales, and inheritance of land.
Need for land reform in India
 In order to remove intermediaries like zamindars, landholders, farm merchants from the production
process, so that the tillers have a stake and incentive in production.
 The tendency of large land holders becoming richer and small land holders not so increases
inequality. So the land had to be redistributed.
 The dependence of a large population and weaker section of the society on agriculture.
 Various agriculture related stresses such as inadequate crop production, dependence on rainfall,
exploitation by money lenders etc, leading to farmer suicides.
 Economic harm due to decline in agriculture productivity.
 To recognize traditional rights of tribal over forest lands, preventing alienation of tribal community
and making them a stakeholder in development process.
Objectives of Land Reforms
 Initially the objective was to provide equitable distribution of land and adequate income to those
who were dependent on it.
 To keep agricultural productivity high.
 To ensure food security of the country.
 To ensure self reliance of the national economy.
 To reduce poverty and inequality.
Steps taken in order to carry forward land reforms
 Abolition of Zamindari Act.
 Tenancy regulation: to improve contractual terms including security of tenure.
 Land Ceiling: where a cap on maximum land ownership was introduced. The land in excess of limit
was distributed amongst the landless.
 Land to the tillers: taking away the land from landholders who did not cultivate it.
 Cooperative farms: to provide for a larger productive land for the community to work on.
 Appropriate compensation for the acquired land.
 The Scheduled tribes and other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006.
Being a state subject, there exist considerable variations in the results achieved by land reform
legislations trying to achieve land to the tiller policy. However, loopholes in these laws have been

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 exploited to evade land ceiling and other reforms. The most notable and successful example of land
reforms are in the states of West Bengal and Kerala. The difference in system of land records and land
administration in the hilly and tribal tracts of north-eastern States also poses challenges to land reforms.
Steps that need to be taken further:
 Government regulation should phase out eventually so that farms can directly sell in the market and
let the market forces govern the prices of farm produce.
 Protection of fertile agricultural land exclusively for agricultural purposes.
 Provision of sufficient loans and capital to the actual tiller of land.
 Promoting land leasing and contractual farming.
 Implementing Forest rights act in true spirit by all the states.

2. What are the different approaches for measurement of National Income? Explain the difficulties in
estimation of national income by each of these approaches. What steps have been taken in recent
times to improve accuracy in national income accounting?
Approach:
 Briefly explain the concept of national income.
 Mention the different approaches to measure it along with the difficulties faced.
 List the steps taken to improve accuracy in national income accounting.
Answer:
National Income is the money value of final flow of output of goods and services produced within an
economy over a period of time, usually one year and net factor income earned from abroad. It can be
measured using the following three Methods:
 Product/Value Added Method- The aggregate value of the final goods and services in different
sectors of the economy like industry, agriculture etc. is calculated by determining the total
production that was made during the specific time period. Difficulties in its estimation are:
o Data available is neither sufficient nor accurate or sufficiently detailed.
o Non-monetised: a significant part of the product (like agriculture) in rural India is bartered which
makes their valuation difficult.
o Self-consumption: The small farmers who constitute a sizeable number in India produce goods
mainly for their own use. The value of such goods cannot be computed.
o Valuation of a new good at constant prices: When a new commodity is produced for the first
time, it is easy to know its current price but difficult to get its constant price.
 Factor Income Method- National income is measured as the total sum of the factor payments (land,
labor, capital and entrepreneurship) received during a certain time period, i.e. income received by
various facrors of production. Difficulties in its estimation are:
o Ignorance: Majority of the people in India are illiterate, uneducated and ignorant. They do not
maintain account of their income and expenditure.
o Lack of occupational classification: In India, many people earn their living from more than one
occupation making it difficult to know the main source and consequently a large part of income
gets excluded from national income.
 Expenditure Method- it measures the national income as the sum total of expenditures made by
individuals on personal consumption, firms on private investments and government authorities on
government purchases. Difficulties in its estimation are:
o Transfer payments: All government expenditure on transfer payments are excluded from
national income.
o Fixed capital consumption: it is quite difficult to measure the correct value of consumption of
fixed capital (e.g. machines etc.) during the year.
o Double counting: it is difficult to exclude expenditure on all intermediate goods and services.

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 The Central Statistics Office (CSO) has adopted a new method of GDP calculation which is in line with the
United Nations System of National Accounts, 2008. It made following changes in the calculation of
national income accounting:
 Changing the base year: The CSO changed the base year from 2004-2005 to 2011-2012.
 Replacing factor costs with market prices: The concept of Gross Value Added (GVA) is considered to
be a better indicator to measure economic activities as it includes not only the cost of production but
also product subsidies and taxes.
 Widening of the data pool: The new GDP incorporates more comprehensive data on corporate
activity than the old one.
 Changes in calculation of labour income: in the new series, an Effective Labour Input (ELI) method is
used.
 Changes in calculation of agricultural income: Value addition in agriculture is now taken beyond
farm produce.
Also, based on the recommendations of NL Sarda committee, government is considering creation of one
single database for inflation, industrial output and employment.

3. Critically discuss whether limiting the Monetary Policy to primarily achieve the objective of range-
bound inflation weakens the capability of the central bank to achieve other macroeconomic goals.
Approach:
 Briefly explain the concept of Monetary Policy and its objectives.
 Analyze how inflation targeting can hamper other macroeconomic goals.
 Discuss why controlling inflation is also essential for the economy.
Answer:
Monetary Policy is the macroeconomic policy laid down by the central bank which involves management
of money supply and interest rates. It is a demand side economic policy to achieve objectives like
inflation, consumption, growth and liquidity.
Under the Monetary policy framework agreement signed between the RBI and the government, RBI has
been mandated to target inflation through monetary policy. It will strive to achieve medium term target
for Consumer Price Index inflation of 42 percent while supporting growth.
However, sometimes the inflation targeting approach of the Central Bank is criticized for hampering
other macroeconomic goals like economic growth, consumption and employment generation as
monetary policy can also be used to promote economic growth by ensuring adequate availability of
credit and lowering the cost of credit. .
As business and industry requires finance for working capital as well as for capital formations, central
bank follows a tight monetary policy to keep inflation in the intended range by raising Cash Reserve
Ratios and Statutory Liquidity Ratios. Similarly, by raising bank rate and repo rate, lending rates of
interests of banks become high. This also discourages private investments, which in turn has a spiral
effect on consumption and employment opportunities as well as capital formation.
However, it can be argued that there is little or no conflict between the objectives of price stability and
growth. Price stability is a means to ensure economic growth in long term. A large expansion in money
supply and bank credits leads to the increase in aggregate demand which tends to cause a higher
inflation.
It should also be noted that apart from demand side inflation, RBI has to take other factors into
consideration like volatile crude oil prices, global turmoil, trade wars etc.
Thus in such dynamic economic conditions there is high possibility of trade off between price stability
and other macroeconomic goals to keep the economy in balance and ensure sustainable growth for long
term.

4. Explain how Fiscal Policy can be used to control inflation, accelerate the rate of economic growth and
achieve economic stability.
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Approach:
 Introduce by explaining the concept of Fiscal policy.
 Discuss in brief how fiscal policy affects inflation, economic stability and the economic growth of the
country.
 Conclude on the basis of the above points.
Answer:
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and
influence a nation's economy. It is the sister strategy to monetary policy through which a central bank
influences a nation's money supply. These are used in various combinations to direct a country's
economic goals.
Fiscal Policy can be used to control inflation, accelerate the rate of economic growth and achieve
economic stability in the following ways:
Inflation:
Fiscal policy and budgetary measures are the effective weapons to control demand-pull inflation in two
ways:
 In case, government expenditure is the main cause behind the demand-pull inflation, then it can be
controlled by cutting down the public expenditure.
 In case, the demand rises due to the rise in private expenditure, taxing income is the most
appropriate way to control inflation.
In case of a very high persistent inflation rate, the government may adopt both these measures
simultaneously to control inflation.
Economic stabilization:
Fiscal policy plays a leading role in maintaining economic stability in the face of external and internal
forces.
 External- In the period of boom, export and import duties are imposed to minimize the impact of
international cyclical fluctuations. To curb the use of additional purchasing power, heavy import duty
on consumer goods and luxury import restrictions are needed. During the period of recession,
government may undertake public works programmes through deficit financing.
 Internal- The progressive tax structure helps to counteract economic disturbance. By varying public
expenditure, the government counteracts the inflationary and deflationary situations in the
economy.
Accelerate the rate of economic growth:
The fiscal policy can affect the rate of economic growth and development of the economy in a variety of
ways such as by increasing the rate of saving and investment, controlling inflation, resource mobilization,
development of the private sector, optimization of resources allocation, creation of social and economic
overheads, balanced regional development, reduction of inequality and promoting economic stability.
Hence, the Fiscal Policy which is closely linked with the overall economic policy strategy forms a vital part
of the economic framework of a country and thus plays a very crucial role in nation’s development.

5. What are the major risks involved in foreign borrowings? Explain in the context of India.
Approach:
 Briefly discuss the need of foreign borrowings.
 Elaborate on different types of risks with suitable examples from the Indian context.
 In conclusion, briefly suggest innovative strategies to prevent the major risks involved in foreign
borrowings.
Answer:
Foreign borrowing or external debt is the debt raised by commercial and public entities of a country from
other countries or foreign sources to fill in the shortcomings of domestic financing. Today most of the

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 foreign borrowings in India are by private businesses, who borrowed at attractive rates from foreign
lenders and are linked to the dollar.
Risks associated with foreign borrowings:
 There could be unexpected changes in the interest rates charged on the foreign loans. This can, for
instance, cause widespread default when rates rise as borrowers may not be able to make higher
interest payments, thus raising the risk of a systematic crises. For example, the raising of interest
rates by U.S. Federal Reserve has already caused borrowing rates to rise in various countries,
including India, where bond yields have shot up sharply.
 Unexpected changes in exchange rate of currencies: For example, an unexpected fall in the value of
the rupee, can cause severe difficulties for Indian companies that need to pay back dollar
denominated loans as they will now have to shell out more rupees than they had previously
estimated to buy the necessary dollars.
 Corporate Borrowings: India’s corporate sector’s dollar exposure continues to grow at a fast pace,
with the increasing proportion of unhedged debt. High corporate debt poses a systemic risk because
it is widespread among sectors like infrastructure, power, road, textiles and gems and jewellery. It
can affect exports as well as employment.
 Sovereign debt risk is condition of default by the government to repay its debt. It is closely tied to
the political developments and internal policy decisions of the government. For example, the Indian
economic crisis of 1990.
 Political risk transpires when a country's government unexpectedly changes its policies, affecting
negatively the foreign corporations, for example, trade barriers, which serve to limit or prevent
international trade. This can have a significant impact on the profits of an organization because it
either cuts revenues from the result of a tax on exports or restricts the amount of revenues that can
be earned.
Despite these negative exposures, international business can open up opportunities for reduced
resource costs and larger lucrative markets through measures such as buying futures, forwards or
options on the currency market, being aware of the potential risks and having contingency plans in place
to deal with problems that may arise.

6. What is meant by Balance of Payments (BoP)? Highlight the factors which give rise to adverse BoP and
the steps that can be taken to solve it.
Approach:
 Briefly define and elaborate about different compositions of Balance of Payments (BoP).
 Highlight the factors which give rise to adverse BoP.
 Suggest the steps that can be taken to solve the problem of adverse BoP.
Answer:
The balance of payments (BoP) of a country summarizes all transactions that a country’s individuals,
companies and government bodies complete with individuals, companies and government bodies
outside the country. These transactions consist of import and exports of goods, services and capital as
well as transfer payments such as foreign aid and remittances.
The BOP is composed of three subaccounts:
 The current account consists of revenue obtained through merchandise trade, services, income
receipts, and one-way transfers.
 The capital account includes transfers of financial assets such as debt payments and transfers of
titles to assets.
 The financial account records trade in stocks, bonds, commodities, and real estate.
The factors that give rise to adverse BoP:
1. Economic Factors
 Higher levels of imports than exports resulting in a deficit in the BOP account.
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  When there is inflation in the domestic economy, foreign goods become relatively cheaper as
compared to domestic goods, which increases imports.
 Cyclical fluctuations, like recession or depression.
 Fall in demand for country’s goods in the foreign markets leads to fall in exports, thereby adversely
affecting the BoP.
 Import of Services from other countries.
2. Political Factors
 Political instability may lead to large capital outflows and reduce the inflow of foreign funds.
3. Social Factors:
 An unfavourable change for the domestic goods leads to a deficit in the BoP.
 High population growth in poor countries adversely affects their BOP because it increases the needs
of the countries for imports and decreases their capacity to export.
Remedial measures to correct imbalance in BoP are:
 The foreign earning should be increased by export led growth. Exports should be encouraged by
taking measures that make them competitive, including subsidies, duty drawbacks, logistics
improvements, etc.
 A control on unnecessary imports like gold in times when CAD comes under severe pressure.
 Inflation discourages exports and encourages imports. Therefore, inflation should be kept in check.
 Taking steps to check currency manipulation and arrest the volatility in currency exchange rate,
which will encourage foreign investment and thus, capital flows into the country.

7. What do you understand by devaluation of a currency? How is it different from currency depreciation?
Explain how an economy benefits or suffers because of depreciation.
Approach:
 Explain devaluation of currency.
 Explain the difference between devaluation and depreciation.
 Discuss the effects of depreciation on economy of a country.
Answer:
Devaluation is a monetary policy tool used by the Government of a country (through its Central Bank) to
deliberately adjust the value of its currency relatively lower than the value of another currency, group of
currencies or standard (e.g. dollar). It means that the country's currency has less purchasing power in
other countries.
Both Devaluation and Depreciation refer to downward adjustment of the value of currency, however the
major difference between the two can be summed up as follows:
 Devaluation happens in countries following Fixed/Semi-Fixed Exchange Rate. Depreciation happens
in countries following Floating Exchange Rate.
 In Devaluation, the government (through its Central Bank) decides what should be the rate of its
currency as compared to the currencies of other countries. In depreciation, the global demand and
supply of currency determines the value of a country’s currency. The exchange rate among
currencies change every day as the investors re-evaluate new information.
 In devaluation, the government pledges to buy and sell as much of its currency as needed to keep its
exchange rate the same. In depreciation, while a country’s government and central bank can try to
influence its exchange rate relative to other currencies; in the end it is the free market that
determines the exchange rate.
Effects of Depreciation of Currency on Economy:
 On Export: When the value of a currency e.g. Rupee depreciates in terms of dollars, it means that 1
dollar can buy more things in India i.e. the prices of Indian Exports will fall. This will cause the
increase in quantity demanded of Indian exports.

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  On Import: Depreciation makes the imports from foreign countries more expensive. Therefore, it
reduces import. Because India imports large quantity of Petroleum and Gold, the depreciation of
rupee affects negatively to its economy.
 On Balance of Trade: With exports increasing and imports declining, it is expected that depreciation
will reduce a country’s trade deficit. However, if the demand for import is inelastic e.g. of Crude Oil,
the demand will not decrease despite depreciation and this will worsen the balance of trade.
Economists believe that the effect of depreciation on BOT can go both ways.
 On Aggregate Demand: Higher prices of imports also induce individuals and firms in India to import
less and substitute domestically produced goods for imports from abroad. Due to increase in exports
and decline in imports, the net aggregate demand for domestically produced goods will increase.
 On Price Level and Inflation: It tends to raise the price level in the country and thus increase the rate
of inflation.
 On National Income: Since National income depends upon Net Export (X-M), it can stimulate the
economy or increase its GDP only when the value of total Export becomes more than the value of
total import. In short term, depreciation is likely to increase the real GNP and Price Level.
When all countries attempt to devalue their currencies, there will be no gain in real income for any of
them. Such a situation actually occurred during the early years of Great Depression (1929-33). Also,
many countries follow the policy of competitive devaluation of their currencies to bring adverse effects
on economies of other countries, called Beggar-thy-Neighbour Policy. Both China and USA (protectionist)
have been criticised to follow such policy.

8. Explain the process of credit creation by the banking system in an economy. Also, highlight the factors
which limit the power of commercial banks to create credit.
Approach:
 Briefly define credit creation and then explain the process for the same.
 Discuss the factors that limit the ability of banks to create credit.
 Conclude by mentioning the significance of credit creation for economy.
Answer:
Credit Creation means that on the basis of primary deposits commercial banks make loans and expand
the money supply. It results in the multiple expansion of banks demand deposits. It is the most important
function of a commercial bank.
Process of Credit Creation
 The money supplied by commercial banks is called credit money. Commercial banks create credit by
advancing loans and purchasing securities. They lend money to individuals and businesses out of
deposits accepted from the public.
 However, commercial banks cannot use the entire amount of public deposits for lending purposes.
They are required to keep a certain amount as reserve with the central bank for serving the cash
requirements of depositors.
 After keeping the required amount of reserves, commercial banks can lend the remaining portion of
public deposits. This tendency of the commercial banks to make loans several times of the excess
cash reserves kept by the bank is called creation of credit.
Factors limiting credit creation power
 Amount of Cash: Higher the cash of commercial banks in the form of public deposits, more will be
the credit creation. However, the amount of cash to be held by commercial banks is controlled by the
central bank.
 Cash Reserve Ratio: If the ratio falls, credit creation would be more.
 Banking habits of the people: If people do not deposit money in the bank, the credit creation cycle
would not kick start.
 Nature of business conditions in the economy: credit creation would be small when the economy
enters into the depression phase. This is because in depression phase, businessmen do not prefer to
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 invest in new projects. In the other hand, in prosperity phase, businessmen approach banks for
loans, which lead to credit creation
 Leakages in credit creation: It implies outflow of cash. It also severely impacts credit creation.
 Sound Securities: Availability of securities is necessary for granting loan otherwise credit creation
will not occur.
 In addition, excess reserves, behaviour of other banks, economic climate, liquidity preference and
monetary policy are also important determinants.
Significance
 Credit creation by banks is one of the important and only source to generate income. And when the
reserve requirement is increased by the central bank it would directly affect the credit creation by
bank. As the lendable funds with the bank decreases and vice versa.

9. What were the key components of the economic reforms undertaken in the Indian economy in 1991?
What objectives were sought to be achieved through them? Examine how successful have they been in
meeting them.
Approach:
 Introduce by giving an outline of the conditions necessary for economic reforms of 1991.
 Mention its key components.
 Highlight the objectives that these reforms aimed to achieve.
 Conclude by evaluating the success of these reforms in meeting its indented objectives.
Answer:
A balance of payments crisis at the time opened the way for an International Monetary Fund (IMF)
program that led to the adoption of a major reform initiative in 1991.
Components
There were three key components of reforms strategy:
 Liberalization: It aimed at withdrawing unnecessary state control by dismantling ‘License Raj’ and
giving a high degree of freedom to entrepreneurs. Several initiatives were taken in this direction - de-
reservation of industries for public sector, abolition of industrial licensing, freedom of production
according to the demand etc.
 Privatization: It also induced private control of public enterprises by dis-investment and reducing the
stake of government in industrial units. .
 Globalization: It was an outcome of the above two measures, as it liberalised the external sector by
allowing partial convertibility of rupee, liberalized imports and opened the economy to foreign
capital.
Objectives
 The primary objective was to open Indian economy to global practices and thrust on market
orientation.
 It intended to break free Indian economy from sluggish single digit growth and build strong foreign
reserves.
 It wanted to achieve economic stability and remove all unnecessary restriction and state control from
the market.
 It also permitted international flow of goods, services, capital, human resources and technology
without any restrictions.
 By reducing the reserved number of sectors to 3, it incentivized the private sector to thrive in the
economy.
Evaluation
 Reforms brought about expansion of the services sector helped largely by a liberalized investment
and trade regime. They also increased consumer choices and reduced poverty significantly.

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  The share of services in GDP had increased by 20 percentage points since 1991 reflecting a decisive
change in the nature of India's economic output. Except agriculture, average growth rate has been
consistently high since 1991.
 Entrepreneurship has surged, so has infrastructural development. India has been one of the most
attractive destinations for FDI and one of the fastest growing countries. Foreign exchange reserves,
which plummeted in 1991, burgeoned year on year since then.
 However, India has not fared well in the manufacturing and agricultural sectors – the two largest
employers. It is high time for India to reset economic agenda and initiate reforms 2.0.
Reforms of 1991 were not merely a one-time event. Economic reforms have to be accompanied by
administrative and governance reforms in order to achieve the objectives of inclusive growth and
sustainable development. The reforms triggered India to pave its own unique path to development,
which still continues to be a work in progress.

10. What do you understand by the Twin Balance Sheet problem? Highlight the steps that have been taken
to address this problem. Also, discuss the role that an Asset Reconstruction Company can play in this
regard.
Approach:
 Define India’s Twin Balance Sheet Problem
 Discuss its origin in brief.
 List and briefly explain steps taken to address this problem
 Discuss the role of an ARC in this context.
Answer:
The Twin Balance Sheet (TBS) problem refers to the stress on balance sheets of banks due to non-
performing assets (NPAs) on the one hand, and heavily indebted corporates on the other.
The genesis of this problem can be found in the investment and credit boom in the mid-2000’s, followed
by problems such as soaring financing costs, and diminishing forecast revenues after the Global Financial
Crisis. The inability of corporates to repay their loans to banks due to squeezed cash flow affected the
banks’ balance sheets and hence their ability to lend more to the corporates.
Steps taken to address TBS problem:
Resolution of the TBS problem required emphasis on 4R’s i.e. Recognition, Recapitalisation, Resolution
and Reform.
Recognition:
 The extent of both stressed and non-performing assets needs to be identified through restructuring
schemes like Asset Quality Review.
 The standing committee on finance recommended public banks to make public the list of their top 30
stressed accounts involving wilful defaulters.
Recapitalisation:
 Implementation of Indradhanush plan for recapitalization of public sector lenders, to ensure
solvency and full compliance with the global capital adequacy norms.
 Basel-III scheme is also being implemented.
Resolution:
 Implementation of Scheme for Sustainable Structuring of Stressed Assets.
 Asset Reconstruction Company (ARC) may be set-up with equity funding from the government and
the RBI.
 Compromise settlement schemes.
 Strategic Debt Restructuring (SDR), Corporate Debt Restructuring (CDR) mechanism and Joint
Lenders' Forum
 Note: All these schemes have since been abolished and are now various options that can be pursued
under Insolvency and Bankruptcy code.

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 Reform:
 Banking Regulation (Amendment) Ordinance, 2017 to deal with stressed assets, particularly those in
consortium or multiple banking arrangements
 Khan Committee recommendations to strengthen Corporate Bond Market, to boost investor
participation and market liquidity in the corporate bond market to be followed.
 Introduction of new Insolvency and Bankruptcy code.
 The Economic Survey suggested Public Sector Asset Rehabilitation Agency or PARA, to buy out the
largest NPA’s from Indian banks.
Role of an Asset Reconstruction Company
 It could assume custody of the largest and most difficult-to-resolve NPAs from lenders’ balance
sheets. This would allow banks to focus on extending fresh credit and supporting the pick-up in
growth.
 ARC taking tough decisions on borrowers-gone-bad, could free bankers from the risks entailed in
large loan write-downs.
 ARCs can provide “market” feedback on valuations of NPAs and provide restructuring solutions for
the debt overhang problem.
Critical Evaluation
 The business model of ARCs is inherently based on high risk. This requires high capital to be invested
in a potentially loss making asset. The number of entities willing to undertake such a risk is very
limited.
 ARC’s are not endowed with adequate risk capital to make a sizeable impact towards
addressing/restructuring net non-performing assets of the Indian banking sector.
 There are concerns about deliberate undervaluation of impaired assets.
 There could be collusion between PSBs, the agency/agencies which purchase non-performing assets
and the sponsors/current owners of the assets.

11. Explain the concept of GDP Deflator. Can it be argued that it is a more accurate indicator of inflation, as
compared to CPI and WPI?
Approach:
 Define GDP deflator in introduction and explain how it is a measure of inflation.
 Explain CPI and WPI and mention how they are not comprehensive measure of inflation.
 Finally, discuss how GDP deflator is a more comprehensive compared to CPI and WPI.
 In conclusion, bring out why CPI is used as inflation measurement as against GDP deflator or WPI.
Answer:
The GDP deflator is the ratio of the value of goods and services an economy produces in a particular year
at current prices to that at prices prevailing during any other reference (base) year.
GDP deflator = (Nominal GDP/Real GDP)*100
This ratio basically shows to what extent an increase in GDP in an economy has happened on account of
higher prices, rather than increased output. Hence, it is a good measure of inflation.
CPI and WPI
Consumer price index (CPI) and Wholesale price Index (WPI) are popular tools to measure inflation in an
economy but they derive from price quotations for select commodity baskets only.
 WPI reflects the change in average prices for bulk sale of commodities at the first stage of transaction
while CPI reflects the average change in prices at retail level paid by the consumer.
 The CPI basket consists of services like housing, education, medical care, recreation etc. which are
not part of WPI basket.
 A significant proportion of WPI item basket represents manufacturing inputs and intermediate goods
like minerals, basic metals, machinery etc. whose prices are influenced by global factors but these
are not directly consumed by the households and are not part of the CPI item basket.
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 Thus, even significant price movements in items included in WPI basket need not necessarily translate
into movements in CPI in the short run. The rise or fall in prices at wholesale level spill over to the retail
level after a lag.
Similarly, the movement in prices of non-tradable items included in the CPI basket widens the gap
between WPI and CPI movements.
Comparison with GDP deflator
Hence, the GDP deflator is the most accurate indicator of the underlying inflationary tendency, as it
covers all goods and services produced in the economy and better gauge of inflation in the economy. The
WPI does not represent service sector, whereas CPI represents the change in the price only at the retail
level. GDP deflator thus provides a better coverage of the trends of inflation in entire economy.
Despite the comprehensiveness it is not used for monetary policy measures by RBI as it is available only
on a quarterly basis along with GDP estimates, whereas CPI and WPI data are released every month.
Also, RBI uses CPI to measure inflation as consumers experience or expect in future is what gets factored
in wage bargains and also determines the allocation of household savings across different assets. Interest
rates will also have to be sufficiently above CPI inflation, so that households continue to park their
savings in bank deposits as opposed to gold or real estate.

12. What is Outcome Budgeting? Explaining its relevance for management of public finance, highlight the
challenges in implementing it.
Approach:
 Explain what you understand by outcome budgeting.
 State its relevance for management of public finance.
 Mention the challenges in implementing outcome budgeting.
Answer:
Outcome budgeting is a budgeting technique that links budgetary outlays to specific outputs i.e. tangible
services or infrastructure provided and outcomes i.e. short-term or long-term benefits to people. It
suggests or lists estimated outcomes of each programme or scheme designed. Each government ministry
and department carries out a comprehensive outcome budgeting exercise wherein all major programmes
and schemes are mapped against outputs, benefits accruing to people and qualitative targets. These
outputs are measured not just in money but also in terms of the quality delivered. Outcome budget was
first introduced in India in 2005-06.
Relevance of outcome budgeting for management of public finance includes:

 It arms citizens with data to hold governments accountable, and in turn empowers the governments
to better orient the bureaucracy towards results.
 Programmes and schemes are linked to a comprehensive set of indicators with targets, thus ensuring
that results are more tangible.
 It helps to reduce costs by identifying budgets that do not contribute enough to outcomes and also
drives better outcomes by highlighting areas where investment can be more effective.
 Programmes that involve more than one ministry or department can be strategically linked through
the outcome budgeting process.
 Under outcome budgeting, the document shows physical dimensions of the financial budget
indicating the actual physical performance in the previous year, current year and targeted
performance during the projected (next) year.
Challenges in its implementation are:
 Capturing certain outcomes through administrative data becomes a tedious task. Thus, there is a
need for more robust systems to generate reliable data.

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  Due to outcomes being driven by multiple internal and external factors and single budget driving
multiple outcomes, it can be difficult to find a direct co-relation between resources deployed and
outcomes achieved.
 Many services are rooted in statutory obligations, which can inhibit resource re-prioritization and
flexibility over some outcomes.
 It is not possible to precisely measure the outcome of every scheme of the government.
 Programmes are often implemented without a comprehensive risk management framework. Further,
internal audit systems in the ministries are weak.
 Sometimes the budgets produced by ministries are not outcome budgets but outlay budgets. They
are merely a compilation of the intentions of programme divisions in terms of vague targets, which
often fail to become outcomes.
As a budgeting method it fixes accountability, makes budget cost effective, communicates program goals
and aids better scheme management. Hence it is more effective and pro-people. Remedial measures to
curb the challenges should be adopted to successfully implement outcome budgeting.

13. What is Capital Account Convertibility? Why has India still not adopted full capital account
convertibility?
Approach:
 Introduce the concept of Capital Account Convertibility (CAC).
 Give reasons why the government has not adopted CAC.
 Conclude with a positive point on CAC.
Answer:
Capital account convertibility (CAC) means the freedom to convert local financial assets into foreign
financial assets and vice versa at market determined rates of exchange. This implies freedom to convert
currency, both in terms of outflows and inflows, for capital transactions.
Even though the need for capital account convertibility has been highlighted time and again so as to
deepen capital markets, controls are used by India. In recent times, Indian government has taken
numerous steps in order to ease CAC via easing access to foreign capital, portfolio flows or foreign direct
investment, liberalisation of external borrowing frameworks, new instruments such as rupee-
denominated offshore bonds (also known as masala bonds) etc. However, India is still far from adopting
full capital account convertibility.
Reasons why India has not adopted full capital account convertibility

 First, CAC is better applicable in case of developed economies than emerging economies because
emerging economies are usually catching up with growth before they can fully adopt capital
convertibility.
 Second, to insulate the economy from erratic flow of capital in times of uncertainty, which can lead
to financial instability.
 Third, It may destabilise the macro-economic parameters. For e.g. it may become difficult to contain
current account deficit and the fiscal deficit, which in turn will have impact on inflation and interest
rates.
 Fourth, free convertibility may increase pressure on the foreign reserve as the current reserves may
prove to be insufficient to service the increased obligations.
 Fifth, Banking system needs to be strong for full capital account convertibility, but as of now, Indian
banks are facing huge NPA problem
Adopting a full capital account convertibility provides an opportunity to deepen domestic financial
markets because large number of investors all around the world participate. It may also aid in
accumulation of reserves, depending upon foreign inflow of currency. At the same time, it needs to be
recognized that owing to the complexities and different context of the Indian case, these changes can
only be introduced gradually and under proper watch of the government over time.

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14. Bringing out the differences between Banks and NBFCs, explain the role that NBFCs play in India's
financial landscape.
Approach:
 Bring out the differences between banks and NBFCs.
 Then discuss briefly various roles being played by NBFCs in financial landscape of India and how they
are complimenting banks.
Answer:
Banks and NBFCs are the key financial intermediaries which offers similar services to the customers,
however some basic differences exists between them.
 A NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans
and advances, acquisition of shares/stocks/government securities etc. but does not include any
institution whose principal business is that of agricultural activity, industrial activity, purchase of sale
of any goods or providing any services and sale or purchase of immovable properties whereas
commercial banks are incorporated under the Banking Regulations Act, 1949 and RBI Act.
 NBFCs cannot accept demand deposits.
 NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on
itself.
 Deposit insurance facility is not available to depositors of NBFCs, unlike in case of banks.
NBFCs are complimenting the banks in India’s financial landscape as banks alone are not able to serve all
the requirements. Various roles played by NBFCs are:
 Role in financial inclusion: NBFCs do not formally figure in bank led model of financial inclusion but
due to their wider and deeper reach in rural areas is providing essential financial services.
 Role of NBFCs in capital market: Investment activity of NBFCs sector comprises around 16 percent
of their total assets.
 Role of NBFCs in infrastructure financing: Infrastructure Finance Companies and Infrastructure Debt
Funds are NBFCs exclusively into financing the infrastructure sector. Some of these companies have
asset books running to lakhs of crores of rupees and are experts in long term project financing.
 Role as credit provider: In the context of the slowdown in bank credit in the wake of asset quality
stress in recent years, double-digit growth in credit by NBFCs emphasizes its role as credit provider.
 NBFCs are helping in attaining the objectives of macroeconomic policies of creating more jobs by
promoting SMEs and private institutions through lending them loans.
Hence, it can be easily confirmed that NBFCs are further complimenting the role played by the banks in
the financial landscape of India.

15. Bring out the difference between tax buoyancy and tax elasticity. Also, highlight the steps taken in
recent times to widen India's tax payer base.
Approach:
 Differentiate between tax buoyancy and tax elasticity.
 Discuss the steps taken in recent times to widen India’s tax payer base.
Answer:
Tax buoyancy and elasticity both are the tools for measuring the tax performance. Tax buoyancy explains
the relationship between the changes in government tax revenue growth and changes in GDP. It is an
indicator of the efficiency and responsiveness of tax revenue mobilization to GDP growth. It is calculated
as a ratio of percentage growth in tax revenues/percentage growth in nominal GDP for a given year. Tax is
considered buoyant if the gross tax revenues increase more than proportionately in response to a rise in
GDP.
On the other hand, tax elasticity refers to changes in tax revenue growth in response to changes in tax
rate. It highlights the impact of changes in the tax rate on tax revenue collection. It is calculated as a ratio
of percentage growth in tax revenue/percentage change in tax rate.
Steps taken in recent times to widen India’s tax payer base

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  Implementation of Goods and Services Tax (GST) has led to the formalization of economy and has a
positive spillover effect on income tax compliance.
 Information-driven approach and sustained efforts in tax collections. For example, tracking
transactions without a valid PAN, booking non-tax filers, pursuing potential taxpayers etc.
 Tax collectors have also been directed to identify new data sources. For e.g. mining of information
from tax deducted at source (TDS) and tax collected at source (TCS) statements to identify deductors
who have not filed the TDS returns.
 Encourage voluntary compliance by sending reminders over email and SMS to persons who had filed
their returns earlier but stopped filing.
 The Income Tax Department also followed potential non-filers through email, SMS, statutory
notices, outreach programmes etc.
 Introduced measures to control black money. For e.g. Amnesty Scheme
Further, our economy needs a culture of tax compliance so that the government can plan public
expenditure effectively and efficiently. Better socio-economic development leads to a decrease in crime
and productive communities. Hence the increase in tax compliance is beneficial for all.

16. How can a trade war impact India? Discuss in light of recent events.
Approach:
 Define trade wars.
 Highlight the recent trade war between US-China.
 Discuss its implications on global rule based order and trade.
 List its specific impact on India.
Answer:
Trade war refers to an economic conflict when a country imposes trade barriers, either tariff barriers like
import duty or non-tariff barriers like quotas, to negatively impact other nation’s trade.
The rising protectionism and a wave of de-globalization in the western world have exacerbated trade
wars.
Recent Examples
US recently imposed additional tariffs on import of steel and aluminium from other countries,
particularly China. China retaliated by imposing tariffs on US goods like automobile, soyabean etc. The
escalation of the trade conflict continues and other nations like Canada, EU and India have also imposed
retaliatory tariffs.
A trade war undermines rule based global trade order. It will undermine the global trade and recovery,
and cost $430 billion loss to global economy, according to IMF estimates. The retaliatory measures have a
domino effect and aggravate geopolitical tensions. The negative effects disproportionately affect
developing countries like India.
Negative Impact on India
 Decline in exports because of threat to rule based trade. It may also impact India’s exports to USA
under Generalized System of Preferences as India is perceived to be unduly benefitting from these
special export provisions for developing countries.
 Unsettle financial markets and discourages investment as a trade war will have inflationary impact
on the US economy and a consequent hike in interest rates by the US Fed. There has already been a
record outflow of FPI investment from India in 2017 and 2018. Trade wars will lend further volatility
to the market.
 Threat to macroeconomic stability: Decline in exports and investment slowdown will potentially hurt
the GDP, devalue rupee, and mount increasing pressure on the current account deficit (CAD).
 Trade sanctions hurt Make in India campaign because trade wars hurt investor confidence.
Positive Impact on India
 Explore bilateral trade opportunities like exporting soyabean to China
 Gain traction in export of commodities like gems, jewelry and textiles.

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  Promote collaboration between nations trying to resist protectionism on multiple fronts, especially
India and China.
 Potential to integrate in global value chain.
According to Raghuram Rajan, ‘Trade war is a lose lose situation”. It not only reduces the world trade, but
also affects the competitiveness of the tariff imposing nation. Previous trade wars like in 1930 deepened
the Great Depression, which led to job decline and loss of GDP. As a way forward, the existing
mechanisms under WTO need to be strengthened and regional cooperation and trade blocks should be
encouraged.

17. What are the salient features of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003?
Highlighting the need for its revision, mention some recommendations of the N K Singh Committee in
this regard.
Approach:
 Give a brief background of the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.
 Mention the salient features of the FRBM Act.
 Briefly suggest the need for the revision of the Act and simultaneously introduce the NK Singh
Committee recommendations.
 Mention the important recommendations of the NK Singh Committee.
Answer:
The Fiscal Deficit and Budget Management Act, 2003 was passed with the objective of engendering fiscal
sustainability by limiting central government debt and fiscal deficit levels. The salient features of the
original Act were:
 Every year, the government will bring down revenue deficit by 0.5% and eliminate it by 2008-09.
 Every year, the government will bring down fiscal deficit by 0.3% and bring it down by 3% by 2008-
09.
 Total liabilities of the Union Government should not rise by more than 9% per annum.
 Union Government would not give guarantee to loans raised by PSUs and State Governments for
more than 0.5% of the GDP in aggregate.
 Union Government would place three more documents along with the budget documents i.e.
Macroeconomic Framework Statement, Medium Term Fiscal Policy Statement and Fiscal Policy
Strategy Statement.
 At the end of the 2nd quarter, the Finance Minister would make a statement on the trend of fiscal
indicators and corrective measures taken thereof.
FRBM Act introduced considerable discipline in government spending and it forced government to raise
its revenue in order to meet fiscal targets. The target for fiscal deficit and revenue deficit was on track to
be met till 2008. However, post financial crisis, the act was amended to increase the fiscal deficit limits.
After that, it has been amended many times along with the yearly budget in order to revise the fiscal
targets and deadlines for meeting them. The deadlines for the implementation of the targets in the Act
were suspended with impunity in 2009 in wake of financial crisis. There was also non-transparency in
measuring deficits and achieving of the targets. Also, targets seemed too rigid. Hence, there is a case for
its revision.
Thus, in 2016, NK Singh Committee was set up to review the FRBM Act and its main recommendations
include:
 The government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020 cut it to
2.8% in 2020-21 and 2.5% by 2023. Enact a new Debt and Fiscal Responsibility Act and in pursuance
of the new Act, enact and adopt the Debt and Fiscal Responsibility Rules.
 Adopt a medium term ceiling for general government debt of 60% of GDP, to be achieved by no later
than Financial Year 2023. Within the given ceiling adopt a ceiling of 40% for the Centre and a balance
of 20% for the States.
 Revenue deficit to GDP ratio to decline steadily by 0.25% age points each year with the path
specified as follows: 2.3% in Financial Year (FY) 2017, 2.05% in FY18, 1.8% in FY19, 1.55% in FY 20,
1.30% in FY21, 1.05% in FY22 and .8% in FY23.

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  It allowed for deviations in certain conditions such as national security, calamities of national
proportion, far reaching structural reforms in the economy, sharp decline in real output growth of
atleast 3 percentage points below the average for the previous 4 quarters etc.
 Constitute a Fiscal Council to prepare multi-year fiscal forecasts, recommend changes in the fiscal
strategy etc.

18. Bring out the difference between proportional, progressive, regressive and degressive taxation. Also
explain why progressive taxation is desirable and popular all over the world.
Approach:
 Highlight the differences between proportional, progressive, regressive and degressive taxation.
 Explain why progressive taxation is desirable and popular all over the world.
 Briefly state the negative repercussions of adoption of a progressive taxation system.
Answer:
The differences between proportional, progressive, regressive and degressive taxation are:
 Proportional Taxation: A tax is called proportional when the rate of taxation remains the same as the
income of the taxpayer increases. In this tax system, all incomes are taxed at a uniform rate,
irrespective of whether the taxpayer’s income is high or low.
 Progressive Taxation: A tax is called progressive when the rate of taxation increases as the taxpayer’s
income increases. In other words, lower income is taxed at a lower rate, whereas higher income is
taxed at a higher rate. A progressive tax takes a larger percentage of people’s income, the larger is
their income.
 Regressive Taxation: A regressive tax is one in which the rate of taxation decreases as the taxpayer’s
income increases. In other words, lower income is taxed at a higher rate, whereas higher income is
taxed at a lower rate. It takes a smaller percentage of people’s income the larger their income is.
 Degressive Taxation: A tax is called degressive when the rate of progression in taxation does not
increase in the same proportion as the increase in income. The tax rate increases up to a point and is
constant thereafter. So, degressive tax is a combination of progressive and proportional taxation - it is
mildly progressive. Thus, the tax payable increases only at a diminishing rate.
The reasons why progressive taxation is desirable and popular all over the world are:
 It is equitable as higher income earners are charged more than lower income earners.
 It is economical, as the cost of collection does not rise when the rate of tax increases.
 It is productive as it yields more revenue.
 It complies with canons of elasticity as a rise in income automatically leads to taxation at a higher
rate. Thus, revenue increases with economic expansion.
 It can lead to better distribution of income and wealth, hence, an increase in general welfare of the
community.
However, it has negative repercussions as it can dampen incentive to work and save, thus, lowering
capital formation. There is also greater scope for tax evasion as higher rate of taxes encourages taxpayers
to evade their income.

19. Bring out the difference between fixed and flexible exchange rate systems. Explain how the flexible
exchange rate system is a system of automatic adjustment in the balance of payments disequilibrium.
Approach:
 Differentiate between fixed and flexible exchange rates
 Discuss why the flexible exchange rate system acts as an automatic adjustment
Answer:
Fixed Exchange Rates
 The fixed exchange rate is officially fixed by the government or a competent authority, not by the
market forces.

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  It keeps the value of the currency fixed against the value of other currencies.
 In this, government intervenes at the time of high inflation to stablise the currency.
Flexible Exchange Rate
 A flexible exchange rate, also known as a floating exchange rate, is a rate which is set according to
the demand and supply of market forces, which is in turn determined by the country’s economic
situation.
 It is particularly determined concerning other currencies, that is, higher the demand of particular
currency, the higher it's exchange rate.
In this, there is no interference of government and the value of currency is fluctuated or shifted freely
according to the demand and supply of international exchange.
In case of a balance of payment disequilibrium, a flexible exchange rate acts as an automatic adjustment
as under flexible (or floating) exchange rates, the disequilibrium in the balance of payments is
automatically solved by the forces of demand and supply for foreign exchange. With depreciation,
imports become costly and thus there is an automatic reaction of reducing them to the extent that they
are elastic. For example, imports of unnecessary goods may be postponed due to their higher costs.
Therefore, there is automatic stabilisation in the BoP account. As such, the equilibrium exchange rate
that creates external equilibrium is automatically achieved by a depreciation (or appreciation) of a
country’s currency in case of a deficit (or surplus) in its balance of payments.

20. The central bank adopts quantitative and qualitative methods to control credit creation by commercial
banks. What is the difference between quantitative and qualitative methods? Also, explain the
concepts of Repo Rate, Cash Reserve Ratio and Statutory Liquidity Ratio.
Approach:
 Define quantitative and qualitative methods to control credit.
 Define Repo, SLR, CRR.
Answer:
The various methods employed by the RBI to control credit creation power of the commercial banks can
be classified in two groups, viz., quantitative controls and qualitative controls.
 Quantitative controls are designed to regulate the volume of credit created by the banking system,
while qualitative measures or selective methods are designed to regulate the flow of credit in
specific uses.
 Some quantitative methods are as under:
o Bank Rate: It has been discontinued as a policy instrument. It was the rate at which banks
borrowed for long term from the RBI. Now it has been aligned to the penal rate, i.e. the MSF
rate, which is usually 1 percentage point higer than repo rate.
o Open Market Operations: Open market operations refer to the sale and purchase of securities
by the Central bank to the commercial banks. A sale of securities by the Central Bank, i.e., the
purchase of securities by the commercial banks, results in a fall in the total cash reserves of the
latter.
o Variable Reserve Ratios: Variable reserve ratios refer to that proportion of bank deposits that
the commercial banks are required to keep in the form of cash to ensure liquidity for the credit
created by them. A rise in the cash reserve ratio results in a fall in the value of the deposit
multiplier. Conversely, a fall in the cash reserve ratio leads to a rise in the value of the deposit
multiplier.
 Qualitative methods to control credit are as under:
o Margin requirements: This refers to difference between the securities offered and amount
borrowed by the banks.
o Consumer Credit Regulation: This refers to issuing rules regarding down payments and
maximum maturities of instalment credit for purchase of goods.
o RBI Guidelines: RBI issues oral, written statements, appeals, guidelines, warnings etc. to the
banks.
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 o Rationing of credit: The RBI controls the Credit granted / allocated by commercial banks.
o Moral Suasion: Psychological means and informal means of selective credit control.
o Direct Action: This step is taken by the RBI against banks that don’t fulfil conditions and
requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a
penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.
Repo rate, CRR and SLR
 Repo rate: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case
of India) lends money to commercial banks for short-term in the event of any shortfall of funds. Repo
rate is used by monetary authorities to control inflation.
 CRR: Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers,
which commercial banks have to hold as reserves either in cash or as deposits with the central bank.
CRR is set according to the guidelines of the central bank of a country.
 SLR: SLR, statutory liquidity ratio is the amount of money that is invested in certain specified
securities predominantly central government and state government securities.

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