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B
Contents

03 09 24 39
Chapter 1 Chapter 2 Chapter 3 Chapter 4
Introduction to National Income Economic Growth Money Supply
Economics and Development

50 67 84 102
Chapter 5 Chapter 6 Chapter 7 Chapter 8
Banking (Part I) Banking (Part II) Inflation Financial Markets

1
123 147 176 201
Chapter 9 Chapter 10 Chapter 11 Chapter 12
Taxation Government External Sector Economic Planning
Budgeting

220 246 277 296

Chapter 13 Chapter 14 Chapter 15 Chapter 16
Industries Financial Inclusion Global Economic Agriculture and
Institutions Food Management

328 353 360

Chapter 17 Previous Year Key Highlights
Infrastructure Questions of Economic
Survey 2020-21

2
 CHAPTER - 1

INTRODUCTION TO ECONOMY

Economics allocation of various natural resources

to maximize the welfare of society.

• The term 'economics' derives from two • We can thus see that 'the problem
Greek words, 'eco' meaning home and of scarcity' is at the heart of study of
'nomos' refers to accounts. economics and thus:
• The subject has developed from being » Scarcity implies that human wants for
about how to maintain the family
goods, services or the resources exceed
accounts into the wide-ranging subject
what is available.
of today.
» Economics tries to balance between
scarcity and choice.
» Economics finds methods of reconciling
Evolution of Economics unlimited wants with limited resources.
• Economics has grown in scope, very
gradually up to the 19th century, however
at an accelerating rate ever since. Significance of Economics
• It was only in the 18th century, that • Resources are finite, and people and
Economics grew as a separate field of governments must make choices.
study when leading philosophers tried to Economics help us know how societies,
answer questions on the driving force of governments, businesses, households,
various economic activities and debated and individuals allocate these scarce
the role that governments should play resources.
with regards to this. • For example, from the limited budget
for agriculture, governments decide
how much to contribute for agricultural
Defining economics subsidies and for agricultural
infrastructure.
• There are a number of definitions of
Economics: • Economics provides us valuable
knowledge for arriving at decisions in
» Economics is a social science focused everyday life.
on the satisfaction of needs and wants • With the help of economics, we can
through the efficient allocation of scarce evaluate government policies and their
resources which have alternative usages. likely outcomes. It provide us with valuable
» It is the science which studies human insights on the state of economy.
behavior as a relationship between ends • Broadly, it tries to answer the following
and scarce means which have alternative three questions:
uses.
» By extension of our basic definition, » What goods and services to produce?
economics, as applied to national and » How to produce these goods and services?
societal level, is concerned with the efficient
» Whom to produce these for?

3
Branches of Economics
• Economics is generally divided into two
main branches, Microeconomics and
Macroeconomics.
Microeconomics
• Microeconomics focuses on the actions
of individual agents within the economy,
like households, workers, and businesses.
• For example, if a person earns 50,000 INR • Free market economies are also known
monthly, how much should he save and
how much should he spend? How should
he allocate his expenditure budget
between different goods and services,
given his unique likes and dislikes?
• Microeconomics believes in the rational
actor model. In this model, individual
actors are considered as rational beings
who make rational calculations to
maximize their utility (well-being) through
their economic decisions.
Macroeconomics
• Macroeconomics is branch of economics
which looks at the economy as a whole.
• It concentrates on broad issues such
as the GDP growth, unemployed rate,
the inflationary increase in prices,
government deficits, and levels of exports
and imports.
• Macroeconomics tries to understand • In a capitalist economy, capital assets, for
what drives the business cycle from boom
to bust, or from growth to recession, and
what controls economic indicators such as
gross domestic product, unemployment,
inflation.
These two are linked closely as the behaviour
of household or consumer or firm depends
upon the state of national as well as the
global economy and vice versa. For example,
business sentiments depend on the state of
the economy.
4
Type of Economic
Systems
Economies can be further characterized into
three types, based on the role of government
and ownership.
Free Market Economy
as the capitalist economies. Before
understanding the Capitalist Economy,
we need to understand the concept of
“Capitalism”.
• Capitalism is often believed of as an
economic system in which private
players or organizations own and control
property in accordance with their
interests, and demand and supply freely
establish prices in markets in a way that
can serve the best interests of society.
• The essential element of capitalism is the
motive to make a profit.
• The 18th-century philosopher and father
of modern economics, Adam Smith said:
“It is not from the benevolence of the
butcher, the baker, or the brewer that we
expect our dinner, but from their regard
to their own interest.”
• It is this logical self-interest that can lead
to economic success and prosperity.
instance mines, factories, and hospitals,
can be privately owned and controlled.
Labour is purchased for money wages.
Capital gains accrue to private owners,
and prices allocate capital and labour
between competing uses.
• The government's role in such an
economy is limited to regulation and
control measures. The other measures
by the government such as ensuring free
competition, consumer rights, etc., are
necessary for ensuring a free and fair
market for all participants. At times this
 role is compared to that of an umpire.
• Examples of Capitalist Economies are
USA, UK, Germany, Singapore etc.
Command Economy
• Inspired by the ideas proposed by the
German philosopher Karl Marx (1818–
1883), this type of economic system first
came up in the erstwhile USSR following
the Bolshevik Revolution (1917). It got its
perfect shape in the People’s Republic
of China (1949). This type of economic
system also spread to other countries
in Eastern Europe such as Poland and
Yugoslavia.
• In this we see two different versions of the
state economies. First, in erstwhile USSR
identified as the socialist economy and
second in pre-1985 China, known as the
communist economy.
• A socialistic economy emphasized on
the collective ownership of the means
of production (property and assets). It
also recognized a large role of the state
in running the economy. In a Socialist
Economy, all the factors of production
are under the ownership and control of
the community, indicated by State. So, all
the factories, machinery, plants, capital
etc. are owned by a community indicated
by State.
• On the other hand, the communist
economy advocated state ownership
of all properties including labour with
absolute power to state in running the
economy.
• The important decisions with respect
to production, supply and prices are
all taken exclusively by the state. Such
economies were also called as Centrally
Planned Economy, Centralized Economy
or Non-market Economy.
• Here, we need to note that, for Karl Marx,
Socialism was a transitional phase to
communism. But, it never did occur in
reality in any State.
5
• Basically, these kind of economies came
in reaction to the challenges prevalent in
the capitalist economic system.
Mixed Economy
• Mixed Economy is a combination of a
capitalistic and socialistic economy,
wherein both the market and government
decide the allocation of resources.
• Apart from private firms and consumers,
the government may itself choose
to produce or consume to affect the
resource allocation and distribution.
• This is usually done to address issues of
under-developed markets or enhance
equitable distribution across citizens.
• India follows the Mixed Economy system.
Thus, property is owned by the state as well
as private entities and the decisions are
also taken jointly by the both.
Sectors of Economy
• According to the 'three sector hypothesis',
the economic activities are broadly
classified into 3 broad categories:
Primary Sector
• It includes all those economic activities
where there is direct use of natural
resources such as agriculture, forestry,
fishing, mining etc.
• The services in this sector are entirely
dependent on the availability of the
natural resource in order to keep day to
day operations running.
• This sector forms the base for all the
other sectors of the economy.
• In India, the primary sector particularly
Agricultural sector provides employment
to almost 53% of the entire workforce
currently working and its contribution to
GDP is around 17%.
Secondary Sector
• Secondary Sector adds value to natural
resources by transforming the
material into valuable products.
• For example, cotton fibre from the plant
is used to spin yarn and weave cloth.
Sugarcane from farms is used as a raw
material to make sugar or gur. We convert
earth into bricks which are then used to
make houses and buildings.
• As these activities are associated with
industries, this sector is also called the
manufacturing or industrial sector.
• In India, the manufacturing industry
provides employment of almost 18% of
the entire workforce currently working.
Contribution of industrial sector to GDP
is around 27%.
I M A G E 1.1: T H E S E C TO R A L C O N T R I B U T I O N TO
Economies based
on the shares of the
particular sector in
GDP
6
Tertiary Sector
• This sector includes all those economic
raw activities where different services are
produced such as education, banking,
insurance, transportation, tourism etc.
• The activities in this sector help in
the development of the primary and
secondary sectors.
• This sector is also called as the Service
sector.
• In India, the tertiary sector contribution
is the largest in terms of share of GDP
at 54% and it employs 29% of the total
workforce.
Sector-wise contribution in the GDP of
India can be understood through the
following graph of 2019-2020:
GDP (%)
Agrarian Economy
• An economy is called agrarian if the share
of its primary sector is 50 % or more in the
total output (GDP) of the economy.
• At the time of independence, India was
an agrarian economy.
Industrial Economy India's direct
• If the secondary sector contributes 50%
or more to the total output (GDP) of the transformation from
economy, it is an industrial economy.
• Higher the contribution from the
primary sector to
secondary sector, the higher the level of
industrialisation.
services
• The natural economic movement for a
country is to go from agrarian economy
Service Economy to an industrial economy to a service
economy but India has leapfrogged
• If the service sector contributes 50% from an agrarian economy to a service
or more to the total output (GDP) of the economy.
economy, it is a Service Economy.
• Trend in sectoral contribution to GDP in
India.
‘India is a Service economy in terms of
contribution in GDP but Agrarian economy
in terms of dependency/employment.’

70

60

50

40

30

20

10

0
1950-51 1960-61 1970-71 1980-81 1990-92 2000-02 2007-08 2018- 19

Primary Secondary Tertiary

I M A G E 1.2: C H A N G I N G S H A R E O F VA R I O U S S E C TO R S I N GDP

Following reasons can be attributed to this
shift:
• India with educational investment
toward secondary and higher education
produced a group of highly educated
workers who have largely worked in the
service sector.
• Well educated human resource, fluent in
English and availability of skilled cheap
labour force (E.g., Cheap labour force in
IT industry as compared to some of the
developed western countries) are some
of the reasons for the rapid growth of the
service sector in the country.
• On the other hand, low growth in the
Secondary sector can be contributed
to License Raj, Restriction on foreign
investment, stringent labour laws and

7
 lack of skilled labour etc.
• Even after the LPG reforms, the lack of
availability of infrastructure, transport,
power, communication severely
impacted manufacturing and industrial
sectors. These factors also created a
base for service sectors. As compared
to secondary sector, the emergence of
various e-commerce platforms is an
example of how digital revolution can
lower transaction costs and increase
productivity which is ultimately
8
responsible for the growth in service
sector.
• Some of the other important factors are:
» Increase in per capita income- leads to
increase in demand for various services
related to education, health etc.
» Increase in tax revenue of the government-
in the form of service tax.
» Rampant migration-of rural population
to semi-urban and urban regions.
 CHAPTER - 2
NATIONAL INCOME
National Income
Accounting
• National income accounting is a book-
keeping system that a government uses
to measure the level of the country's
economic activity in a given time period.
• Though national income accounting
is not an exact science, but it provides
useful insight into how well an economy
is functioning.
• Some of the metrics calculated by using
national income accounting consist of
Gross Domestic Product (GDP), Gross
National Product (GNP) and Gross
National Income (GNI) etc.
• The information collected with the help
of national income accounting can be
used for a different variety of purposes
like the distribution of income within
a population, evaluating the current
standard of living, comparing activities
within various sectors in an economy,
as well as changes within those sectors
over the period of time. A thorough
analysis can assist in determining overall
economic stability within a nation.
• The quantitative information associated
with national income accounting can be
used to determine the effect of various
economic policies.
Gross Domestic
Product (GDP)
• Gross Domestic Product is the value of all
final goods and services produced in the
domestic territory of the country during a
9
financial year.
• GDP includes only purchases of newly
produced goods and services and does
not include sale or resale of used goods
(but services provided in reselling are
included in GDP).
What is domestic territory?
• It includes political/geographical
boundaries of the country including
territorial waters and airspace.
• Ships and aircraft owned and operated
by residents between two or more
countries. For example, Air India flight
between Japan and China is part of the
domestic territory of India.
• Fishing vessels, oil and natural gas rigs
and floating platforms operated by a
resident of a country in the international
waters. For example, Fishing boat
operated by Indian fishermen in the
international waters of the Indian Ocean.
• Embassies, Consulate and Military
establishments of a country located
abroad.
Goods
• Goods, in simple terms, are material
things that satisfy human needs. Goods
can be classified as:
» Final Goods: Final Goods can be further
classified as:
− Consumption/Consumer Goods
− Capital/Producer Goods
» Intermediate Goods
Final Goods
• These are the Goods that are meant for
final use or final consumption. They do
not pass through any more stages of
production or transformation.
• A final good is thus a product that the
consumer finally uses.
• For example, shirt is a final good, bricks
used for construction of house are final
goods.
• For example, tools, machinery, vehicle
etc.
Intermediate Goods
• Intermediate goods are the goods that
are utilized as a raw material or input for
the production of final goods.
• For example, copper used for making
utensils, steel sheets used for making
automobiles, etc.

Consumption/Consumer Goods
• Consumer goods are those final goods
which are bought for consumption by
consumers.
• For example, food, clothing etc.
Capital/Producer Goods
• Capital goods are those final goods
which help in the production of other
goods.
• They do not get transformed during the
production process rather they make
production possible.
Why only final goods are
counted?
• The value of final goods already includes
the value of the intermediate goods that
have entered into the production process
as inputs.
• Counting them individually will lead to
the error of double counting.
• Lat us take an example of the agricultural
sector. Suppose in a year a farmer
produces 100 Rs. worth of potatoes. A
Chips Company had to buy Rs. 50 worth
potato to produce Chips worth Rs. 200.
Now consider the following table:

Farmer Chips company

Production Value 100 200

Intermediate Good Used 0 50

Value added
(Production Value - 100-0= 100 200-50 = 150
Intermediate Good)

Total GDP when 100 + 200 = 300

intermediate goods are (Here, we can see the value of potato i.e. Rs. 50 is counted
included twice first in farmer’s case then for chips Company)

Total GDP when only Final

200-50 = 150
Good are counted

10
Financial/Fiscal/Accounting
Year
• It is a period of 12 months, used by
governments, businesses, and other
organizations in order to calculate
budget, profit, losses, etc.
• In India, this period starts from 1st April
and ends on 31st March.
• One financial year is divided into 4
quarters.
Q1 = 1st April-30th June.
Q2 = 1st July-30th September.
Q3 = 1st October-31st December.
Q4 = 1st January-31st March.
Different uses of the concept
of GDP
• To determine the growth rate of an
economy. The growth rate of 6%
means that the size of the economy has
increased by 6% from last year.
• It is a quantitative concept and its volume
indicate the ‘strength’ of the economy.
But it does not tell anything about the
‘qualitative’ aspects of the economy. For
example, GDP will talk about the value
of goods that a country produces but it
will not talk about the quality of goods
produced by the country. It also does
not focus on any negative impacts this
process has on the stakeholders.
• For example, pollution as a byproduct of
economic activity is not considered while
calculation of GDP.
• It is used for the comparative analysis by
international organizations like IMF etc.
11
Potential Gross Domestic Product (GDP)
• It is a theoretical concept. It is an
estimate of the value of the output
that the economy would produce if
labor and capital had been employed
at their maximum sustainable rates (at
steady growth and stable inflation).
• However, the cost of increasing
inflation could make an economy
momentarily produce more than its
potential level of production.
• The potential labour force depending
on various demographic factors and
participation rates, the capital stock,
the non-accelerating inflation rate of
unemployment, and the level of labour
efficiency decide this potential output
which is very important to calculate
the output gap.
Net Domestic
Product (NDP)
• Net Domestic Product (NDP) is the
annual measure of the economic output
of a nation that is adjusted to account for
depreciation.
NDP = GDP - Depreciation
Different uses of the concept
of NDP
• It is used to understand and analyze the
loss due to depreciation to the economy.
• It is also used to show the achievement
of the economy in the area of research
and development in reducing loss due to
depreciation.
Depreciation
• The monetary value of an asset decreases
over time due to use, wear, and tear. This
 decrease in value is called depreciation.
• It is an annual allowance for wear and
tear of a capital good.
• In other words, it is the cost of the good
divided by the number of years of its
useful life.
• Ministry of Commerce and Industry in
India announces the rate at which assets
depreciate.
GNP/GNI
• Gross National Product/Gross National
Income (GNP/GNI) is the monetary value
of all final goods and services produced
by the normal resident (explained
below) of the country in a financial year
regardless of production location.
• Residence, rather than citizenship, is the
criterion for determining nationality in
GNP calculations, as long as the residents
spend their income within the country.
• As per the global accounting conventions,
residents are generally those people who
have lived in the country for the past one
year or more. Similarly, non- residents
are those who have stayed outside the
country for the past one year or more.
GNP = GDP + Net Factor Income from
abroad
GNP = GDP + Money flowing from
foreign countries - Money flowing to
foreign countries
• The items which are included in Net
Factor Income from abroad are:
a. Trade Balance
• It is the Net outcome of total import and
export (i.e. Export-Import) of a country in
a year.
• For India, in recent years the trade balance
is negative (Since, Import > Export). For
instance, India's Trade Balance was minus
12
USD 14.1 billion in March 2021, compared
with a deficit of around USD 12.6 billion in
the previous month.
b. Interest on external loans
• The Net outcome of the inflow of interest
payment (on money lent out) and the
outflow of interest payment (on the
money borrowed).
• That is, inflow of interest payment -
outflow of interest payment.
• For India, it has been always Negative
(Since, for India Outflow of Interest
Payment > Inflow of Interest Payment).
c. Private Remittances
• The Net outcome of the money inflow
and outflow by Indian national working
outside and the foreign national working
in India.
• For India, it is Positive since India is the
largest recipient of remittances in the
world.
• For example, Suresh who works in Dubai
sends money back to his family in India,
hence that money will be included in
private remittance while calculating GNI.
In the case of India, NFIA is Negative.
Hence, India’s GNP is lower than its GDP.
Normal Resident
• It refers to the individual who usually
resides in a country, whose economic
interest lies in that country.
• Normal Resident include:
» Citizens and Non-Citizens (residing for
more than 1 year)
» Institutions
• For example, Lisa who is an American
 GDP = A + C
National works in a software company NORMAL RESIDENTS GNP = A + B
in Delhi for past five years is a Normal [MOSTLY INDIANS + B
Resident since her economic interest lies RARE FOREIGNE R]
DOMESTIC TERRITORY OF INDIA
A
in India and her stay in India has been for
more than one year. NON - RESIDENTS
[RARE INDIANS +
MOSTLY FOREIGNE R]
C

Different uses of the concept A- Income earned by the normal

of GNP
• GNP is preferred to GDP by organizations
such as the World Bank because it
indicates both internal as well as external
strength of the economy.
resident from the domestic territory.
B- Income earned by the normal
resident from abroad.
C- Income earned by the non-resident
from the domestic territory of the
country.

Difference between GDP and GNP

GDP GNP

It measures the market value of all final It measures the market value of all final
goods and services produced within the goods and services produced regardless
domestic territory of a country. of production location.

The focus on GNP is on production by

The focus on GDP is on domestic production.
normal residents.

It highlights the strength of the country's It highlights how the resident of the
economy. country contributes to the economy.

Net National Cost

Product (NNP)
• Net National Product (NNP) is the
(Gross National Product (GNP) minus
depreciation.
NNP = GNP - Depreciation
• NNP is used to find Per Capita Income
(PCI) of the country.
PCI = NNP/total population of a nation.
• Cost is the value of money that has been
used up to produce something or to
deliver a service.
• The value of total produced goods and
services can be calculated at either at
Factor Cost or market cost.
Cost
Factor Cost Market Cost

13
Factor Cost
• It is the input cost that the producer has
to incur in producing goods and services.
• Factor Cost includes all factors of
production used in producing a good or
service.
• The factors of production comprise land,
labour, capital, and entrepreneurship.
• It is the price of the commodity from the
producer side.
Market Cost
• It is the cost at which the goods are sold
in the market.
• It is derived by adding the Net indirect
tax (E.g. GST) to Factor Cost (FC).
Market Cost = Factor Cost + Net Indirect
Tax (Indirect tax - Subsidy)
• Market cost is used for determining actual
GDP transaction i.e. GDP at Market Price
= GDP at FC + Indirect Taxes - Subsidy.
• For example, Ramesh sell 100 cakes.
The cost of production of cake is Rs. 9,
Ramesh sells 100 products.

Factor Market
Number of Cost Net Indirect Price GDP at GDP at
Years Tax Subsidies
Products per unit Tax per unit MP FC
product product

2014-15 100 9 2 1 2-1 = 1 10 1000 900

2015-16 100 9 3 1 2-1 = 1 11 1100 900

• From January 2015 Government of India NFIA D

started estimating GDP at Market Price. GDP GNP NNP ID - Sup
(at
• Generally, Factor Costs are used to Market
Price)
NI
(NNP at
UP + NIH
+ CT -
measure economic growth whereas FC) TrH
PTP +
Market Prices are used for actual PI
NP
transactions. PDI

I M A G E 2.1: D I A G R A M M AT I C R E P R E S E N TAT I O N O F
T H E S U B C AT E G O R I E S O F A G G R E G AT E I N C O M E
Relation between different measures of
income:
• GNP = GDP + NFIA NFIA: Net Factor Income from Abroad,
D: Depreciation, ID: Indirect Taxes, Sub:
• GNP = NNP (at MP) + depreciation
Subsidies, UP: Undistributed Profits, NIH:
• NNP (at MP) = NNP (at FC) + Net Net Interest Payments by Households,
Indirect taxes CT: Corporate Taxes, TrH: Transfers
• NNP (at FC) = NI received by Households, PTP: Personal
Tax Payments, NP: Non-Tax Payments,
PI: Personal Income, PDI: Personal
Disposable Income

14
Current Price vs
Constant Price
• Current Price- Goods and Services
are valued at the price of their year of
production.
» Used for measuring actual transactions.
» GDP at Current Price gives us Nominal
GDP.
• Constant Price-Goods and Services are
valued at base year price.
» Used in Estimating economic growth.
» GDP at Constant Price gives us Real GDP.
Nominal GDP
• Nominal GDP is GDP calculated at
current Market Prices.
• Nominal GDP will incorporate all the
changes in Market Prices that have
occurred during the current year due to
inflation or deflation.
• Because Nominal GDP is measured in
current prices, growing nominal GDP
might reflect a rise in prices as opposed
to growth in the number of goods and
services produced. Hence, the nominal
GDP presents a distorted picture of the
actual growth.
15
Real GDP
• Real GDP is GDP calculated at the Market
Prices at base year.
• If we are comparing the GDP growth
between two years, the nominal GDP
growth might be overestimated due to
the effect of inflation.
• Therefore, Economists use the prices
of goods from a base year to act as a
reference point when comparing GDP
from one year to another.
• For example, if 2011 were chosen as the
base year, then real GDP for 2019 is
calculated by taking the quantities of all
goods and services purchased in 2019
and multiplying them by their 2011 prices.
• Nominal GDP > Real GDP. (But in theory
this is not the case always.)
GDP Deflator
• GDP deflator measures the impact of
inflation on the gross domestic product
(GDP) i.e. how much a change in GDP
relies on changes in the price level.
• It is calculated by dividing nominal GDP
by real GDP and then multiplying by 100.
• The GDP Deflator can be viewed as a
conversion factor that transforms real
GDP into nominal GDP.
• Table below shows the relation between
Nominal GDP, real GDP, and GDP deflator.
 Real GDP =
GDP at
Number of Current Base Year GDP at GDP Nominal GDP/
Years Current
Products Price Price Base Price Deflator GDP Deflator)
Price
* 100

2011-12 100 10 10 1000 1000 100 1000

2012-13 100 15 10 1500 1000 150 1000

2013-14 100 22.5 15 2250 1500 150 1500

Income
• The income of a person has three forms.

Income

Nominal Income Real Income Disposable Income

[ Person’s Wages] [ Nominal Income
Adjusted for Inflation]
I M A G E 2.2: F O R M S OF INCOME

National Income or NNP at Personal Disposable Income

Factor Cost
• National Income at Factor Cost = NNP
at Market Price - Indirect Tax + Subsidies.
Personal Income (PI)
• Personal Income is the part of the National
Income received by the household.
• PI = NI - Undistributed profits - Net
interest payments made by the
households - Corporate Tax + Transfer
Payment to the household from the
government and firms.
(PDI)
• It is the income left with the individuals
after the payment of direct taxes from
personal income.
• It is the actual income which can be
spent on consumption by the household.
PDI = Personal Income (PI) - Personal tax
payment - Non-tax payment
National Disposable Income
(NDI)
• It is the total income which is available

16
 for use with all the resident of a country
during a financial year.
NDI = NNP MP + Other current transfer
from the rest of the world
NDI = NI + Net Indirect taxes + Transfer
payment from the rest of the world
• NDI gives the idea of what is the
maximum amount of goods and services
the domestic economy has at its disposal.
Private Income
• It is the total income (earned as well as
unearned) of the private sector during
the financial year.
Private Income = Earned income of
private sector + Unearned income of the
private sector
[ e.g. transfer payment]
Base Year
• Base year is a year which is used as a
basis for comparison by a price index
such as GDP growth, CPI etc.
• The base year is allocated the value of
100 in an index.
• For example, to find the rate of inflation
between 2013 and 2018, 2013 is the base
year or the first year in the time set.
GDP Deflator: 2011-12 = 100
WPI : 2011-12 = 100
Base year Reference value =100
• The base year is changed periodically to
take into account new goods and services
in the economy.
17
Criteria for selection of base
year
• A base year has to be a normal year
without large fluctuations in trade, prices
of commodities and variable should be
on an average.
• The base year chosen should not be very
old (so as to better reflect the basket of
items to be measured)
• Moreover, the year chosen should have
data available for all the necessary
variables.
Data Collection
Agency in India
Central Statistical Office (CSO)
• Central Statistical Office (CSO) in the
Ministry of Statistics and Programme
Implementation (MoSPI) is responsible
for macroeconomic data gathering and
record keeping.
• Release estimates of GDP, NI, GNP, NDP,
Per Capita Income, CPI, IIP etc.
• The CSO coordinates with the various
State governments and organizations
to collect and compile data required to
calculate GDP and other statistics.
• For example, At State level, State
Directorates of Economics and Statistics
(DESs) compile their respective State
Domestic Product and other indicators.
• All the required data is collected and
aggregated by CSO and used to arrive at
the final numbers.
“New GDP Series”
2015
• The Central Statistical Office (CSO)
came out with the new series of national
 account with 2011-12 as the base year for
computing National Account Statistics
like GDP, GNP etc.
• The New GDP Series will expand the size
of the economy by broadening its base
in the farm, corporates, and unorganized
sectors.
• The growth rate of the economy will now
be measured by GDP at Market Price
which will be called as GDP as they are
practiced internationally. Earlier, GDP at
Factor Cost was used for calculation of
GDP.
• Earlier: GDP at Factor Cost
• Now: GDP at Market Price
• The sector-wise estimate of Gross Value
Added is calculated at the Base Price
instead of at Factor Cost.
In simple terms, for any product or
commodity, the Base Price is the amount
receivable by the producer from the
purchaser for a unit of a product minus
any tax on the product plus any subsidy
on the product.
However, GVA at basic prices will consist
of production taxes and eliminate
production subsidies offered on the
commodity.
On the other side, GDP at Market Prices
comprise both production and product
taxes and excludes both production and
product subsidies and GVA at Factor
Cost consist of no taxes and excludes no
subsidies.
• GVA at Factor Cost + (production
taxes less production subsidies) =
GVA at basic prices
• GDP at Market Prices = GVA at basic
prices + product taxes- product
subsidies
• In the current series, the data for
corporate income is collected from the
Ministry of Corporate Affairs MCA-21
records which allow information even for
small level firms.
18
• It covers data of financial sector from
stock exchanges, financial institutions
and from various regulators like Securities
and Exchange Board of India (SEBI).
Production taxes
• These taxes are imposed on production
and are independent of the volume of
actual production.
• These are direct taxes.
• For example, Stamp duty, Registration
fees, Professional tax.
Production Subsidies
• These are paid by the government
in relation to production and are
independent of actual production.
• For example, Subsidies to railways, Input
Subsidies to farmers etc.
Product Tax
• Product Tax is paid on per unit of Output.
• These are Indirect tax.
• For example, Sales tax, Excise tax, Service
tax etc.
Product subsidies
• These are paid by the government on per
unit of output.
• For example, food, petroleum, fertilizer
subsidies to farmers etc.
Criticism of New Methodology
• The 2011-12 series used for the first time
used, an untested MCA21 database of
Ministry of Corporate Affairs.
• Doubtful GDP numbers: The GDP growth
for financial year 2017 (the year of
 demonetization), was raised to 8.1%, the
highest in the decade. For the financial
year 2018, the year of GST introduction, it
was raised from 6.7% to 7.2%. But these
two events have been described by the
expert as twin shock to the economy
and it is difficult to see how an economic
growth rate could accelerate in such
scenario.
Positives of New Methodology
• It confirms to international standards i.e.
based on the convention of IMF.
Measurement of National Income
Product/Value added Expenditure Method
Method
I M A G E 2.3: M E T H O D
Product or Value-Added
Method
• The value-added method is also called
as output method or product method,
and its primary goal is calculating the
national income by taking into account
the value added to a product during the
different stages of production.
• In this method, NI is estimated by adding
up value addition of each firm for all
three sectors namely Primary, Secondary
and Tertiary Sector.
• As this method emphasizes on net
value addition by every component
19
• It is based on more sources of data (for
instance, MCA21 is a larger database for
industries).
Measurement of
National Income
• National Income (NI) is the total income
earned by the normal resident of a
country during the financial year.
• There are 3 methods for the measurement
of National Income.
Income method
FOR MEASUREMENT OF N AT I O N A L I N C O M E
in production, therefore the following
factors should be excluded or subtracted
from the output of the enterprise.
» Net Indirect Taxes
» Raw materials consumption
» Capital consumption
• For example, Suppose a year a farmer
produces 100 rupees worth of wheat for
which he does not need any assistance of
any input. Therefore, the entire amount of
Rs. 100 is the contribution of the farmer.
The baker had to buy Rs. 50 worth of
wheat to produce bread worth of Rs. 200.
 Farmer Baker

Total production Value 100 200

Intermediate Goods Used 0 50

GVA (Gross Value Added) = (Production

100 200 - 50 = 150
value - Intermediate Good)

Income method Items not included

• In this method, NI is calculated by adding
the income of all factors of production in National Income
within the domestic territory in terms
of rent, royalties, interest, profit, wages, • The items that are not incorporated in
salaries, etc. the calculation of National Income are -
GDP = W + In + P + R
» Intermediary Goods = to avoid double
W = Wage and salaries. counting.
In = Interest Payments. » Transfer Payments like gifts, scholarships,
P = Gross Profit. remittances.
R = Rent. » Sale/Purchase of Old/Second-hand
goods (but the broker commission is
included).
Expenditure Method » Black Money.
• In this method, all the expenditure on » Capital Gains.
consumer goods and investment which » Household Services (only housewives
are produced within the domestic territory services if paid is counted).
incurred by the household, government,
firms are summed up to get NI.
GDP = C + I + G + (X-M) Facts regarding
C = Private
expenditure.
final consumption
National Income
G = Government final consumption • 1st estimate of National Income (NI) in
expenditure. India was made by Dadabhai Naoroji for
I = Expenditure on final Goods [ the year 1867-68. It was published in his
Investment or Capital Formation] book titled ‘Poverty and Un-British Rule
X = Exports M= Imports X-M = Net in India’.
Exports • 1st scientific estimate of National Income

20
 (NI) was made by Professor V. K. R. Rao
for the year 1931-32.
• The first official estimate of National
Income (NI) was made by the Ministry of
Commerce for the year 1948-49.
• In 1949 the government established the
National Income Committee under the
Chairmanship of Dr. P. C. Mahalanobis.
• Since 1956, the Central Statistical
Organization has been estimating
National Income (NI) and related
aggregates. These are published in
the Report titled ‘National Accounts
Statistics’.
Domestic Income
• It is the total income earned in the
domestic territory during a financial year.
DI = NDPFC
NDPFC = GDPFC - Depreciation
• Domestic Income can be calculated both
at current (Nominal DI) and constant
(Real DI).
Closed Economy vs
Open Economy
Closed Economy
• Closed Economy is an economy that
has no economic relations with other
countries of the world.
• Due to this, the Gross Domestic Product
and Gross National Product are the same
in a closed economy.
Open Economy
• Open Economy is an economy that has
economic relations with other countries
of the world.
• Due to this, Gross Domestic Product and
21
Gross National Product are not the same
in an open economy.
GDP and Welfare
• Countries with higher GDP per capita
often have a high score in various
development and welfare indices.
• Yet, there are various limitations to the
usefulness of GDP as the measure of
welfare:
Distribution of GDP is not
uniform
• If the GDP of the country is rising the
welfare may not rise as a consequence.
This is because the rise in GDP may be
concentrated in the hands of very few
individuals or firms. Economic inequality
is not revealed by the GDP figures.
Non-Monetary Exchange
• Many activities in the economy are
not estimated in monetary terms. For
example, the domestic services women
perform at home are not paid for. In
developing countries, where many
remote regions are underdeveloped,
the exchange takes place as barter
exchange which is not registered as part
of economic activity. This is the case of
underestimation of GDP.
Externalities
• Externality is an economic term which
refers to the benefits (or harm) a firm or
individual causes to another for which
they are not paid (or penalized).
• In other words, externalities can be
defined as the indirect effects that have
an impact on the consumption and
production opportunities of others.
• Pollution is a traditional example of
externality. The producer of the good
focuses on the cost and profitability and
does not pay attention to the indirect
costs to those who are harmed by
pollution.
• Externalities are among the main reasons
for which the governments intervene in
the economic sphere.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) In terms of economy, the visit
by foreign nationals to witness the
XIX Commonwealth Games in India
amounted to (2011)
(a) Export
(b) Import
(c) Production
(d) Consumption
Ans. (a)
• Explanation: The income was from
“tourism” and that is an invisible export
of service.
Q.2) A “closed economy” is an economy in
which - (2011)
(a) the money supply is fully controlled
(b) deficit financing takes place
(c) only exports take place
(d) neither exports nor imports take
place
Ans. (d)
• Explanation: A closed economy is one
that has no trade activity with outside
economies.
• A closed economy is self-sufficient, which
means no imports come into the country
and no exports leave the country.
22
• A closed economy's intent is to provide
domestic consumers with everything they
need from within the country's borders.
Q.3) The National income of a country
for a given period is equal to the: (2013)
(a) The total value of goods and services
produced by the nationals.
(b) Sum of total consumption and
investment expenditure.
(c) Sum of personal income of all
individuals.
(d) Money value of final goods and
services produced.
Ans. (a)
• Explanation: National income has
been defined in a number of ways. It is
the total value a country’s final output
of all new goods and services produced
within a given year. In other words, it is
the total amount of income accruing to
a country from economic activities in a
year.
Q.4) A decrease in tax to GDP ratio
of a country indicates which of
the following? (2015)
1. Slowing economic growth rates
2. Less equitable distribution of national
income
Select the correct naswer using the code
given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (b)
• Explanation: Note: You will be able to
solve this question more effectively after
taxation module.
• Tax GDP ratio shows the tax revenue for
a country measured in terms of GDP.
• For example, if India’s tax GDP ratio is
 16%, it means that the government gets in the last decade.
16% of its GDP as tax contribution from Which of the statements given above is/
the public and entities. are correct?
• Here, Tax GDP ratio shows the richness of (a) 1 only
the government’s exchequer.
(b) 2 only
• The government’s ability to spend on
socio-economic development programs, (c) Both 1 and 2
military, salary, pension heads etc., (d) Neither 1 nor 2
depends on tax GDP ratio. Ans. (b)
• Lower tax GDP ratio indicates a less
equitable distribution of national income. • Explanation: Note: Rate of growth of Real
Gross Domestic Product has fluctuated a
lot during the last decade and reduced
Q.5) With reference to the India economy, significantly in 2008-09 because global
consider the following statements: (2015) financial crisis.
1. The rate of growth of real Gross • The rate of growth of real Gross Domestic
Domestic Product has steadily Product has fluctuated over the decade.
increased in the last decade.
• But, the Gross Domestic Product at
2. The Gross Domestic Product at Market Market Prices (in Rupees) has steadily
Prices (in rupees) has steadily increased increased in the last decade.

12%

10% 10.09%
10% 9.53%
GDP growth rate compared previous year

9.04%

7.9%
8% 7.59%
6.9%
6.4%
5.88% 5.9%
6%
4.9%

4%

2%

0%
2004 2005 2006 2007 2008 2009 2010 2011 2012* 2013* 2014*

I M A G E 2.4: R E A L GDP G R OW T H R AT E F R O M 2004 TO 2014

23
 CHAPTER - 3

ECONOMIC GROWTH AND

DEVELOPMENT
Is a person’s well-being solely dependent • Economic Growth focuses on the
on his economic well-being? Are people quantitative aspects of growth of the
of countries with a higher Economic economy like GDP and NDP.
growth happier? What is the difference
between development and economic
growth? Very often these two words are
mistakenly understood the same. But in
Economic
the 1960s economists made a distinction
between Economic Growth and Economic
Development
Development. • Economic development refers to the
process of economic growth which is

Economic Growth
accompanied by an improvement in the
well-being of the people.
• It indicates a progressive change in
• An increase in an economic variable (like socio-economic structure in the economy
GDP, GNI, NI etc.) over a period of time is
and focuses on both quantitative and
known as economic growth.
qualitative growth of the economy.
• Concept of Economic growth is applicable • It measures all aspects like Wealth,
both for an individual (increase in Income)
Health, Education, etc.
and for Nation (with an increase in goods
and services produced by it over a period
of time).

Difference between Economic growth and

development
Economic Growth Economic Development

Economic growth is a narrower concept. It refers to

an increase in the production of goods and services Economic development is a much broader concept.
of a country.

Economic development is a 'Multidimensional'

Economic growth is considered one dimensional as
concept as it focuses on income, social welfare and
it focuses only on income.
other dimensions.

It is a Quantitative Concept. It is both Quantitative and Qualitative Concept.

24
Economic growth is possible even without economic Economic development cannot
development.
It is a short term process.
Indicators are of Economic Growth are: Real GDP, Indicators of economic development are literacy
Real per capita income etc.
Indicators
of Economic
Development
• There are various indicators to measure
the level of economic development of a
nation are as follows -
Net Economic Welfare (NEW)
• Net Economic Welfare (NEW) is a broader
concept than GNP to measure economic
welfare.
• It adjusts GNP by adding the value of
beneficial non-market activities such as
Value of leisure and Subtracting ‘bads’
from it such as pollution.
NEW = GNP + Value of Housewives Services +
Value of leisure - Expenditure on defence - Cost
of Environment Degradation
• It is a theoretical concept which highlights
limitations of GDP. It was given by Paul
Samuelson.
Real per capita Income
• Real GDP per capita is a Real GDP
divided by the number of people.
• It is used to compare the standard of
living between countries and expressed
in terms of commonly used international
currencies such as the Dollar, Euro etc.
• Real GDP helps to ascertain the country's
development status.
25
be achieved
without economic growth.
It is a long term process.
rate, poverty ratio etc.
• Real GDP is not a satisfactory measure of
economic development because -
» It is based on the value but does not
take into account its various sector
composition (agriculture, secondary or
tertiary Sector).
» Real GDP does not take into account the
distribution of National income i.e., the
inequalities present in the society.
» It is silent on welfare dimension of
economic development namely reduction
in poverty, political liberty, literacy etc.
• Real per capita income was used earlier,
because of the lack of any satisfactory
quantitative indicator of economic
development.
Physical Quality of Life Index
(PQLI)
• Physical Quality of Life Index (PQLI)
attempts to measure national well-being
using social indicators. These indicators
are:
» Life Expectancy at birth
» Infant mortality rate
» Literacy Rate
• All three indicators are measured on a
scale which ranges from 1 to 100 where
1 represents the worst performance and
100 is the best performance.
• The average value of three-component is
PQLI.
• It was developed by economist Morris
David Morris.
Human
Development Index
• This index is used to measure a country's
overall achievement in its social and
economic dimensions.
• Human Development Index (HDI) was
introduced by the United Nations
Development Programme (UNDP) in
World Human Development Report in
1990 to measure well-being.
• HDI was developed by economist
Mahbub ul Haq.
• HDI measures the achievement of a
nation in three basic dimensions of
human development.
» A long and healthy life: Calculated by life
expectancy.
» Access to Education: Measured by the
adult literacy rate and enrolment ratio.
» Decent Standard of living: Assessed by
Gross National Income (GNI) per capita
adjusted for the price level of the country.
• The HDI helps the United Nations
determine which countries need
assistance, specifically Least Developed
Countries (LDC).
DIMENSION Long & healthy life
INDICATORS Life expectancy at birth Expected year
of schooling
DIMENSION Life Expectancy Index
INDEX
Human Development Index (HDI)
26
• From 2010 UNDP began using a new
method for calculating HDI. It used the
following three indices:
» Life Expectancy Index (LEI): Measures
life expectancy. This dimension uses
life expectancy at birth as its indicator.
It is defind as “the number of years a
new-born infant could expect to live
if prevailing patterns of age-specific
mortality rates at the time of birth were
to stay the same throughout the child’s
life”. It is calculated using a minimum
value of 20 years and a maximum value
of 85 years.
» Education Index (EI): It is average of mean
years of schooling and expected years
of schooling. Estimates for mean years
of schooling are based on the duration
of schooling at each level of education.
Expected years of schooling estimates
are based on two factors: enrolment by
age at all levels of education and the
number of children of school age in the
population for each level of education.
» Income Index (II): It measures GNI per
capita adjusted in Purchasing Power
Parity terms (PPP). UNDP shifted from
adopting GDP per capita to GNI per
capita because GNI per capita is suitable
to consider the wellbeing of people rather
than the income of the country.
• HDI is the geometric mean of the above
three indices.
Knowledge A decent standard of living
Mean year GNI per capita (PPP $)
of schooling
Education Index GNI Index
Classification of countries on
the basis of HDI
HDI scores lie between from 0 to 1 for
different countries.
» A score of 0-0.49 means low development
(For example, Mali).
» A score of 0.5-0.69 means medium
development (for example, India).
» A score of 0.7-0.79 means high
development (For example, China).
» Above 0.8 means very high development
(For example, Norway).
• Out of total 189 countries, India has ranked
131 on the Human Development Index
2020. The country fell into the category
of the medium human development
(With an HDI value of 0.645). In 2019,
India’s rank was 129.
1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
1990 2000 2010
I M A G E 3.1: I N D I A PERFORMANCE IN
YEARS
• Between 1990 and 2018, HDI value of
India increased by 50 percentages (from
0.431 to 0.647), which places it above
the average for other countries of South
Asian (0.642) and above the average for
countries which are part of the medium
human development group (0.634).
• The Report states that ‘as the gap
in basic standards is narrowing, with
an unprecedented number of people
escaping poverty, hunger and disease.
The next generation of inequalities and
disparities is opening up, especially
around education, technology, and the
27
climate crisis. These inequalities are a
roadblock to achieving the 2030 agenda
for sustainable development.
Changes in Human
Development Report
UNDP introduced three new indices in the
year 2010: Inequality-adjusted Human
Development Index (IHDI), Multidimensional
Poverty Index (MPI) and Gender Inequality
Index (GII).
Inequality-adjusted Human
Development Index (IHDI)
• The IHDI is the HDI (Human Development
Index) adjusted for inequalities in the
distribution of achievements in each of
the three components of the HDI (health,
education, and income).
• The IHDI will be equivalent to the HDI
value when there is no inequality.
However, it falls below the HDI value as
inequality rises.
• The difference between the HDI and the
IHDI represents the ‘loss’ in potential
human development due to inequality
and can be expressed as a percentage.
• Atkinson index is used to measure income
2020
HDI OV E R T H E inequality.
Multidimensional Poverty Index
• Multidimensional Poverty Index (MPI)
measures poverty on the basis of
deprivation at household and individual
level in health, education, and standard
of living.
• The above three dimensions are sub
divided into 10 indicators: health (child
mortality, nutrition), education (years
of schooling, enrollment), and living
standards (water, sanitation, electricity,
cooking fuel, floor, assets).
• It is developed by UNDP and Oxford
 Poverty & Human Development Initiative of living.
(OPHI) and it replaced the Human Poverty
Index (HPI).
• The 2019 Multidimensional Poverty Index
(MPI) states that across 101 countries, 1.3
• MPI identifies which of the above 10 billion people are multi-dimensionally
deprivations any household experiences. poor.
A household is classified as poor if it
suffers deprivations across one-third or
• India MPI value is 0.123 and India
accounts for 28 per cent of the 1.3 billion
more of the weighted indicators.
multi-dimensional poor in the world.
• MPI is calculated as follows:
• India managed to lift 27.1 crores, people,
MPI = H* A out of poverty from 2005-06 to 2015-16,
H = Percentage of people who are MPI recording the fastest reduction in the MPI
poor. value during the period.
A = Intensity of poverty (average
number of deprivations a poor person
suffers).
Gender Inequality Index (GII)

• The MPI goes beyond income as the sole
indicator for poverty, by exploring the
ways in which people experience poverty
in their health, education, and standard
• It is an index for measurement of gender
disparity.
• It uses the following three dimensions to
measure gender disparity –

DIMENSION health Empowerment Labour market

INDICATORS Maternal Adolescent Female and male population Female and male Female and male
mortality birth with at least shares of labour force
ratio rate secondary education parliamentary seats participation rates

DIMENSION
Female reproductive Female empowerment Female labour Male empowerment Male labour
INDEX
health index index market index index market index

Female gender index Male gender index

Gender Inequality index (GII)

• The Gender Inequality Index (GII) Gender-related Development Index

provides insights into gender disparities (GDI)
in health, empowerment and the labour
market. Unlike the human development • Gender-related Development Index is
index (HDI), however, higher values in the an index to measure gender disparities
GII indicate worse achievements. with respect to three dimensions of HDI
i.e. Health, Knowledge and Standard of
• This index is a composite measure to
living.
quantify the loss of achievement within
a country because of gender inequality. GDI =
HDI (females)
HDI (males)
• India has a Gender Development index
(GDI) value of 0.829 ranking it 129 of 189 • It addresses gender-gaps in life
countries on the 2018 gender inequality expectancy, education, and incomes.
index.

28
• More than GDI value, lesser the gender
disparity.
Has development
delivered happiness?
• For past decades, the world has chased
GDP growth to bring ‘posterity’ and
‘happiness’. We have succeeded in
growing global economic output. Yet
‘wellbeing’ and ‘happiness’ indices have
largely remained flat, inequality has
increased, natural resources have been
degraded.
• Our focus on GDP growth to achieve
happiness has not worked in delivering
happiness.
Indicator of
Happiness
• There are various indicators to measure
the level of happiness of a nation. Some
such indicators are:
Gross National Happiness
• Gross National Happiness index is utilized
to measure the collective happiness and
wellbeing of a population.
• The term Gross National Happiness was
coined in 1972 by the then king of Bhutan,
Jigme Singye Wangchuck.
• Gross National Happiness is based on
four dimensions- Sustainable Economic
Development, Good Governance,
Preservation of Cultural Values, and
Conservation of environment.
• The objective of GNH is to achieve a
balanced development in all facets of life
that are essential for happiness.
29
World Happiness Report
• World Happiness Report is a measure
of happiness, published by the United
Nations Sustainable Development
Solutions Network (UN SDSN) since 2012.
• It was developed by Helliwell, Layard,
and Sachs.
• The Report measures the happiness and
well-being of a country and helps to guide
public policy based on the following six
parameters -
» Real GDP per capita (at PPP)
» Healthy Life expectancy
» Social Support
» Freedom to make life choices
» Generosity
» Perception of Corruption
• The Report uses data from the Gallup
World Poll.
World Happiness Report 2019
• This is the 7th annual World Happiness
Report, which ranks the 156 countries of
the world.
• The focus of the Report was - Happiness
and Community.
• The Report was topped by Finland.
• India is ranked 140th place compared to
133rd place in 2018. India is among the
five countries that had the largest drop
since 2008.
• People in war-torn South Sudan are the
most unhappy.
Indian State’s Happiness
Initiative
Madhya Pradesh
• Madhya Pradesh became the first state
to announce its happiness department.
• Madhya Pradesh in collaboration with
Indian Institute of Technology (IIT)
Kharagpur to develop a happiness index
for measuring the well-being of the
people.
Andhra Pradesh
• Andhra Pradesh is the second state in
the country after Madhya Pradesh to
start happiness Index Department.
• Its ‘Sunrise AP Vision 2029’ has taken
Bhutan as a model to focus on matters
including health, time use, education etc.
Maharashtra
• Government of Maharashtra is
contemplating to introduce a separate
'happiness ministry' to encourage
positivity in society.
Social Progress
Index
• The Social Progress Index (SPI) measures
the extent to which countries fulfil the
social and environmental needs of their
citizens.
• The index is based on a range of social and
environmental indicators that capture
three dimensions of social progress:
» Basic Human Needs
» Foundations of Wellbeing
» Opportunity
• The 2019 Social Progress Index includes
data from 149 countries on 51 indicators.
• The index is published by Social Progress
Imperative and is based on the writing
of Amartya Sen, Douglas North, and
Joseph Stiglitz.
• Norway tops the 2019 SPI ranking, India
30
is ranked 102nd out of 149 countries.
Environmental
Performance Index
• Environmental Performance Index is
used to measure the environmental
performance of a country.
• EPI highlights leaders, best practices and
provides guidance for other countries
that want to be leaders in environmental
sustainability.
• The index is prepared by Yale University,
Columbia University in collaboration
with World Economic Forum (WEF).
• The First Environmental Performance
Index Report was published in the year
2006.
• The Environmental Performance Index
(2018) ranks 180 countries of the world
on 24 performance indicators across
10 issues covering environmental health
and ecosystem vitality.
• India is ranked at 177 places out of 180
countries in the Environment Performance
Index-2018.
• Switzerland topped the index and
Burundi was in the bottom of the index.
• Low scores on the EPI suggests the
necessity for national sustainability
efforts on a number of fronts, particularly
protecting biodiversity, cleaning up air
quality, and reducing GHG emissions.
Purchasing Power
Parity (PPP)
• When making comparisons among
countries which use different currencies
it is necessary to convert values, such
as national income (GDP), to a common
currency. This is done through purchasing
 power parity (PPP).
• Purchasing Power Parity states that the
expenditure on a similar commodity
must be the same in both currencies
when accounted for the exchange rate.
Cost of Good X in currency in 1
Purchasing Power Parity (PPP) =
Cost of Good Y in currency 2
• For example, Suppose the cost of cake
in India is Rs. 250, and the cost of the
same cake in the USA is $ 10. Therefore,
purchasing power parity will be 250/10 =
Rs. 25 per dollar.
• Purchasing Power Parity (PPP) is very
important and is used to compare the
national income and standard of living.
• The World Bank every three years
compares countries in terms of PPP and
the .
• India is ranked third in the world on the
basis of GDP (PPP) behind China and
the USA.
Difference between Market
Exchange Rate & PPP
• The market exchange rate is the Market
Price of one currency in terms of another
currency.
• Thus, the present market exchange rate
for Indian rupees is in the range of 65 to
70 rupees per U.S. dollar.
• The market exchange rate depends
on the demand and supply of these
currencies in the open market.
• PPP exchange rate measures the relative
purchasing power of different currencies.
• India ranks third when GDP is compared
in terms of purchasing power parity at
$11.40 trillion.
• Whereas India is the fifth-largest
economy, with a nominal GDP of $2.936
trillion.
• For Example, GDP calculation at Market
31
Price, India’s economy is well behind
Japan. However, price levels in Japan are
much higher than that of India.
• So, when the national income of the two
countries is adjusted in terms of PPP
(using the ), Indian economy surpasses
Japanese economy because of lower
prices in India.
Least developed
countries (LDC)
• LDCs is a list of developing nations that,
according to the United Nations (UN), are
at the bottom of the Human Development
Index ratings.
• The classification of the least developed
country was introduced by the Economic
and Social Council (ECOSOC) of UNO in
1971.
• Countries are classified as LDCs on the
basis of the following criteria:
» Low-income criteria - A country must
have GNI per capita less than $1025 to
be included on the LDC list.
» Human asset Index- It is a composite
index of education and health used as
an identification criterion for LDCs.
» Economic Vulnerability Index (EVI)-
The Economic Vulnerability Index is
a composition of the following eight
indicators:
− Population size
− Remoteness
− Merchandise export
− Contribution of agriculture in the
Gross Domestic Product (GDP)
− Homelessness owing to natural
disasters
− Instability of agricultural production
− Instability of exports of goods and
services
 − Share of the population residing in
low elevation coastal zone
• At present 47 countries are in the Least
Developed countries (LDCs) list.
• Various International Organization give
special assistance to LDCs.
• Criteria of LDCs are reviewed every three
years by the Economic and Social Council
(ECOSOC).
• Countries may "graduate" out of the LDC
categorization after indicators exceed
these criteria in two consecutive reviews.
Millennium
Development Goals
(MDGs)
• The United Nations Millennium
Development Goals (MDG) are eight
goals that all 191 UN members had
agreed to achieve by the year 2015.
• The Eight Millennium Development Goals
- demands of the current generation
» Eradicate extreme poverty and hunger.
» Achieve universal primary education.
» Promote gender equality and empower
women.
» Reduce child mortality.
» Improve maternal health.
» Combat malaria, HIV/AIDS, and other
diseases.
» Ensure environmental sustainability.
» Develop a global partnership for
development.
India’s achievement in MDGs
• India is a signatory to the Millennium
Declaration accepted at the United
Nations General Assembly (UNGA) in
32
September 2000 and has made its
commitment towards the eight important
development goals.
• The goals of the MDGs converge with
India’s own development goals to
decrease child mortality, poverty and
other concerns.
• India has witnessed significant
improvement towards the MDGs, with
some goals having been met ahead of
the 2015 deadline, but, progress has been
inconsistent.
• For example, according to official
national estimates, India has achieved
the target for reducing poverty by half,
but it is falling short of achieving the
target for reducing hunger.
What is Sustainable
Development?
• UN World Commission on Environment
and Development (UNWCED) defines
it as “the development that meets the
without compromising the needs of future
generations to meet their own needs.
• It is related to Carrying Capacity which
refers to the capacity of the environment
to absorb the adverse impact of human
activity.
• Sustainable Development presents a
framework to generate economic growth,
achieve social justice, and preserve
environmental sustainability.
• It recognizes that growth must be both
inclusive and environmentally sound to
reduce poverty and meets the needs of
the future generation.
Dimension of Sustainable
Development
• There are 3 dimensions of Sustainable
 Development -
» Economic Dimension- Economic
Dimension deals with encouraging
business and organization to increase
investment, efficiency in production,
economic growth.
» Social Dimension- It deals with
encouraging people to participate in
environmental sustainability.
» Environmental Dimension- It defines
how to protect ecosystems, air quality,
focuses on the elements that place stress
on the environment.
Indicator of Sustainable
development
Green GDP
• Green Gross Domestic Product (Green
GDP) is an index of economic growth
where the environmental consequences
of growth are factored in while calculating
conventional GDP of a nation.
• The economic cost of water pollution,
land degradation is not incorporated in
the GDP.
• For example, WWF’s ‘Living Planet’
Report, which finds that “25% of India’s
total land is undergoing desertification.
This will have a direct influence on the
future food production thus affecting our
agrarian economy as the country could
see a decrease in crop production.
• Ministry of Statistics and Programme
Implementation (MOSPI) set up an expert
group in 2011 led by Partha Dasgupta, with
the mandate of developing a framework
for a green national account in India. The
process is not yet completed.
33
Genuine Saving
• Genuine Saving measures the
sustainability of economic development.
• Genuine Saving = Gross Saving -
Depreciation in man-made capital -
Depreciation in Natural capital
• Natural Capital includes world stock of
all-natural assets like soil, air, water etc.
• Man-Made Capital includes goods and
services that are used to produce other
goods and services, such as machines,
tools etc. it can also include ‘financial
capital’ like money.
• It has emerged as the important leading
economic indicator of sustainable
economic development.
Sustainable
Development Goal
(SDG)
• They are a universal set of targets, goals
and indicators that UN member will be
expected to use to frame their nation’s
policies over the next 15 years.
• Sustainable Development Goals (SDGs)
follow Millennium Development Goals
which expire in 2015.
• The United Nations (UN) adopted the 2030
Agenda for Sustainable Development
which consist of 17 Sustainable
Development Goals (SDG), associated
169 targets and 304 indicators.
• The table below highlight 17 Sustainable
Development Goals (SDG) and India’s
effort toward achieving each of them.
 Goals Objective Description India Efforts

-Mahatma Gandhi National

Rural Employment Guarantee
BY 2030, End poverty in all its Scheme (MGNREGA)
Goal-1 No poverty
forms everywhere.
-National Social Assistance
Programme (NSAP)

-Targeted public distribution

system (PDS), National
Achieve food security, end hunger Nutrition Mission (NNM),
Goal-2 Zero Hunger
and better nutrition by 2030.
-National Food Security Act
(NFSA)

-National Health Mission

(NHM)
Good Health and Promote wellbeing and ensure
Goal -3
Well-being healthy lives for all at all stages. -Ayushman Bharat

Make Sure that all boys and girls

complete free, equitable and -Sarva Shiksha Abhiyan (SSA)
Goal-4 Quality Education
quality primary and secondary -National Education Policy
education by 2030.

To attain gender equality and -Sukanya Samridhi Yojana

Goal-5 Gender Equality
empower all females. -Janani Suraksha Yojana

Ensure affordability, availability -Swachh Bharat Abhiyan.

Clean Water and and sustainable management
Goal-6 -National Rural Drinking
Sanitation of water and sanitation for every
individual by 2030. Water Programme.

Ensure access to reliable,

Affordable and
Goal-7 affordable, sustainable and -National Solar Mission.
Clean Energy
modern energy for all by 2030.

-National Skill Development

Mission,
Decent Work and Promote sustained, inclusive, and
Goal-8 -Deendayal Upadhyaya
Economic Growth sustainable economic growth.
Antodaya Yojana,
-Atal Innovation Mission

Build resilient infrastructure,

Industry, Innovation promote inclusive & sustainable -Make in India
Goal-9
and Infrastructure industrialization and foster -Start-Up India
innovation by 2030.

34
 -National Mission for
Empowerment of Women
-Rajiv Gandhi Scheme for
Empowerment of Adolescent
Decrease inequality within and
Goal-10 Reduced Inequality Girls (SABLA)
amongst countries by 2030.
-Kasturba Gandhi Balika
Vidyalay (KGBV)
-PMKISAN

-Smart Cities Mission

-Atal Mission for Rejuvenation
Make cities and human
Sustainable Cities and Urban Transformation
Goal-11 settlements inclusive, resilient,
and Communities (AMRUT)
secure, and sustainable.
-Pradhan Mantri Awas Yojana
(PMAY)

Responsible -National Policy on Biofuels

Ensure sustainable consumption
Goal-12 Consumption and for managing the efficient use
and production patterns.
Production of natural resources.

Take important and urgent action

-National Action Plan on
Goal-13 Climate Action to tackle climate change and its
Climate Change
effects.

Conserve and sustainably

-National Plan for the
utilize the seas, oceans and
Goal-14 Life Below Water Conservation of Aquatic Eco-
marine reserves for sustainable
systems
development.

Protect, restore, and promote -National Afforestation

sustainable utilization of Programme
Goal-15 Life on Land terrestrial ecosystems, combat
-Project Tiger
desertification and halt
biodiversity loss. -Project Elephant

-Development of
Promote inclusive and peaceful Infrastructure Facilities for the
Peace and Justice societies for sustainable Judiciary
Goal-16
Strong Institutions development; give access to
justice for all. - Introduction of AADHAR
card

-India’s membership in
Strengthen various means of
institutions like the Shanghai
Partnerships to implementation and revitalize
Goal-17 Cooperation Organization,
Achieve the Goal the international partnership for
BRICS, and its New
sustainable development.
Development Bank.

35
Why do we need Sustainable
Development Goals (SDGs)?
• SDGs carry forward the unfinished
agenda of MDGs.
• Millennium Development Goals were
drawn up by a group of experts, whereas
SDGs were drafted after a long and
extensive consultative process hence are
more comprehensive.
• MDGs was focused only on 8 goals, 21
targets and 63 indicators, while SDGs
includes 17 goals with 169 targets.
• MDGs had adopted baseline data for
the year 1990, while for the SDGs, the
baseline is from 2015 estimates.
Challenges in achieving SDGs
• Financing SDGs: Cost for implementing
SDGs is huge, which for a developing
I M A G E 3.2: D O U G H N U T
36
country like India puts pressure on
existing resources.
• Defining Indicators: A number of targets
in SDGs are not quantified. Hence,
measurement of progress in those
indicators will depend on the availability
of data.
• Accountability: There was a lack of
accountability for inputs into MDGs. This
issue needs to be addressed in SDGs.
Doughnut shape development model:
• The Doughnut economic model is a visual
framework for sustainable development.
The central hole of the model reveals the
proportion of people globally falling short
on life’s essentials, such as water, food,
water, healthcare, and political freedom
of expression. A big part of humanity’s
test is to get everyone out of that hole.
SHAPE DEVELOPMENT MODEL
• At the same time, however, we cannot
afford to be overshooting the Doughnut’s
outer crust if we are to safeguard
Earth’s life-giving systems, like a healthy
oceans, stable climate and a protective
ozone layer, on which all our wellbeing
fundamentally depends.
• This model was planned to observe the
performance of an economy by the
extent to which the needs of individuals
are met without overshooting Earth's
ecological ceiling.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) Consider the following specific stages
of demographic transition associated with
economic development: 2012
1. Low birth rate with a low death rate
2. High birthrate with a high death rate
3. High birthrate with a low death rate
Select the correct order of the above stages
using the codes given below :
(a) 1 2 3
(b) 2 1 3
(c) 2 3 1
(d) 3 2 1
Ans. (c)
• Explanation: This is a very easy question.
Economic Development means improved
living conditions.
• An improved living condition means a
low birth rate and low death rate.
• For example, we can say that India
has achieved impressive demographic
transition owing to the decline of crude
birth rate, crude death rate, total fertility
rate and infant mortality rate.
37
Q.2) Economic growth in country X
will necessarily have to occur if - 2013
(a) There is technical progress in the
world economy
(b) There is population growth in X
(c) There is a capital formation in X
(d) The volume of trade grows in the
world economy
Ans. (C)
(Note: You will be able to clearly understand
this question when we will study the Indian
Industries Module.)
• Explanation: Internally capital formation
takes place when a country does
not spend all its current income and
consumption, but saves a part of it and
uses it for investment for increasing
further production.
• This act of saving and investment is
described as capital accumulation or
capital formation.
Q.3) Increase in absolute and per capita
real GNP do not connote a higher level of
economic development, if: 2018
(a) Industrial output fails to keep pace
with agricultural output.
(b) Agricultural output fails to keep
pace with industrial output.
(c) Poverty and unemployment increase.
(d) Imports grow faster than exports
Ans. (c)
Explanation: Per capita, GNP is the entire
value of all the goods and services produced
by a country in a year, comprising income
from foreign investments, divided by the
number of people living there.
• For nations which have huge foreign
investments, GNP per capita is a more
accurate economic indicator.
• GNP = GDP + Net income inflow from
abroad: Net income outflow to foreign
countries.
• The question clearly mentions the impacts
 on development and development is a
multidimensional concept. If poverty
and unemployment increases, the
growth is not equally distributed. It is
concentrated in a few hands. Thus,
it does not connote a higher level of
economic development.
Q.4) Consider the following statements:
2019
1. Purchasing Power Parity (PPP) exchange
rates are calculated by comparing the
prices of the same basket of goods and
services in different countries.
2. In terms of PPP dollars, India is the sixth
largest economy in the world.
Which of the statements given above is/are
correct?
38
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (a)
• Explanation: Purchasing Power Parity
(PPP) is an economic concept that
compares different countries' currencies
with the help of a "basket of goods"
approach.
• According to this idea, two currencies are
in equilibrium—referred as the currencies
being at par—when a basket of goods is
priced similar in the countries, considering
the exchange rates.
• By purchasing power parity (PPP), an
exercise that seeks to find the ‘true’ value
of a currency vis-à-vis the dollar, India’s
rank is third, behind the US and China.
 CHAPTER - 4
MONEY SUPPLY
Money
• Money in general terms is a medium
of exchange. It is also referred to as
currency. It is a medium in which the
prices of various goods and services are
expressed.
• Economically, each government has its
own money system. Cryptocurrencies are
also being developed for financing and
international exchange across the world.
• The need for money arose because of the
inefficiency of the Barter system.
Barter System of exchange
• It is a system of exchange where the
participants in a transaction directly
exchange goods or services for another
goods or services in return.
• For example, onion can be exchanged for
potato, rice for pulses, etc.
• Barter System can be bilateral or
multilateral.
• Bartering does not involve money; a
person can buy items by exchanging an
item.
Limitations of Barter System
• Lack of Double coincidence of wants:
For barter to occur between two parties,
both parties need to have what the other
wants.
• Lack of common measure of value: In
a monetary economy, money plays the
role of a measure of the value of different
goods, so their values can be assessed
against each other; this important role
may be absent in the barter economy.
39
• Indivisibility of certain goods: The barter
system of exchange was not applicable
in case of goods that lose their value if
divided into parts.
» For example, the value of one cow is
equal to two goats. This implies that if an
individual needs one goat in exchange
for the cow, then in this condition he/she
has to sacrifice half of his/her cow.
• Lack of standards for deferred payments:
Deferred payment are those payments
that are made in the future (like loans,
interest). Since commodities are used
as the medium of exchange in a barter
system it is difficult to make the deferred
payment since there is no standard for
making such payments.
• Difficulty in storing wealth: If a society
relies exclusively on perishable goods,
storing wealth for the future may be
impractical.
Evolution of Money
• Money went through a long evolution
before moving to the modern banking
system.
• Some of the major stages through which
money has evolved are as follow:
I. Commodity Money
• In the earliest period some commodities,
for their use, were more sought than
others.
• Such commodity assumed the role of
currency and used as a medium for
exchange.
• People used salt, rice, wheat, cow as
Commodity Money.
• The inadequacy of commodity money
 led to the evolution of Metallic Money.
II. Metallic Money
• With the discovery of metal, it was used
as the main standard of value because
of its advantage like divisibility, easy
transportation, etc.
• The problem of uniformity of weight and
purity of metals lead to the evolution of
Paper Money.
III. Paper Money
• The invention of Paper Money was a
very important stage in the evolution of
Money.
• Paper Money is printed and regulated by
Central Banks of the country (In India’s
case it is RBI).
• Use of Paper Money has become
universal along with Coins.
IV. Bank Deposit
• People keep a part of cash into bank
deposits which they can withdraw in the
future through cheque.
• Cheque (has replaced Paper Money
for the major portion of commercial
transactions.
• A cheque is not money as it is an
instruction from a bank deposit holder to
transfer the required money in another
person’s account.
• Hence, cheque itself is not money, it
performs the functions as money.
V. Plastic Money
• The latest type of money is Plastic Money.
• Plastic Money usually refers to the debit
and credit cards and are considered
alternatives to cash for everyday
payments.
• They aim at removing the need to carry
cash for everyday payment.
VI. Digital Money
• The latest type of Money is Digital Money.
• It is a currency available in digital/
40
electronic form.
• Digital Money can be transferred with the
help of technologies like smartphones,
Internet.
Functions of Money
The major functions of money can be
distinguished as:
• Medium of exchange: Money is used
as a medium of exchange to facilitate
the transactions. It eliminates the
inefficiencies of the barter system, such
as the "coincidence of wants".
• Unit of account: Money acts as a standard
measure and common denomination
of trade. Money is used to measure the
value of goods or services produced and
also record financial transactions.
• Store of value: Money can be utilized for
current consumption and it can also be
held over a period of time and can be
used for future payments.
• Standard of deferred payment: Money
plays an important role in lending and
borrowing. This function of money allows
to defer payment from preset to a future
date.
Properties of Money
To fulfill its various functions, money should
have certain properties:
• Fungibility: Its individual units must
be capable of mutual substitution (i.e.,
interchangeability).
• Durability: Able to withstand repeated
use.
• Portability: Easily carried and
transported.
• Divisibility: It can be broken down into
smaller denomination.
• Stability of value: Its value should not
fluctuate.
Types of Money
I. Full-bodied money: Full Bodied money
is one whose value in money is the same
as the value in the commodity (intrinsic
value). For example: Gold coin, silver
coin etc.
II. Token money: Token Money is one
whose value in money is much more
than its value as a commodity. For
example, coins.
III. Representative full-bodied money: It is
a type of token money issued against an
equivalent number of bullions (gold and
silver) with Central Banks/governments.
IV. Legal tender: It is a medium of payment
recognized by law as a means for
meeting a financial obligation.
» Usually, coins and paper currencies
are legal tenders, but the definitions
vary from jurisdiction to jurisdiction.
For example, personal cheques,
credit cards etc., may not be a legal
tender in every jurisdiction.
» It can be limited or unlimited in
character. For example, Coins
function as limited legal tender in
India. Hence, 50 paise coins can
be offered as legal tender for dues
up to ₹10 and smaller coins for
payments up to ₹1000.
» Currency notes are unlimited legal
tender and can be offered as
payment for dues of any size.
V. Non-legal tender: It is a medium of
payment that is not necessary to be
accepted. For example, personal
cheques, credit cards etc.
VI. Fiduciary Money: It is the money that
is used for transactions based on trust
between the payer and payee. For
example, cheque is not a compulsorily
accepted mode of payment but the
transactions on the trust are based on
the mutual trust of the parties involved.
VII. Fiat Money: It is Government-issued
41
currency without intrinsic value that is
not backed by a physical commodity
like gold etc.
» It does not have a use-value, and it
has value only because a government
maintains its value.
For example, U.S. Dollar, Indian
Rupee etc.
» Since central banks regulate how
much currency is printed with
fiat money, governments' central
banks have greater control over the
economy.
» It is inconvertible and cannot be
redeemed.
» As fiat money is not connected
to physical reserves, it risks losing
value because of inflation or even
becoming worthless in the occasion
of hyperinflation.
VIII. Near Money: Near Money is highly liquid
non-cash assets like cheques, demand
drafts etc.
IX. Plastic Money: Plastic Money usually
refers to the debit and credit cards and
are considered alternatives to cash for
everyday payments.
X. Digital Money: It is a currency available
in digital form and is a money balance
noted electronically on a stored-value
card or other devices.
» It is also called electronic money or
electronic currency.
» They may be centralized (E.g.,
digital wallets, debit cards, etc.) or
decentralized (cryptocurrency).
Gresham’s Law
• Gresham’s Law state that “bad money
drives out good money”.
• Whenever coins containing precious
metals have been used along with
metal coins of the same denomination,
 both acting as legal tender, the more
valuable commodity (precious metal) will
gradually disappear from circulation.
• Good Money is the money that shows
little difference between nominal value
and its commodity value (value of a
commodity like gold etc.).
• Bad Money is the money whose
commodity value is lower than the
nominal value.
• Gresham’s Law is named after Sir Thomas
Gresham, an English financier during the
Tudor Dynasty.
• For example, A discounted product
of inferior quality may drive out non-
discounted product of good quality in
the price-sensitive market like India.
Money Supply
• It is the total stock of all types of money
(currency, deposit) held by the public at
any specific point of time.
• It is very significant to note that the term
public includes all the economic entities
except government and banking system
(this money is not in actual circulation
in the economy hence not part of the
money supply).
• The money supply can comprise cash,
coins, and the balances held in checking
and savings accounts, and other near
money substitutes.
• Money Supply is only that part of the
total stock of money which is held by the
public at a particular point of time.
• It measures the total purchasing power
in the economy.
Change in the money supply
• Alteration in the money supply has long
been considered to be a major factor
in driving macroeconomic performance
and business cycles.
42
• Rise in the supply of money typically
lowers interest rates (since more money
leads to more opportunity to get loans
hence lower interest rates), which in turn,
creates more investment and puts more
amount of money in the consumer hands,
thereby stimulating spending. Businesses
respond by ordering more raw materials
and increasing production. The increased
business activity raises the demand for
labour. The opposite can take place if
the money supply falls or when its growth
rate declines.
• Macroeconomic schools of thought that
emphasis heavily on the role of money
supply include Monetarist school by
Milton Friedman.
Velocity of Money
• It is the rate at which money is exchanged
in an economy.
• It is related to the number of times that
money transfers from one transaction to
another. Simply put, it is the rate at which
people spend money.
• For example, Consider an economy
consisting of two individuals, farmer, and
seed supplier, they have ₹100 between
them in a year.
• Farmer buys seed from seed supplier for
Rs. 100.
• Seed Supplier buys wheat from the
farmer for Rs. 80.
• Seed Supplier spends the remaining on
transportation Rs. 20.
• In a course of time, Rs. 200 changed
the hands, even though the size of the
economy was Rs. 100.
• This entire multiplication in the value of
goods and services exchanged is made
possible with the help of the velocity of
money in an economy.
• The equation for GDP = Money Supply *
Velocity of Money.
• In the above example GDP = 200, Money
supply = 100.
• Hence, the Velocity of Money is 2/year.
Monetary aggregates
• Money is utilized as a medium of
exchange, a unit of account, and as a
ready store of value. Its different functions
are associated with various empirical
measures of the money supply. There
is no single "correct" measure of the
money supply. Instead, there are various
measures, classified along a spectrum or
continuum between broad and narrow
monetary aggregates.
• Narrow money aggregates include only
the most liquid assets, the ones most
easily used to spend (currency, checkable
deposits).
• Broad money aggregates incorporate
fewer liquid types of assets (certificates
of deposit, etc.).
• This continuum corresponds to the
way that various types of money are
more or less impacted and controlled
by monetary policy. Narrow measures
comprise those more directly affected
and controlled by monetary policy,
while broader measures are less closely
associated with monetary-policy actions.
• It is a matter of constant argument as
to whether broader or narrower versions
of the money supply have a more
predictable connection to nominal GDP.
• The several categories of money are
typically classified as "M"s.
• The "M"s generally ranges from M1
(narrowest) to M3 (broadest) but which
"M"s are essentially focused on in policy
formulation depends on the central bank
of the country.
• The Reserve Bank of India (RBI) defines
the monetary aggregates as:
43
Reserve Money (M0) =
Bankers' deposits with the Reserve Bank of
India (RBI) + 'Other' deposits with the RBI +
Currency in circulation
• The another name of the Reserve Money
is “High Powered Money” and also
Monetary Base.
• It is the total liability of RBI.
• Currency in circulation includes Notes
and Coins in circulation.
• Banker’s deposit with RBI is Banks current
account deposit with RBI.
• Other deposits include balance in the
account of foreign Central Banks and
Government, the account of international
agencies such as IMF, etc.
• It can also be written as
Net RBI's credit to the Government + RBI's claims
on banks + RBI's credit to the commercial sector +
RBI's net foreign assets + Government's currency
liabilities to the public: RBI's net non-monetary
liabilities.
M1 (Narrow Money) =
Currency with the public + Deposit money of
the public (Demand deposits with the banking
organizations) + 'Other' deposits with the
Reserve Bank of India (RBI)
M2 =
Savings deposits with Post office savings banks
+ M1
M3 (broad money) =
M1+ Time deposits with the banking system
• It can also be written as
Bank credit to the commercial sector + Net bank
credit to the Government + Net foreign exchange
assets of the banking domain + Government's
currency liabilities to the public: Net non-
monetary liabilities of the banking sector (Other
than Time Deposits)
M4 =
Entire deposits with post office savings banks
(excluding National Savings Certificates) + M3
Liquidity
• Liquidity refers to the degree to which an
asset or security can be quickly bought
or sold in the existing market at a price
reflecting its intrinsic value.
• In another words: the ease of converting
it to cash.
• Cash is universally recognized as the
most liquid asset, while tangible assets,
such as real estate, fine art, etc. are all
relatively less liquid.
• Other types of financial assets, ranging
from equities to partnership units, fall at
various places on the liquidity spectrum.
• The liquidity of these kind of measures
are in order M1>M2>M3>M4 i.e., M1 is
most liquid and M4 is least liquid.
Money Multiplier
• Money Multiplier is the ratio of the Broad
Money (M3) to Reserve Money (M0).
Money Multiplier = M3/M0
• It shows the connection between the
monetary base and money supply in the
economy.
• It can also be considered as the amount
of money that banks generate with each
unit of money. The commercial banks
accept deposits from its customers. After
keeping a certain amount as a reserve,
44
banks distribute the remaining as loans
for injecting liquidity in the economy.
• Mathematically, money multiplier
formula can be represented as:
Money Multiplier = 1/r (Where r = Required
reserve ratio or cash reserve ratio.)
• Central Bank of the country can influence
the money supply in the economy. The
money supply can be increased in an
economy by purchasing government
securities such as treasury bills and
government bonds.
• The reverse happens when the central
bank tightens the money supply, by
selling securities on the open market,
drawing liquid funds out of the banking
system.
Bank Deposit
• Bank deposit is money kept in banking
institutions for future use.
• Bank deposit refers to liability owned by
the bank to the depositor.
Types of Bank Deposit
• Bank offers two types of kinds of deposit
account.
» Demand Deposit: Demand Deposit
account consists of funds that can be
withdrawn at any time.
There are two types of demand deposit
accounts -
− Current Account Demand Deposit.
− Saving Account Demand Deposit.
» Term Deposit/Time Deposit: Term
deposit account is used to hold money
for a fixed period
Money deposited in term deposit cannot
be withdrawn before its maturity that is
fixed a particular time.
 There are two types of term deposit
account:
• Fixed Deposit.
• Recurring Deposit.
Current account demand deposit
• The money in the current account is
available for immediate access.
• The current account deposit is used by
businesses to conduct their business
transactions since there is no constraints
or restriction on the number of
transactions in a day.
• Bank does not offer interest rates in the
current account demand deposit.
Saving account demand deposit
• Saving account unlike Current account
has restrictions on the number of
withdrawals as well as the amount of
withdrawal in a specific period.
• Bank offers fixed interest rates for saving
account demand deposit.
Fixed account Deposit
• A fixed account demand deposit allows a
deposit to be made for a specified period.
• Banks offer deposit holder with a fixed
interest rate at a regular rate which is
higher than the Saving account.
Recurring account Deposit
• In the Recurring deposit, a fixed amount
is deposited at regular intervals for a
fixed term.
• The total deposit along with interest is
payable on maturity by the bank.
• The rate of interest presented by the
bank on this deposit is higher than saving
account but less than fixed account
deposit.
45
Liquidity Trap:
An economic situation when the interest
rate is so low that people prefer to hold
money rather than invest it. In such
circumstances investors do not go to
increase investment even if the interest
rates on loans are reduced because
People are too afraid to invest.
Cryptocurrency
• It is a virtual or digital currency that is
created, stored, and transacted using
block chain technology.
• The word ‘Cryptocurrency’ is derived from
an encryption technique cryptography.
It is used to secure the decentralized
network.
• The most important characteristic
of Cryptocurrency is that it is not
controlled by any central authority (like
central banking system) instead it uses
decentralized control.
• Example of cryptocurrency is Bitcoin,
Digicoin, Litecoin, SOV etc.
Blockchain Technology
• Blockchain technology is also called as
a distributed ledger technology wherein
the data of any of the individuals are
saved as blocks.
• The information related to the addition of
the block is shared with everyone on the
blockchain and which makes modification
or hacking of the information difficult.
• Basic understanding of Blockchain
technology can be related to this example.
Just Imagine a Microsoft Excel sheet file
in your computer system with important
details of some transactions you made.
You can refer to it a ledger. Now, suppose
that your file is copied to hundreds of your
friends’ computer system, linked to each
other establishing a network. The ledger
 in your computer system has become a with a technology to consistently update
distributed ledger. After that imagine this this Microsoft Excel sheet, whenever you
network of computer systems is designed or your friends update the ledger.

Cash Semi - Digital Digital Economy

based Economy (Cash + based on Block
economy Bank regulated Chain Technology
online transactions)

Problems Problems Problems

1.Cost of 1.Single Server - 1.Decentralised

printing risk of hacking and thus trust
based
2. Theft of 2. Slow
cash 2. Can be created
transactions
by anybody
3.Time
consuming

I M A G E 4.1: B E N E F I T S OF C R Y P TO C U R R E N C Y

How can one get • 1 bitcoin = 100 million Satoshi.

cryptocurrency?
• Cryptocurrency can be obtained in three
ways:
• Mining: It is the process of adding the
transaction to the public ledger known
as the blockchain. It is done using special
software and high-speed computers.
• Payment: By selling goods to a person
who owns the cryptocurrency or the
person who is involved in the process of
mining.
• Purchasing: Purchasing cryptocurrency
by using currency.
Bitcoin
• It is one of the most popular and used
cryptocurrency in the world.
• Bitcoin was invented by
Nakomoto in the year 2009.
• The smallest unit to be recorded in the
blockchain of the bitcoin is known as
Satoshi.
Cryptocurrency around the
world
Venezuela
• Venezuela adopted Petro Cryptocurrency
in year 2018.
• Venezuela adopted Petro cryptocurrency
because Venezuela is facing
hyperinflation.
Marshall Island
• Marshall Island adopted SOV or Digital
Sovereign in the year 2018.
• SOV is used as legal tender and provides
Marshall Island with its own currency
reducing its dependence on the .
Satoshi
India and Cryptocurrency
• India is necessarily a cash-based
economy, but the ‘Digital India’ initiatives
of the government have increased
emphasis on digital currency.

46
• In 2017, the Indian government formed a
committee headed by Subhas Chandra
Garg to study issues related to virtual
currencies.
• The committee recommendation is as
follows:
» Banning of cryptocurrency: Due to
risk and volatility associated with
cryptocurrency.
» Digital Ledger Technology: The Report
highlighted the positive of Digital Ledger
Technology (DLT). DLT based system can
be used by banks and other financial
firms for the process like fraud detection,
loan issuance, etc.
» Other proposals: Committee suggested
that the government should keep an eye
for ‘official digital currency’ as RBI Act
1943 permits the government to approve
Digital Currency.
• The reasons as stated by the Subhash
Committee for banning cryptocurrency
are as follows:
» Volatile nature of cryptocurrencies
(however, other investments are also
volatile, and this should be left to the
investors).
» These are used for transactions between
criminal groups and for criminal activities.
» No government backing.
Advantages of Cryptocurrency
• Easy to use: Since cryptocurrency uses
modern technology like the Internet,
smartphones etc. Funds can be
transferred directly between the parties
without the involvement of third parties
like banks.
• Low transaction cost: Since
cryptocurrency removes the third party
like banks in the transaction its lower
transaction cost in comparison to the
conventional banking system.
47
• Transparency: In cryptocurrency, every
transaction is recorded on the blockchain.
Blockchain keeps the information about
every transaction.
• Decentralization: Since blockchain does
not store any information in a central
location. Information is distributed across
networks of computers making it difficult
to tamper with.
Disadvantages of
Cryptocurrency
• Lack of knowledge: Most people do not
know what cryptocurrency is and how to
use cryptocurrency.
• Volatility: Since cryptocurrency is not
regulated. Hence, its prices vary greatly
from one day to another.
• Technology Cost: Cryptocurrency saves
transaction cost, but for the transaction
to make happen it require a computer,
electricity making its adaptability difficult
for a country like India.
UPSC CSE PRELIMS
Previous Year
Questions
Q.1) Which of the following measures
would result in an increase in the
money supply in the economy? 2012
1. Purchase of government securities from
the public by the Central Bank
2. Deposit of currency in commercial
banks by the public
3. Borrowing by the government from the
Central Bank
4. Sale of government securities to the
public by the Central Bank
Select the correct answer using the codes
given below:
(a) 1 only
(b) 2 and 4 only
 (c) 1 and 3
(d) 2, 3 and 4
Ans. (c)
Explanation:
Note: You will be able to do this question
more effectively after reading “Money
Market module”.
Explanation: Different ways to increase
the money supply in an economy
• Print more money: Generally, this is done
by the Central Bank, though in some
country’s governments can dictate the
money supply. For instance, in Zimbabwe
in 2000s, the government printed more
money to pay wages.
• Reducing interest rates- Lower interest
rates decrease the cost of borrowing.
This makes investment comparatively
more profitable, and so encourages
economic activity. Consumers will also
see cheaper interest payments leading
to higher disposable income.
• Central Bank buying government
securities- If the Central Bank buy
Government securities people who were
holding the bonds have more money to
spend. Therefore, in certain conditions,
this can lead to an increase in the money
supply.
Q.2) Consider the following liquid assets:
2013
1. Demand deposits with the banks
2. Time deposits with the banks
3. Savings deposits with the banks
4. Currency
The correct sequence of these decreasing
order of Liquidity is
(a) 1-4-3-2
(b) 4-3-2-1
(c) 2-3-1-4
(d) 4-1-3-2
Ans. (d)
48
• Explanation: Most liquid assets are the
currency assets since they can be used
anytime.
• The least liquid assets are the time
deposits, which are the deposits for a
fixed time period and can only be used
upon their maturity.
• Demand deposits are more liquid than
saving deposits because they can be
demanded by the holder from the bank
at any time.
Q.3) Supply of money remaining the same
when there is an increase in demand for
money, there will be: 2013
(a) a fall in the level of prices
(b) an increase in the rate of interest
(c) a decrease in the rate of interest
(d) an increase in the level of income and
employment
Ans. (b)
• Explanation: With an increase in
demand for money, people will deposit
less money in banks. Hence, banks will
increase the rate of interest to attract
people to deposit money in the bank.
• Let us understand this through an
example Supply of money is constant
and demand of money is increasing, it
means more people are willing to loan
from banks, but the supply of money is
constant, so the bank will increase its
rate of interest at which loan is given.
Q.4) The problem of international liquidity
is related to the non-availability of: 2015
(a) goods and services
(b) gold and silver
(c) dollars and other hard currencies
(d) exportable surplus
Ans. (c)
Note: : This question you will be able to
do after reading “Foreign Investment and
trade module”
• Explanation: The concept of
 international liquidity is related with
international payments. These payments
arise out of international trade in goods
and services and also in connection with
capital movements among one country
to another.
• International liquidity refers to the
commonly accepted official means of
settling imbalances in international
payments which is basically dollars and
hard currencies.
Q.5) With reference to ‘Bitcoins’ sometimes
seen in the news, which of the following
statements is/are correct? 2016
1. Bitcoins are tracked by the Central
Banks of the countries.
2. Anyone with a Bitcoin address can send
and receive Bitcoins from anyone else
with a Bitcoin address.
3. Online payments can be sent without
either side knowing the identity of the
other.
Select the correct answer using the code
given below.
(a) 1 and 2 only
(b) 2 and 3 only
(c) 3 only
(d) 1, 2 and 3
Ans. (b)
• Explanation: Bitcoin is a decentralized
virtual or digital currency without a
central bank or single administrator. It
can be sent from one user to another on
the peer-to-peer bitcoin network without
the need for intermediaries
• Various transactions are verified by
network nodes through cryptography
and recorded in a public distributed
ledger called a blockchain.
Q.6) Which one of the following statements
correctly describes the meaning of
legal tender money? 2018
49
(a) The money which is tendered in courts
of law to defray the fee of legal cases
(b) The money which a creditor is under
compulsion to accept in settlement of his
claims
(c) The bank money in the form of
cheques, drafts, bills of exchange, etc.
(d) The metallic money in circulation in a
country
Ans. (b)
• Legal tender money is a type of payment
that is protected by law.
• Legal tender is also known as a forced
tender which is very secure and it is
impossible to deny the legal tender while
subsiding a debt which is assigned in the
same medium of exchange. In another
words, we can say that the term legal
tender does not represent the money
itself, rather it is a kind of status which
can be bestowed on certain types of
money.
• The options given in the Question does
not properly explain the definition of
legal tender money. So, the most suitable
answer is b.
Q.7) If you withdraw Rs. 1,00,000 in cash
from your Demand Deposit Account
at your bank, the immediate effect on
aggregate money supply in the economy
will be
(a) to reduce it by Rs. 1,00,000
(b) to increase it by Rs. 1,00,000
(c) to increase it by more than Rs.
1,00,000
(d) to leave it unchanged
Ans. (d)
• Explanation: In the given case, while the
'DD' (net demand deposits with banks)
component will fall by Rs. 1,00,000, the 'C'
(currency held by the public) component
will increase by Rs. 1,00,000, thus, leaving
the money supply unchanged.
 CHAPTER - 5

BANKING (PART I)

• Allahabad Bank (1865) was the first bank

What is a bank? that was completely run by Indians.
• Punjab National Bank Ltd was set up in
• A bank is a financial institution that
1894. It the oldest existing bank by Indian.
provides banking facilities and other
financial services to its customers. • Central Bank established in 1911 became
1st bank to be owned and managed by
• Banking Services include accepting
Indians.
deposits and giving loans.
• In 1921, all the Presidency Bank were
• Banks also provide many financial
merged to form Imperial Bank of India.
services like currency exchange, wealth
management, etc. • This became State Bank of India in 1955
by an Act of Parliament.
• Banking Sector is one of the key drivers of
the economy. It provides liquidity to the
economy which helps to create demand.
For example, car loans provided by banks Nationalization of
Banks
create demand for the car and hence
help in the growth of automobile sector.
• Due to the importance of banks for the
financial stability of the economy, banks
• Nationalization is the process of
transferring private assets of the banking
are highly regulated in most countries.
sector entities under the control of the
• Banking System is a group or network government.
of institutions which provide financial
services to people. Banking System
controls the money supply in the economy. Objectives of Nationalization
• At the time of independence, there were
Evolution of Bank in many small banks in India. One of the
reasons was to streamline the functioning
India of banks.

• The first bank of India was the General • To provide access to banking service to
the masses and reduce inequalities.
Bank of India, established in 1786.
• East India Company established three • To provide social orientation to the
banking sector i.e. to ensure adequate
individual banks which were called as
credit flow in agriculture and rural sectors.
Presidency Bank.

» Bank of Calcutta (1809)

» Bank of Bombay (1840) State Bank of India
» Bank of Madras (1843) • In 1955, the Government of India
nationalized Imperial Bank of Indian and
• Bank of Hindustan was established in was given the name “State Bank of India”.
1870.

50
• State Bank of India was established under • Allahabad Bank • Dena Bank
the The State Bank Of India Act, 1955. • Bank of India • Indian Overseas
• In the year 1959, the Government • Punjab National Bank
passed the SBI (Associates) Act, 1959 Bank • Indian Bank
to nationalize eight private banks with • Bank of Baroda • United Bank
good regional presence and named them • Bank of • Syndicate Bank
Associate of the SBI. Maharashtra • Union Bank of
• On 1st April 2017, the Government of India • Central Bank of India
merged 5 Associate Bank and Bhartiya India • UCO Bank
Mahila Bank with SBI. • Canara Bank
• Five associate banks which were merged • Six more banks with deposits greater
are State Bank of Bikaner and Jaipur, than 200 crores were nationalized in
State Bank of Hyderabad, State Bank of 1980.
Mysore, State Bank of Patiala, State Bank
of Travancore. • These banks were:
• Following this merger, SBI became the » Andhra Pradesh
largest bank of India and one of the top
» Corporation Bank
50 largest banks in the world.
» New Bank of India
» Oriental Bank of Commerce
Banking Nationalization Act of » Punjab & Sind Bank
1969 » Vijaya Bank
• In 1969, the Government of India » The nationalization of Bank in 1980
nationalized 14 major Indian Commercial became important to ensure that priority
Banks with a deposit of more than 50 sector lending reaches the poor through
crores. a wide branch network.

Some positives of this move:

• Banking under government control provided the public implicit faith and enormous
confidence related to the sustainability of the banks.
• It was responsible for major rise in bank deposits and financial savings.
• it had improved the overall performance of the agriculture and small-scale industries.
• It has also led to increased penetration of various banks in to part of india.

Some Negatives of this move:

• Banking sector is a highly competitive segment. However, the nationalisation of
banks had decreased the competition amongst the private and public banks.
• It had created a bureaucratic attitude in the functioning of the banking sector.
• Lack of initiative and resposibility, red-tapism, inordinate delays are common
characteristics of nationalized banks.
• Since 2012, Non-Performing Assets (NPA) issue is at least partly justified by the credit
bubble that developed under political patronage that emerged out of government's
control over banking sector.

51

Reserve Bank Of
India
• Reserve Bank of India is the Central Bank
of India. It is the regulator of the entire
banking system in India.
• Reserve Bank of India was established on
1st April 1935 following the enactment of
the RBI Act 1934.
• The purpose of the RBI Act 1934 was to
issue notes and maintain reserves, but
the Act did not cover Banking Regulation.
• Reserve Bank of India was a privately
owned Bank, but it was nationalized in
1949.
• Banking Regulation Act 1949 conferred
on RBI a wide range of regulatory and
supervisory power with the objective to
develop the banking system of India.
Functions of RBI
• The issuer of currency: RBI is the sole
Agency in the country that can issue
currency and coins in India except for
One-Rupee coin and note both which is
issued by the Finance Ministry.
» RBI prints and distributes currency along
with regulation of the flow of currency in
the economy.
• Banker of Government: RBI provides
Banking services to both Central and
State governments. These services
include deposits, loans, etc.
• Bankers to the banks: RBI as the Central
Bank of India, supervises the Commercial
Banks of the country. RBI provides
various services to these banks like loans
to meet short and long term liabilities,
issue license to Banks and Lender of last
resort etc.
• Inflation targeting: RBI is tasked with the
function of stabilizing the rate of Inflation.
52
• Regulator of foreign exchange: RBI
stabilizes the value of Indian currency in
the global economy. RBI manages India’s
foreign currency assets and gold reserve.
• Developmental functions: RBI ensure
credit availability to productive sectors,
promote financial inclusion, set up various
institutions like SIDBI, NABARD etc.
• Other functions: RBI acts as an agent of
the government of India at IMF, controls
credit and monetary policy, publishes
monetary and banking data, etc.
Credit and Monetary
Policy
• Monetary policy refers to the policy of the
Central Bank through which the desired
level of money supply and demand is
regulated in the economy.
• The primary goal of the monetary policy
is to maintain price stability while keeping
in mind the objective of growth.
• Credit Policy is a part of monetary
policy. It refers to the set of principles
that determines whom and how much to
lend? At what rate money is to lend?
• RBI has the right to announce monetary
policy from time to time depending upon
the state of the economy.
• There are many tools through which RBI
achieves the desired level of credit and
monetary policy.
• These tools are:
» Quantitative Instrument: Quantitative
instrument deals with the quantity/
volume of the money supply. These
instruments regulate or control the total
volume of bank credit.
− Cash reserve ratio (CRR)
− Statutory Liquidity Ratio (SLR)
− Bank Rate
 − Repo Rate securities, and prevent banks from facing
− Reverse Repo Rate insolvency issues.

− Marginal Standing Facility (MSF) • SLR is determined by RBI. Current SLR is

− Open Market Operation
» Qualitative Instrument: Qualitative
Instrument does not regulate the volume
of credit but regulates bad credit which
creates economic instability.
18.25%.
Note: If the Bank fails to meet with the
CRR and SLR requirement, a penalty at a
rate of 3% per annum above the bank rate
is imposed.

− Margin Requirement Difference between CRR and SLR

− Moral Suasion CRR SLR
− Direct Action
Banks are required to
− Rationing of credit Banks are required to
maintain SLR in liquid
maintain CRR in cash
assets (government
only.
securities, gold, etc.).
Cash Reserve Ratio (CRR)
IN SLR, securities are
In CRR, the cash reserve
• Cash Reserve Ratio (CRR) refers to is kept with RBI.
kept with the bank
the percentage of total deposits that themselves.
commercial banks are required to keep
in the form of cash with the RBI. Banks do not earn Banks earn interest on
interest on CRR. the SLR.
• Banks are not allowed to use this fund
for their commercial purposes, and no
interest is paid by the RBI on CRR balance
kept by banks with the RBI.
How CRR and SLR changes affect
Money Supply
• One of the main aims of CRR is to remove
excess cash from the economy. • CRR and SLR changes affect the money
• Cash Reserve Ratio (CRR) is determined supply in the economy.
by RBI. Current CRR is 4%. • For example, Suppose there is a bank
XYZ. CRR fixed by RBI is 5% and SLR is
25%.
Statutory Liquidity Ratio (SLR)
Total Deposit of bank 100 cr
• Statutory Liquidity Ratio (SLR) refers to XYZ (Net Demand and
the percentage of total deposits (includes Time Liability)
Net Demand and Time Liability (NDTL))
of a bank which is to be maintained by CRR (at 5%) 5 cr
the bank with them in the form of liquid
asset (non-cash form) in addition to cash SLR (at 25%) 25 cr
reserve ratio.
• Liquid assets are assets that are readily Money Left with XYZ 100-5-25 = 70 cr
converted into cash. For example, Gold,
Government securities, etc. • Now Suppose RBI, increases CRR to 10%
and SLR to 40%.
• The main aim of SLR is to regulate bank
credit, ensure banks invest in government

53
 Government securities, Corporate
Total Deposit of bank 100 cr
Securities, or any other securities which
XYZ (Net Demand and
Time Liability) Government permits for the transaction.
• Bank usually uses this route to fulfil short
CRR (at 10%) 10cr term liquidity crunch.
• Repo Rate is also known as Policy Rate.
SLR (at 40%) 40cr A change in the policy rate will alter
all other short-term interest rate in the
Money Left with XYZ 100 - 10- 40 = 50cr economy, thereby influencing the level of
economic growth and inflation.
• As shown in the above example, when
RBI increases CRR and SLR, the money
left with the bank has decreased from 9.00%

70cr to 50cr.
6.00%

Bank Rate
3.00%

• Bank Rate is the interest rate charged 0.00%

Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

Jan-19
Apr-14
Jul-14
Oct-14

Apr-15
Jul-15
Oct-15

Apr-16
Jul-16
Oct-16

Apr-17
Jul-17
Oct-17

Apr-18
Jul-18
Oct-18

by the RBI for long term lending to
commercial banks and other financial
institution.
• Commercial Banks, State Governments
and Financial Institutions also use bank
rate to borrow funds from RBI to meet
their long-term requirements.
• Bank rate influences the lending rate of
commercial banks. Higher the Bank rate
higher will be the interest rate charged
by the banks.
• RBI aligned Bank rate with the Marginal
Standing Facility (MSF) (discussed in
below section) in 2012.
• RBI can use Bank rate to curb excess
liquidity from the economy and vice
versa.
Apr-19
Jul-19
Oct-19
I M A G E 5.1: R E P O R AT E O V E R 5 Y E A R S
• The graph shows changes in Repo Rate
over 5-year time. Repo Rate is fixed by RBI
taking into consideration the economic
growth prospects.
Types of Repo Rate
• Repo Rate is of two types based on
maturity:
» Overnight Repo: It refers to the Repo
with single-day maturity.
Indian Repo market is dominated by the
overnight Repo market.
» Term Repo: It refers to Repo that has a
fixed maturity longer than one day.

Repo Rate (Ready Forward Contract)

• Repo Rate or Repurchase Rate is the
interest rate charged by RBI for short
term lending to commercial banks.
• Bank borrows funds from RBI by
selling securities with an agreement to
repurchase the securities on a mutually
agreed future date at an agreed price.
• Securities used in Repo Rate can be
Reverse Repo
• Reverse Repo is the rate of interest RBI
pays to commercial banks when RBI
borrows funds from the banks.
• Reverse Repo is used to absorb excess
liquidity from the economy.
• Reverse Repo Rate allows banks to park
excess funds with the RBI to earn interest

54
 rate. This serves two purposes:
» One reduces excess liquidity from the
economy.
» Second lower loan disbursal by banks
hence prevent bank losses due to NPA.
• An increase in Reverse Repo will decrease
money supply since it will encourage
banks to park their funds with RBI to earn
interest and vice versa.
Liquidity Adjustment Facility (LAF)
• Liquidity Adjustment Facility (LAF) is a
facility extended by the RBI, to scheduled
commercial banks that allow banks to
borrow money through Repo or park
excess funds with RBI through Reverse
Repo.
money supply in the economy. This is
important when inflation is high and
there is a need to cut rising price level.
But increase in rates decreases the level
of economic activity.
Repo Rate ↑ → Interest Rate ↑ → Consumption,
Investment ↓ → Growth ↓
• On the other hand, when inflation is under
control, and economic growth is slow, RBI
cuts Repo Rate and Reverse Repo Rate.
This leaves with more money with banks.
More availability of loans will increase
the money supply in the economy. This is
important to increase the level of overall
economic activity.
Repo Rate ↓ → Interest Rate ↓ → Consumption,
Investment ↑ → Growth ↑

• Liquidity Adjustment Facility (LAF) is the

Combat Combat
mechanism used by RBI for managing the Inflation Deflation
liquidity needs of commercial banking. (increase in (decrease in
• LAF is used to aid banks in adjusting the price) price)
day to day mismatches in liquidity.
CRR, SLR ↑ ↓
• Components of LAF are:
Repo Rate ↑ ↓
» Repo
» Reverse Repo Bank Rate ↑ ↓

» Term Repo (for 14 and 7 days)

OMO RBI will Sell Purchase/Buy
» Overnight Repo (explained government government
later) securities securities
» Overnight Reverse Repo
• Above table, shows the changes in
• The introduction of the Liquidity facility in monetary policy instrument to combat
India was based on the recommendation inflation and deflation in the economy
of the Narsimham Committee on banking by RBI.
sector reform.
• It was introduced by RBI in the year 2000.
• Under LAF, the Minimum credit limit is Rs. Marginal Standing Facility (MSF)
5 crore. • Marginal Standing Facility is the penal
rate at which banks can borrow money
from the RBI over and above what is
How Repo Rate controls inflation available to banks through the LAF
• High Repo Rate and Reverse Repo Rate window.
leave less money available with banks, to • Under MSF, banks can overnight borrow
lend. Less availability of loan will restrict up to 1% of their Net Demand and Time

55
 Liabilities (NDTL) at the interest rate of
1%.
• MSF would be last resort for banks once
they exhaust all the borrowing options
including Liquidity Adjustment Facility
(LAF).
• Bank offer Government Securities to RBI
within the limits of the statutory liquidity
ratio (SLR).
• The scheme has been introduced by RBI
with the main aim of reducing volatility
in the overnight lending rates in the inter-
bank market.
• The minimum amount which can be
accessed through MSF is Rs.1 crore and
in multiples of Rs.1 crore.
• Since MSF is penal rate MSF is always
fixed above the Repo Rate.
• Thus, MSF is now placed at 25% above
the Repo Rate. Bank Rate is aligned to
the MSF rate.
• Repo Rate will be in the middle, the
Reverse Repo Rate will be 25 basis points
below it and the MSF rate 25 basis points
above it.
• Current Rates are as follows:
Reverse Repo Rate - 4.90% Repo Rate - 5.15%
Bank Rate - 5.40% MSF- 5.40%
Total Deposit of Bank OMO (Open Market Government Securities
XYZ Operation)
100
RBI sells government
100 securities worth Rs. 20 30cr + 20cr =50 cr
cr, and Banks XYZ buy it
RBI buys government
100
securities worth Rs. 20 cr
56
• (These rates are not constant but are
fixed by RBI based on the requirement of
the economy)
Bank Rate = MSF > Repo Rate > Reverse Repo
Open Market Operation (OMOs)
• Open Market Operation is the sale and
purchase of government securities in the
open market by the RBI.
• The main aim of the Open Market
Operation is to regulate money supply in
the economy.
• The purchase of Government Securities
by the RBI will increase the money supply
in the economy, whereas the sale of
Government Securities absorbs excess
liquidity from the economy.
• Open Market Operations changes the
proportion of Securities held by RBI,
Commercial Banks while maintaining the
total stock of securities the same.
• RBI carries Open Market operations
through commercial banks and does not
directly deal with the public.
• For example, let us take an example where
XYZ bank, buys and sells government
securities.
• Let us consider the following situation:
Money left
with Bank XYZ
30 cr 70 cr
50 cr
30cr - 20cr = 10 cr 90 cr
• As seen in the above example when RBI
sells Government Securities in the market
it reduces money supply from 70cr to 50cr.
Similarly, when RBI buys Government
Securities it increases the money supply
from 70cr to 90 cr.
Qualitative Instrument
Margin Requirement
• Banks keep aside some proportion of
loan(margin) whenever banks lend to
some specified sectors for safety.
• If the margin requirement for a particular
sector is increased, it will reduce the flow
of credit in that sector. If the Margin
requirement for a particular sector is
decreased, it will increase the flow of
credit in that sector.
• For example, suppose a loan of Rs. 100
is needed in rural sector and the margin
requirement is 20% which is equal to
20% of 100 = 20. Hence, maximum loan
that banks can give is 100-20= 80.
• RBI can increase the flow of credit in
the above example by increasing or
decreasing margin requirement.
Rationing of Credit
• Rationing of credit is a method through
which RBI set the limit on the amount of
loans, that can be made in a particular
sector.
• Credit Rationing is used by RBI to
regulate credit flow, particularly in case
of speculative activities.
Moral Suasion
• Moral Suasion refers to the persuasion
by RBI on Scheduled Commercial Banks
to follow certain policy without any strict
action.
• Under Moral Suasion, RBI can issue
57
suggestions, guidelines etc. for Scheduled
Commercial Banks regarding particular
policy.
Direct Actions
• Direct Actions refers to strict actions taken
by RBI against a Scheduled Commercial
Bank.
• Under Banking Regulation Act, 1949
RBI has authority to take strict actions
against any Scheduled Commercial Bank
which does not adhere to the direction of
the RBI.
Urijit Patel
Committee
• An expert committee was appointed to
examine the monetary policy framework
of the RBI in 2014.
• The committee was headed by Urijit Patel,
with the aim to revise and strengthen and
the Monetary Policy Framework.
• The main recommendations of the
committee are:
» RBI should adopt new CPI (Consumer
Price Index) to measure inflation and
anchor monetary policy.
» RBI should target CPI at 4%, + 2% [range
is between 2% to 6%].
» Monetary Policy should be done by the
Monetary Policy Committee (MPC), which
is 5 members Committee.
− Governor
− Deputy Governor in charge of
monetary policy
− RBI Executive Director in charge of
monetary policy.
− Two External Members
» Government debt and management
 must be taken by the government’s Debt
Management Office, with the Market
Stabilization Scheme (MSS) and Cash
Management Bill should be phased out.
» Open Market Operation (OMO) should be
used for liquidity management, and not
used to manage yields on government
securities.
» All sector specific refinance should
be phased out as committed to Asian
Development Bank in 1992.
Monetary Policy
Committee
• Monetary Policy Committee is entrusted
with the task of setting policy interest
rate (Repo Rate) to contain inflation
within the defined target level.
• Contrary to the recommendation of the
Urijit Patel Committee (where RBI was to
set inflation target), the Finance Ministry
has set an inflation target for RBI.
• The Reserve Bank of India and the
Government of India signed the Monetary
Policy Framework Agreement in 2015.
• In 2016 Government gave statutory
backing to Monetary Policy Committee
with the amendment in RBI Act 1934.
• Functions of MPC -
» RBI will be responsible for containing
inflation targets at 4% (with a deviation
of 2%).
» MPC will have six members:
− RBI Governor (Chairperson)
− RBI Deputy Governor in charge of
monetary policy,
− One official nominated by the RBI
Board
− Three members would be nominated
by Government of India [committee
headed by Cabinet Secretary]
58
» Members of MPC will hold the office for 4
years, and not eligible for reappointment.
» Not eligible for MPC selection -
− Members of Parliament/Legislature/
Public servant/or anyone having a
conflict of interest with RBI.
− Anyone above the age of 70.
» The MPC takes decisions based on a
majority vote (by those who are present
and voting).
» In case of a tie, the RBI governor will have
the second or casting vote.
» The decision of the Committee would be
binding on the RBI.
» The quorum for the meeting of the MPC
is four members.
» RBI is mandated to publish a Monetary
Policy Report every six months, explaining
the sources of inflation and the forecasts
of inflation for the coming period of six to
eighteen months.
» If RBI fails to meet the inflation target,
RBI will give an explanation in the form
of a Report to the Central Government.
» In the Report RBI, give reasons for failure,
remedial actions as well as estimated
time within which the inflation target
shall be achieved.
• The MPC replaces the previous system
where the RBI governor, with the aid
and advice of his advisory committee,
RBI governor had complete control over
monetary policy decisions.
• The history of suggestions for setting
up an MPC can be tracked back to
2002 when the Y. V. Reddy Committee
recommended for an MPC to decide
policy actions. Subsequently, suggestions
were made to set up an MPC in 2006 by
the Tarapore Committee, in 2007 by the
Percy Mistry Committee, in 2009 by the
Raghuram Rajan Committee and then in
2013, both in the Report of the Financial
Sector Legislative Reform Commission
 (FSLRC) and the Urijit Patel Committee.
• With the introduction of the Monetary
Policy Committee, the RBI will follow
a system similar to the one followed by
most global central banks.
Monetary Policy
Transmission
• Monetary Policy transmission refers to
the process by which a central bank’s
monetary policy changes (Repo Rate) is
passed through the financial system to
affect the public.
• Monetary Policy transmission is
dependent on Repo Rate. How far
changes in Repo Rate can bring change in
banks’ interest will depend on Monetary
Policy Transmission. The passing of rate
changes by MPC is crucial for regulating
inflation, growth etc.
• To improve Monetary Policy Transmission,
RBI introduced the Marginal Cost of
Funds Based Lending Rate (MCLR)
system in 2016.
Marginal Cost
of Funds Based
Lending Rate
(MCLR)
• The marginal cost of funds based lending
rate (MCLR) refers to the minimum interest
rate of a bank below which it cannot lend,
except in some cases allowed by the RBI.
• This new methodology replaces the base
rate system introduced in July 2010.
59
• RBI decided to shift from base rate
to MCLR because the rates based on
marginal cost of funds are more sensitive
to changes in the policy rates. This is very
essential for the effective implementation
of monetary policy.
Base Rate
• Base Rate is the minimum rate of
interest set by RBI below which banks
are not allowed to lend to its customer.
Base Rate vs MCLR
• Base rate calculation is based on
the cost of funds, a minimum rate of
return, operating expenses, and cost
of maintaining cash reserve ratio.
• MCLR is based on the marginal cost
of funds, tenor premium, operating
expenses, and cost of maintaining
cash reserve ratio.
Limitation of
Monetary Policy
• Large Non-Monetized Economy: In Rural
Economy, many transactions are barter
in nature. Hence, monetary policy fails to
influence this large section of people.
• Lack of financial Inclusion: Non-banking
financial intermediaries like moneylenders
etc. operate in large numbers, they are
not under the regulation of RBI. This limit
the effective transmission of monetary
policy changes.
• Natural Factors: Many natural factors
like a cyclone, floods, unseasonal rains
etc. affect crop production hence
inflation. For example, Rising prices of
onion cannot be controlled by monetary
policy.
Banking Sector
Reform
Committee on Financial
System (CFS)
• Government of India, in 1991 constituted
a nine-member committee headed by M.
Narasimham.
• The Narasimham Committee 1 was
constituted with the aim to bring out
“operational flexibility” and “functional
autonomy” to enhance efficiency,
productivity, and profitability.
• The major recommendations of
Narasimham Committee 1 are as follow-
» Establishment of a four-tier hierarchy for
the banking structure consisting of three
to four large banks with SBI at the top.
» The private sector banks should be
treated equally with the public sector
banks. The ban on setting new banks in
the private sector should be lifted and the
licensing policy in the branch expansion
must be abolished.
» Statutory Liquidity Ratio (SLR) and
Cash Reserve Ratio (CRR) should be
progressively brought down from 1991-92
levels.
» The priority sector should be redefined
to comprise small and marginal farmers,
tiny industrial sector, small traders, and
weaker sections.
» The government’s share of public sector
banks should be disinvested to a certain
percentage.
» Interest rates should be deregulated to
suit the market conditions.
» The Government has to be more liberal in
the expansion of foreign bank branches
and also foreign operations of Indian
60
banks should be rationalized.
» The RBI should be the primary authority
for the regulation of the banking system
in the country.
Narasimham Committee II
• Government of India, in 1998 constituted
a committee on Banking Sector Reforms
(BSR) under the chairmanship of M.
Narasimham.
• The Narasimham Committee 2 was
constituted with the aim to initiate the
second generation of financial sector
reforms.
• Narasimham committee Report II has
focused on structural changes so as to
strengthen the banking system to make
it more stable.
• The major recommendations of the
Narasimham Committee Report II are
mentioned below:
» Merger among strong public sector
banks and closure of weaker banks if
their rehabilitation is not possible.
» The committee recommended the idea
of setting up an asset reconstruction
fund to tackle the problem of huge non-
performing assets (NPAs) of public sector
banks.
» Competition between the public sector
and private sector banks should be
enhanced.
» Formation of asset reconstruction fund
to tackle the problem of huge non-
performing assets of public sector banks.
» Capital adequacy norms should be
enhanced from the present level of 8 %
but did not specify the amount to which
it should be raised.
Operation Twist
• 'Operation Twist’ is economic condition when the central bank utilizes the proceeds
from the sale of short-term securities to buy long-term government debt papers,
leading to easing of interest rates on the long-term papers.
• Operation Twist first appeared in 1961 as a method to strengthen the U.S. dollar and
accelerate cash flow into the economy.
• In 2019 and 2020, the Reserve Bank of India (RBI) conducted its version of ‘Operation
Twist’ with the help of simultaneous purchase and sale of government securities
under Open Market Operations (OMOs). Under this, the Reserve Bank of India
will buy long term bonds of the government and at the same time sell short term
securities of the government.
Inverted Yield Curve
• Generally, someone who lent to the government or a corporation for one year (by
purchasing a one-year government or corporate bond) would anticipate to obtain
a lower interest rate as compared to someone who lent for five or ten years, making
the yield curve upward-sloping.
• An inverted yield curve represents a condition in which long-term debt instruments
have lower yields as compared to short-term debt instruments of the same credit
quality. An inverted yield curve is sometimes described as a negative yield curve.

» The Banking Sector Reform Committee
further suggested that the existence
of healthy competition between public
sector banks and private sector banks
was essential.
• Lower bank rates can help to expand the
UPSC CSE PRELIMS
Previous Year
lends money to domestic banks, often
in the form of very short-term loans.
Managing the bank rate is a method by
which central banks affect economic
activity.
economy by lowering the cost of funds
for borrowers, and higher bank rates help
to reign in the economy when inflation is
higher than desired.

Questions • In order to curb liquidity, the central bank

Q.1) The lowering of Bank Rate by the
Reserve Bank of India leads to: 2011
(a) More liquidity in the market
(b) Less liquidity in the market
can resort to raising the bank rate and
vice versa.
Q.2) The Reserve Bank of India (RBI) acts
as a bankers’ bank. This would imply
which of the following? 2012

(c) No change in the liquidity in the 1. Other banks retain their deposits with
market the RBI.

(d) Mobilization of more deposits by 2. The RBI lends funds to the commercial
commercial banks banks in times of need.

Ans. (a) 3. The RBI advises the commercial banks

on monetary matters.
• Explanation: A bank rate is the interest Select the correct answer using the codes
rate at which a nation's central bank given below:

61
 (a) 2 and 3 only
(b) 1 and 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (d)
• Explanation: As bankers’ bank, the RBI
holds a part of the cash reserves of banks,
lends them funds for short periods, and
provides them with centralized clearing
and cheap and quick remittance facilities.
• In the early stages of the development
of central banking, banks used to keep
some of their cash reserves voluntarily
with a leading bank which gradually took
over the role of a central bank.
• Under the Reserve Bank of India Act, 1934
and the Banking Regulation Act, 1949
(as amended from time to time), the RBI
enjoys extensive powers of supervision,
regulation, and control over commercial
and co-operative banks.
• The Bank’s regulatory functions relating
to banks cover their establishment
(i.e., licensing), branch expansion, the
liquidity of their assets, management
and methods of working, amalgamation,
reconstruction, and liquidation.
• The control by the Bank is exercised
through periodic inspection of banks
and follow-up action and by calling for
returns and other information from them.
• The objective of such supervision and
control is to ensure the development of
a sound banking system in the country.
Q.3) The Reserve Bank of India regulates
the commercial banks in matters of: 2013
1. Liquidity of assets
2. Branch expansion
3. Merger of banks
4. Winding-up of banks
Select the correct answer using the codes
given below.
(a) 1 and 4 only
62
(b) 1 and 2 only
(c) 2, 3 and 4 only
(d) 1, 2, 3 and 4
Ans. (d)
• Explanation: The Reserve Bank of India
(RBI) is the central bank of India, which
was established on April 1, 1935, under
the Reserve Bank of India Act.
• The Reserve Bank of India uses monetary
policy to create financial stability in
India, and it is charged with regulating
the country's currency and credit
systems.
• The main purpose of the RBI is to conduct
consolidated supervision of the financial
sector in India, which is made up of
commercial banks, financial institutions,
and non-banking finance firms. Initiatives
adopted by the RBI include restructuring
bank inspections, introducing off-site
surveillance of banks and financial
institutions and strengthening the role
of auditors.
Q.4) An increase in the Bank Rate generally
indicates that the: 2013
(a) market rate of interest is likely to fall
(b) Central Bank is no longer making
loans to commercial banks
(c) Central Bank is following an easy
money policy
(d) Central Bank is following a tight
money policy
Ans. (d)
• Explanation: Bank rate is the rate
charged by the central bank for lending
funds to commercial banks.
• Bank rates influence lending rates of
commercial banks.
• Higher bank rate will translate to higher
lending rates by the banks.
• In order to curb liquidity, the central
bank can resort to raising the bank rate
and vice versa.
• In India, the Reserve Bank of India
determines the bank rate, which is the rate
at which it makes loans to commercial
banks with no collateral (RBI Act 1934
sec.49 ) The Reserve Bank of India also
provides short term loans to its clients
(keeping collateral) at what is called the
Repo Rate.
• This rate is revised periodically.
• However, there is no predetermined
schedule.
• The Repo Rates are changed reactively
depending on the economy.
• As in other countries, Repo Rates affect
the money flow into the nation's economy
and affect the inflation and commercial
banks' lending or interest rate.
Q5) In the context of Indian economy,
Open Market Operations’ refers to: 2013
(a) Borrowing by scheduled banks from
the RBI
(b) Lending by commercial banks to
industry and trade
(c) Purchase and sale of government
securities by the RBI
(d) None of the above
Ans. (c)
• Explanation: An open market operation
(OMO) is an activity by a central bank to
give (or take) liquidity in its currency to
(or from) a bank.
• A central bank uses OMO as the primary
means of implementing monetary policy.
• The aim of open market operations
is— supplying commercial banks with
liquidity and sometimes taking surplus
liquidity from commercial banks.
• Monetary targets, such as inflation,
interest rates, or exchange rates, are used
to guide this implementation.
Q.6) The terms ‘Marginal Standing
Facility Rate’ and ‘Net Demand and Time
Liabilities’, sometimes appearing in the
news, are used in relation to 2014
63
(a) banking operations
(b) communication networking
(c) military strategies
(d) supply and demand of agricultural
products
Ans. (A)
• Explanation: Marginal Standing Facility
(MSF) is a new scheme announced by the
Reserve Bank of India (RBI) in its Monetary
Policy (2011-12) and refers to the penal
rate at which banks can borrow money
from the central bank over and above
what is available to them through the
LAF window.
Q.7) If the interest rate is decreased
in an economy, it will 2014
(a) decrease the consumption
expenditure in the economy
(b) increase the tax collection of the
Government
(c) increase the investment expenditure
in the economy
(d) increase the total savings in the
economy
Ans. (c)
• Explanation: Lower Interest rates
encourage additional investment
spending, which gives the economy a
boost in times of slow economic growth.
• Changes in interest rates affect the
public's demand for goods and services
and, thus, aggregate investment
spending.
• A decrease in interest rates lowers the
cost of borrowing, which encourages
businesses to increase investment
spending.
• Lower interest rates also give banks
more incentive to lend to businesses
and households, allowing them to spend
more.
Q.8) In the context of Indian economy which
of the following is/are the purpose/purposes
of ‘Statutory Reserve Requirements’? 2014
1. To enable the Central Bank to control
the amount of advances the banks can
create
2. To make the people’s deposits with
banks safe and liquid
3. To prevent commercial banks from
making excessive profits
4. To force the banks to have sufficient
vault cash to meet their day-to-day
requirements
Select the correct answer using the code
given below.
(a) 1 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2, 3 and 4
Ans. (b)
• Explanation: Statutory liquidity ratio
(SLR) refers to reserve requirement
that the commercial banks in India are
required to maintain in the form of cash,
gold reserves, RBI approved securities
before providing credit to the customers.
• Statutory liquidity ratio is determined by
the Reserve Bank of India maintained
by banks. The SLR is determined by a
percentage of total demand and time
liabilities.
• When there is a rise in the SLR, a bank
is also restricted in terms of its leverage
position. Hence, this decrease in the SLR
will enable a bank to release more funds
into the economy and in turn, contribute
towards the overall development of the
economy and vice-versa.
Q.10) When the Reserve Bank of
India reduces the Statutory Liquidity
by 50 basis points, which of the
following is likely to happen? 2015
(a) India’s GDP growth rate increases
drastically.
64
(b) Foreign Institutional Investors may
bring more capital into our country.
(c) Scheduled Commercial Banks may
cut their lending rates.
(d) it may drastically reduce the liquidity
to the banking system.
Ans. (c)
• Explanation: SLR cut means more
liquidity which may prompt the banks to
lower the lending rates.
Q.11) With reference to Indian economy,
consider the following: 2015
1. Bank rate
2. Open market operations
3. Public debt
4. Public revenue
Which of the above is/are component/
components of Monetary Policy?
(a) 1 only
(b) 2, 3 and 4
(c) 1 and 2
(d) 1, 3 and 4
Ans. (c)
• Explanation: Public debt is not part of
Monetary Policy (it is a part of Fiscal
policy) and OMOs together with CRR,
SLR, Repo, Reverse Repo by RBI are
certainly a part of their monetary policy.
• So, the answer should be the option C.
Q.12) What is/are the purpose/purposes
of the ‘Marginal Cost of Funds based
Lending Rate (MCLR)’ announced by RBI?
2016
1. These guidelines help improve the
transparency in the methodology
followed by banks for determining the
interest rates on advances
2. These guidelines help ensure availability
of bank credit & interest rates which
are fair to the borrowers as well as the
 banks
Select the correct answer using the code
given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (c)
• Explanation: The marginal cost of funds-
based lending rate (MCLR) refers to the
minimum interest rate of a bank below
which it cannot lend, except in some
cases allowed by the RBI.
• Reasons for introducing MCLR:
» RBI decided to shift from base rate
to MCLR because the rates based on
marginal cost of funds are more sensitive
to changes in the policy rates. This is very
essential for the effective implementation
of monetary policy.
Q.13) Which of the following statements
is/are correct regarding the Monetary
Policy Committee (MPC)? 2017
1. It decides the RBI’s benchmark interest
rates.
2. It is a 12-member body including the
Governor of RBI and is reconstituted
every year.
3. It functions under the chairmanship of
the Union Finance Minister.
Select the correct answer using the code
given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 2 and 3 only
Ans. (a)
• Explanation: The Monetary Policy
Committee of India is responsible for
fixing the benchmark interest rate in
India.
65
• The meetings of the Monetary Policy
Committee are held at least 4 times a
year and it publishes its decisions after
each such meeting.
• The committee comprises six members,
three officials of the Reserve Bank of India
and three external members nominated
by the Government of India.
• They need to observe a "silent period"
seven days before and after the rate
decision for "utmost confidentiality".
• The Governor of Reserve Bank of India
is the chairperson ex officio of the
committee.
• Decisions are taken by the majority with
the Governor having the casting vote in
case of a tie.
• The current mandate of the committee
is to maintain 4% annual inflation until
March 31, 2021, with an upper tolerance
of 6% and a lower tolerance of 2%
• The committee was created in 2016 to
bring transparency and accountability in
fixing India's Monetary Policy.
• The monetary policy is published after
every meeting with each member
explaining his opinions.
• The committee is answerable to the
Government of India if the inflation
exceeds the range prescribed for three
consecutive months.
Q.14) "Gold Tranche" (Reserve Tranche)
refers to: 2020
(a) a loan system of the World Bank
(b) one of the operations of a Central
Bank
(c) a credit system granted by WTO to
its members
(d) a credit system granted by IMF to its
members
Ans. (d)
• Explanation: A reserve tranche is a
part of the required quota of currency
every member country must give to the
International Monetary Fund (IMF) that
 can be used for its own purposes—
without a service fee or economic reform
provisions.
Q.15) What is the importance of the term
"Interest Coverage Ratio" of a firm in
India? 2020
1. It helps in understanding the present
risk of a firm that a bank is going to
give loan to.
2. It helps in evaluating the emerging risk
of a firm that a bank is going to give
loan to.
3. The higher a borrowing firm's level of
Interest Coverage Ratio, the worse is its
ability to service its debt.
Select the correct answer using the code
given below.
(a) 1 and 2 only
(b) 2 only
66
(c) 1 and 3 only
(d) 1, 2 and 3
Ans: (a)
• Explanation: The term ‘The interest
coverage ratio’ refers to a debt ratio and
profitability ratio utilized to determine
how comfortably a company can pay
interest on its outstanding debt. A
greater coverage ratio is better, although
the ideal ratio may differ by industry.
Therefore, statement 3 is not correct.
• The Interest coverage ratio is also known
as “times interest earned.” Lenders,
creditors, and investors often utilize this
formula to decide a company's riskiness
relative to its existing debt or for future
borrowing. This ratio is utilized to see
how well a firm can pay the interest on
outstanding debt.
• Therefore, statements 1 and 2 are correct.
 CHAPTER - 6

BANKING (PART II)

• It is also called Capital to Risk-weighted

Why Bank is Asset Ratio (CRAR).

important for the • Risk Weighted Assets (RWA) refers to

the assets with different risk profiles. For
Economy? instance, an asset-backed by collateral
would carry lesser risks as compared to
• In an economy, banks play a very loans, which have no collateral.
important role by offering a service • For example, Let us take an example of a
to people to save, provide finance to bank XYZ, it has a Capital Reserve of Rs.
businesses for investment and expansion. 1 crore.
• Bank loans to businesses are important XYZ Capital Reserve= Rs. 1crore.
for enabling economic growth. Deposit of XYZ = Rs. 100 crore
• Loans provided by banks to business has Loan given by XYZ = Rs. 70 crore [Rest
a certain amount of risk associated with Rs. 30crore kept as CRR & SLR]
it, of non-payment of loans.
Suppose there is Loss = Rs. 5 crore
• Central Banks of the world have adopted
various tools to minimize the risk. • But since the Bank has only Rs. 1 cr in
Capital rest Rs. 4 crore will be shared
» Some of the tools are: among depositors which is unjust.
» Cash Reserve Ratio (CRR) • Thus, Central banks are instructing the
» Statutory Liquidity Ratio (SLR) banks to increase capital. More the
capital by owners of banks, the more
» Capital Adequacy Ratio (CAR) will be the capability of the banks to
(CRR and SLR are explained in chapter 5) overcome the crisis.
• RBI introduced the Capital to Risk-
Capital Adequacy Weighted Assets Ratio (CRAR) systems
for Indian Banks in the year 1992.
Ratio (CAR)
• It is the percentage of total capital to Tier 1 Capital
total risk-weighted assets. • Tier 1 Capital/Core Capital is the capital
that can absorb losses without bank
CAR =
Total Capital
* 100 =
Tier 1 Capital + Tier 2 Capital
* 100
required to cease operation.
Risk-Weighted Assets Risk-Weighted Assets
• Tier 1 Capital is the primary indicator to
• CAR is the parameter to measure the measure a bank's financial strength.
financial soundness of the Bank. • Tier 1 capital is disclosed reserves,
• CAR ensures that banks have enough that appear on the bank's financial
capital to cover the risk of potential loss statements. These include:
and to protect the depositor and general
creditors against losses. » Share Capital,

67
» Undistributed Profit, and
» Preference Share Capital.
• Tier 1 capital will be more in the form of
equities.
Tier 2 Capital
• Tier 2 Capital/Supplementary Capital
is the capital that can absorb losses in
the event of winding-up of bank and
therefore provides a lesser degree of
protection to depositors.
• Tier 2 capital includes undisclosed funds
that do not appear on a bank's financial
statements.
• Tier 2 capital include:
» Subordinate Debt,
» Revaluation Reserve,
» General loan-loss reserves, and
» Hybrid (debt/equity) capital instruments.
• Most of the Tier 2 capital is in the form of
debts and reserves etc.
At the end of 1974, in the aftermath of seri-
ous disturbances in international currency
and banking markets (failure of Bankhaus
Herstatt in West Germany), the Basel
Committee (Committee on Banking Reg-
ulations and Supervisory Practices) was
established.
Basel Norms
• Basel Norms are standards set by
the Basel Committee on Banking
Supervision (BCBS).
• BCSC is an international committee
established with an aim to develop
standards for banking regulation.
• In 2019, the BCBS has 45 members from
28 Jurisdictions, consisting of Central
Banks and authorities with responsibility
of banking regulation.
68
• Basel Norms are agreed upon at Basel,
Switzerland at the meeting of the Bank
of International Settlement (BIS).
• BIS encourages cooperation among
central banks with a common goal of
ensuring financial stability and common
standards of banking regulations across
the globe.
• Basel Committee’s decisions have no
legal force neither it is a multilateral
organization. The committee formulates
supervisory standards and guidelines and
recommends best practices in banking
regulations.
Basel I
• Basel I norms was agreed in the year 1998,
hence minimum capital requirement was
imposed on banks.
• In Basel I norms, the minimum capital
requirement was fixed at 8% of Risk-
Weighted Assets.
• Basel I norms focused entirely on credit
risk (risk of default on loan).
• India adopted Basel I guidelines in 1999.
Basel II
• Basel II norms were introduced in the
year 2004 and were reformed version of
Basel I norm.
• Basel II norms focus on three main pillars:
» Minimum Capital Requirement: Banks
should maintain a minimum capital
adequacy requirement of 8% of risk
assets.
» Supervisory Review: Banks are required to
develop and use better risk management
methods in managing and monitoring all
the three types of risks that a banking
sector faces, viz. market risk, credit risk,
and operational risks.
» Market Discipline: Banks need to
 mandatorily disclose their risk exposure
to the central bank.
• Presently banking system of India follows
Basel II norms.
Basel III
• In the year 2010, Basel III guidelines were
released in response to the financial crisis
of 2008.
• Basel III aims at:
» Improving Banking sector ability to
absorb shock arising from financial and
economic instability.
» Improve Governance and Risk
Management of the banking sector.
» Strengthen transparency and Disclosure.
• The minimum requirement for common
equity has been raised under Basel III
from 2% to 4.5% of total Risk-Weighted
Assets (RWA).
Buffers introduced in Basel III
Norms
Capital Conservation Buffer (CCB)
• It is a mandatory capital that financial
institutions are required to hold in
addition to another minimum capital
requirement.
• The minimum capital requirement is 9%
in India.
• The CCB would be 2.5% over and above
the minimum capital requirement.
• It is maintained in the form of common
equity Tier 1 Capital.
69
Counter-Cyclical Capital Buffer
(CCCB)
• Counter-Cyclical Capital buffer is the
capital to be kept by a bank to meet
business cycle related risks.
• These are an additional provision that
banks are expected to make during good
times to provide for capital erosion during
bad business periods.
• The buffer may fluctuate from zero to
2.5% of the total risk-weighted assets
(RWA) of banks.
• It is maintained in the form of common
equity Tier 1 Capital.
Challenges in the
implementation of Basel III
Norms
Higher capital requirement for bank
• The public sector banks (PSBs) in India
will require large capital requirements
under Basel III. This will be difficult for
the banks, because of the large number
of bad loans on their books.
Mounting Pile of Stressed Assets
• The banking sector in India is facing
challenges due to low credit growth,
deteriorating asset quality and low
profitability.
Economic and policy changes
• In India, the banking domain is
facing headwinds because of policy
and economic regulations like GST,
demonetization, Real Estate (Regulation
and Development) Act of 2016.
• This could slow the procedure for
implementation of global risk norms
mentioned under Basel III.
Basel Norm Criteria
Basel II
Common Equity 2%
Tier 1 Capital 4%
Total Capital 8%
(Tier 1 + 2 + 3)
• Tier 3 capital is tertiary capital, which
several banks hold to support their
market risk, commodities risk, and foreign
currency risk. Tier 3 capital comprises a
greater variety of debt than tier 1 and tier
2 capitals.
Non-Performing
Asset (NPA)
• An asset gets converted into non-
performing when it ceases to create
income for the bank i.e., when the
borrower pays neither the interest nor
principal after a certain period of time.
• Non-performing Asset (NPA) shall be an
advance(loan) where:
» Installment and/or interest of principal
remain unpaid for a period of more than
90 days in respect of a term loan.
» Installment and/or interest of principal
remains unpaid for two harvest seasons
but for a period not surpassing two half
years in the situation of an advance
granted for agricultural purposes.
» Any amount to be received remains
unpaid for a period of more than ninety
days in respect of other accounts.
Categories of NPAs
• Banks are required to categorize NPAs
70
Basel III RBI
4.5% 5.5%
6% 7%
8% 9%
(Tier 1 + 2)
further into the following three categories
on basis of the period for which the asset
has remained as non-performing asset:
» Sub-standard Assets
− Assets which has remained NPAs
for a period less than or equal to 12
months.
» Doubtful Assets
− An asset is to be categorized as
doubtful assets if it has remained NPA
for a period exceeding 12 months.
» Loss Assets
− An asset is to be classified as loss
assets, where loss has been recognized
by the bank or the RBI inspection
or internal or external auditors, but
the amount has not been written off
wholly.
− In another words, such asset is
considered uncollectible.
Indian Banks and NPA
• Data on NPAs is regularly published
by RBI as part of its Financial Stability
Reports.
• As per RBI provisional data on global
operations, as on 31st March, 2019, the
aggregate amount of gross NPAs of PSBs
and Scheduled Commercial Banks (SCBs)
 was Rs. 8,06,412 crore and Rs. 9,49,279
crores, respectively.
• According to Financial Stability Report
(FSR) released by the RBI, banks'
gross NPAs may increase to 13.5% by
September 2021, as compared to 7.5%
in September 2020 under the baseline
scenario.
• Declining profitability of the banks makes
them vulnerable to adverse economic
shocks and consequently putting
consumer deposits at risk.
• Increasing volume of Bank frauds is
swallowing all the economic development
of India and is producing financial
indiscipline in the country. Big defaulter
such as Vijay Malya, Mehul Choksi and
Nirav Modi usurps thousands of crores
which not only adds to growth in the
quantum of Non-Performing Assets
(NPAs) but takes out the sizable reserves
that could have otherwise been utilized
for economic well-being of thousands
of poor people willing to become
entrepreneurs with banks’ support and
plan to start up their small businesses.
Causes for increase in NPAs
• Excess expansion of corporate during
the boom period. However, as economic
growth stagnated following the 2008
global financial crisis the repayment
capability of these corporations reduced.
This contributed to what is now identified
as India’s Twin Balance Sheet problem,
where both the banking sector (that
gives loans) and the corporate sector
(that takes and must repay these loans)
have come under financial stress.
• Domestic and economic slowdown.
• Indiscriminate lending without proper
credit risk assessment.
• Political pressure to lend to particular
enterprises.
• Long delays and gestation periods of
71
several infrastructure projects.
• External Factors, such as decreases in
global commodity prices leading to
slower exports.
Impact of NPAs on Indian
Economy
• The crisis of NPAs in the Indian banking
system is one of the foremost and the
most formidable problems that had
impacted the entire banking system.
» Profitability
− NPAs impact profitability, banks
stop to earn income on one hand
and attract higher provisioning (set
aside an amount in an organization's
account) compared to standard
assets on the other hand.
» Capital Adequacy
− According to the Basel norms, banks
are required to maintain adequate
capital on risk-weighted assets.
− Every increase in the NPAs level adds
to risk-weighted assets which require
banks to increase their capital.
» Liability Management
− In the light of high non-performing
assets, banks tend to lower the
interest rates on deposits on one
hand and likely to levy higher interest
rates on advances. This may hamper
economic growth.
» Public confidence
− The credibility of the banking system
is also affected greatly due to higher
level NPAs because it has impacted
the confidence of the general public of
the society with respect to soundness
of the banking system.
What is being done to manage
the issue of growing NPAs?
• The actions taken to prevent and resolve
NPAs can broadly be classified into two
kinds. First, regulatory means of resolving
NPAs with various laws (like the Insolvency
and Bankruptcy Code) and second,
remedial measures for banks prescribed
and regulated by the RBI for the internal
restructuring of stressed assets.
Insolvency and Bankruptcy Code
(IBC)
• IBC provides a time-bound procedure
to resolve insolvency in companies and
amongst individuals. Insolvency is a
condition where companies or individuals
are unable to repay their outstanding
debt.
• When a default in repayment happens,
creditors gain control over the debtor’s
(who owes money) assets and must take
decisions to resolve insolvency within a
180-day period.
• Under IBC, a financial creditor may
file an application before the National
Company Law Tribunal for starting
the insolvency resolution process. The
National Company Law Tribunal must
find the existence of default within
fourteen days.
• A Committee of Creditors (CoC)
comprising financial creditors will be
constituted for taking decisions with
respect to insolvency resolution. The
CoC may either choose to restructure the
debtor’s debt by preparing a resolution
plan or liquidate the debtor’s assets.
• The Committee of Creditors will appoint
a resolution professional who will make
and present a resolution plan to the
CoC. The CoC must approve this plan,
and the process of resolution must be
finalized within 180 days. This process
may be extended by a period of up to
72
ninety days if the extension is approved
by NCLT.
• If the CoC does not approve the resolution
plan, the debtor will go into liquidation.
• The IBC also adds that the resolution
process must be finalized within 330
days. This includes time for any extension
granted and the time taken in legal
proceedings in relation to the process.
• Debt Recovery Tribunal is the
Adjudicating Authority with jurisdiction
over individuals and unlimited liability
partnership firms. Appeals from the order
of Debt Recovery Tribunal shall lie to the
Debt Recovery Appellate Tribunal (DRAT).
• National Company Law Tribunal (NCLT)
shall be the Adjudicating Authority with
jurisdiction over companies, limited
liability entities. Appeals from the NCLT
order shall lie to the National Company
Law Appellate Tribunal (NCLAT).
• The administration of the Insolvency
and Bankruptcy Code, 2016 has been
transferred to the Ministry of Corporate
Affairs.
SARFAESI Act 2002
• SARFAESI (Securitization and
Reconstruction of Financial Assets and
Enforcement of Securities Interest) Act,
2002, was framed to address the problem
of NPAs (Non-Performing Assets) or bad
assets.
• The provision of the act allows banks
and other financial institution to auction
residential or commercial properties to
recover loans.
• In case of loan default, banks can
seize the collateral/securities (except
agricultural land) without the intervention
of the court.
• The law does not apply to
» Unsecured loans,
» Loans below ₹100,000
» Where the remaining debt is below 20% • Government has amended the SARFAESI
of the original principal. Act in 2016 to empower the Asset
Reconstruction Companies (ARC).
• The SARFAESI Act provides for the
establishment of Asset Reconstruction
• ARC is a specialized and dedicated
financial institution that buys the NPAs or
Companies (ARCs) which are to be
bad assets from the financial institutions
regulated by RBI.
or banks so that the latter can clean up
• Banks/Financial Institution can sell their balance sheets.
securities to Asset Reconstruction
Companies (ARCs).
• ARCs are registered under the RBI and
regulated under the SARFAESI Act, 2002.

4R framework
The 4R formula (Recognition, Recapitalization, Resolution, Reform) suggested by the
Economic Survey 2015-16 to resolve NPAs crisis.
• Recognition: Banks must value their various assets as far as possible close to true
value as the Reserve Bank of India has been emphasizing.
• Re-capitalization: Once they do so, their capital position must be protected through
infusion of equity as the banks have been demanding.
• Resolution: The various underlying stressed assets in the corporate segment must
be sold or rehabilitated as the government has been desiring.
• Reform: Future incentives for the private sector and corporates must be set-
appropriate to prevent a repetition of the problem.

Prompt Corrective Action (PCA)
• To ensure that Commercial banks do not
go bust, RBI has put in place some trigger
points to assess, monitor, control and
take corrective actions on banks which
are weak and troubled. The process or
mechanism under which such actions are
taken is known as PCA.
− Those banks with CRAR of more than
6.25 percent but less than 7.75 percent
fall in the threshold 2.
− If bank’s common equity Tier 1 (the
bare minimum capital under CRAR)
falls below 3.625 percent, it gets
categorized under the threshold 3
level.

• Framework of PCA considers banks as » Banking organizations that have a Net

risky if they slip below certain standards
on three parameters — Asset Quality,
Capital Ratios, and Profitability.
» It has 3 risk threshold levels (1 being the
lowest and 3 the highest) on basis of
where a bank stands on these ratios.
− Banking organizations with capital
to risk-weighted assets ratio (CRAR)
of lower than 10.25 percent but
more than 7.75 percent fall under
threshold 1.
NPAs of 6% or more but less than 9% fall
under threshold 1, and those with 12%
or more fall under the category of third
threshold level.
» On profitability, banks with a negative
return on assets for two, three and four
consecutive years fall under threshold 1,
threshold 2 and threshold 3, respectively.
• Once the PCA is imposed, Banks are not
allowed to renew or access costly deposits
or take different steps to increase their
fee-based income. Banks will also have

73
 to introduce a special drive to reduce the
stock of NPAs and contain generation of
fresh NPAs.
• They will also not be permitted to enter
into new lines of business. RBI will
also impose restrictions on the bank
on mergers, borrowings, etc. from the
interbank market.
Other important RBI
Committees
PJ Nayak Committee
• RBI constituted the P.J. Nayak committee
in 2014 to review the governance of
Board of Banks in India.
• The Committee was presided by P J
Nayak and its major recommendations
are -
» Repeal the SBI Act, the SBI Subsidiaries
Act and the Bank Nationalization Act
(1970, 1980). This is because the provision
of these acts require the government
to have above 50 percent share in the
banks.
» The Government should establish a
Bank Investment Company (BIC) as a
core investment company to hold equity
stakes in banks which are currently held
by the Government. Bank Investment
Company should be incorporated under
the Companies Act 2013.
» The government to allocate its share in
the banks to this BIC. Consequently, the
BIC would become the parent holding
company of all these national banks, and
bank would become subsidiaries of BIC.
BIC will be an autonomous body and will
have the authority to appoint the Board
of Directors and make other important
policy decisions.
» Until the BIC is created, a temporary
body called as the Bank Boards Bureau
(BBB) will be established to do the various
74
functions of the BIC. Once BIC is formed,
the BBB will be dissolved.
» The BBB will advise on appointments to
the board, banks’ chairman and other
executive directors.
» The Government should consider
decreasing its holding in public sector
banks to less than 50%, in order to
restore a level playing field for different
public sector banks.
Nachiket Mor committee
• The “Committee on Comprehensive
Financial Services for Small Businesses
and Low-Income Households” was set
up by the RBI under the chairmanship of
Nachiket Mor.
• The committee was tasked for framing
a clear vision for financial inclusion and
financial deepening in India.
• Committee has outlined six vision
statements for full financial inclusion and
financial deepening in India:
» Universal Electronic Bank Account
(UEBA):
− Each Indian resident, above the
age of eighteen years, would have
an individual, full-service, safe, and
secure electronic bank account.
» Ubiquitous Access to Payment Services
and Deposit Products at Reasonable
Charges:
− The Committee envisions that every
resident in India would be within a
fifteen-minute walking distance of a
payment access point.
» Sufficient Access to Affordable Formal
Credit:
− Each low-income household and
small-business would have access
to a formally regulated lender that
 is capable of assessing and meeting
their credit needs.
− Such a lender must also be able to
offer them a full range of suitable
credit products at an affordable price.
» Universal Access to a Range of Deposit
and Investment Products at Reasonable
Charges:
− Each low-income household and
small-business would have access to
providers that can offer them suitable
investment and deposit products.
− Such services must be available to
them at reasonable charges.
» Universal Access to a Range of Insurance
and Risk Management Products at
Reasonable Charges:
− Each low-income household and
small business would have access
to providers that have the ability to
offer them suitable insurance and risk
management products.
− These products must at minimum
allow them to manage risks related
to (a) commodity price movements;
(b) longevity, disability, and death of
human beings; (c) death of livestock;
(d) rainfall; (e) damage to property.
» Right to Suitability:
− Each low-income household and
small-business would have a legally
protected right to be offered only
suitable financial services.
− She will have the right to seek legal
redress if she feels that due process to
establish Suitability was not followed
or that there was gross negligence.
• The main recommendation of the
committee are as follow:
» Aadhaar will be the prime driver towards
rapid expansion in the number of bank
accounts.
75
» Monitoring at the district level such as
deposits and advances as a percentage
of gross domestic product (GDP).
» Adjusted 50 per cent priority sector
lending target with adjustments for
sectors and regions based on difficulty in
lending.
Mission
Indradhanush
• The government of India, in order to
resolve the issues faced by the Public
Sector Banks launched a 7-pronged plan
called “Mission Indradhanush”.
• Mission Indradhanush aims at revamping
the functioning of the Public Sector
Banks to enable them to compete with
the Private Sector Banks.
• (There is another mission of the
Governent with the same name. Mission
Indradhanush (MI) of the Ministry of
Health and Family Welfare, was launched
in 2014 and aims at increasing the full
immunization coverage to children to
90%.)
• The seven components include:
» Appointments
− Separation of the important posts
of Chief Executive Officer (CEO) and
the Managing Director (MD) to avoid
concentration of power and smooth
functioning of the different banks.
− Induction of talent from various
private sector into public banks.
» Bank Boards Bureau (BBB)
− The Appointments Board of the
PSBs (Public Sector Banks) would be
substituted by the Bank Board Bureau
(BBB).
− It would advise banks in the matters
of raising funds, mergers, and
 acquisitions etc.
− BBB will have 3 ex-officio members
Types of Banks in
and 3 expert members in addition to
the chairman.
India
RBI
» Capitalization:
− Because of the high NPAs and the SCHEDULED BANKS NON- SCHEDULED BANK
need to meet the provisions of the
Basel III norms, capitalization of
banks by inducing Rs. 70,000 crores REGIONAL RURAL PRIVATE SECTOR
in next 4 years. BANK BANK

» De-stressing PUBLIC SECTOR

BANK
DIFFERENTIAL
BANK

− Solving problems arising in the I M A G E 6.1: T Y P E S OF BANK IN INDIA

infrastructure sector in order to check
the stressed assets in the banks.
» Empowerment
− Providing better flexibility and
autonomy to PSBs in hiring manpower.
» Framework of Accountability
− The evaluation of the working of banks
would be based on new performance
indicators.
− Quantitative Parameters like growth,
Non-Performing Assets Management,
diversification, return on capital,
financial inclusion.
− Qualitative Parameters like steps
taken in improving asset quality,
human resources initiatives etc.
Scheduled Banks
• Any kind of bank which is listed in the
Second Schedule of the Reserve Bank
of India (RBI) Act, 1934 is considered a
scheduled bank.
• To qualify as a scheduled bank:
» The paid-up capital and collected funds
of the bank must not be less than Rs. 5
lakh.
» Any activity of the bank will not adversely
affect the interests of the depositors.
• Scheduled banks include State Bank of
India, Nationalized Banks, Regional Rural
Banks, Foreign Banks, Private Sector
Banks.

» Governance Reforms • Scheduled Banks are eligible for

− Gyan Sangam conferences amongst
the government officials and bankers
for resolving the banking sector
issues and deciding the future course
of action.
obtaining debts/loans on bank rate from
the RBI and are given membership to
clearing houses.
Non-Scheduled Banks
• They are those banks which are not listed
in the second schedule of the RBI Act,
1934.
• Non-scheduled banks are not entitled
to borrow from the RBI for normal

76
 banking purposes, except in emergency
circumstances. For Example, Jammu &
Kashmir Bank.
Note: All other types of banks will be
covered in financial inclusion module.
Types of ATM
A. Bank’s own ATM
• These types of ATM are owned and
operated by the bank and carry the
bank logo.
B. Brown Label ATM
• These ATMs are owned and maintained
by the service provider, but the bank
manages the cash and connectivity to
the bank network.
• They carry the logo of the bank which
outsource their services.
C. White Label ATM
• These are owned and operated by a third
party (non-banking firm).
• To aid financial inclusion and ATM
penetration in the country, the RBI has
permitted the launch of White Labelled
ATMs.
• These white label ATMs will not display
the logo of any particular bank.
• TATA launched the first white label ATM in
India under the brand name of Indicash.
Non Resident Indian
Deposit
• Foreign Exchange Management
(Deposit) Regulations, 2000 allows NRIs
(Non-Resident Indians) to have deposit
accounts with authorized dealers and
77
with banks sanctioned by the Reserve
Bank of India. These accounts include:
» Non-Resident External Account (NRE
account)
» FCNR (B) [Foreign Currency Non-Resident
(Bank)] account
» Non-Resident Ordinary Rupee Account
(NRO account)
FCNR (B) account
• These kinds of accounts can be opened
by Overseas Corporate Bodies (OCBs)
and NRIs with an authorized dealer.
• The type of accounts can be opened in
the form of term deposits.
• Deposits of funds are permitted in , Pound
Sterling, Euro and Japanese Yen.
• Rate of interest valid to this type of
accounts are in accordance with the
directives issued by Reserve Bank of
India.
NRE account
• NRE accounts can be opened by
Overseas Corporate Bodies (OCBs) and
NRIs with authorized dealers and with
banks approved by RBI.
• These can be in the form of current,
savings, recurring or fixed deposit
accounts.
• Deposits are permitted in any permitted
currency.
• Rate of interest valid to these accounts is
in accordance with the directives issued
by RBI.
NRO account
• These kinds of accounts can be opened
by any individual resident outside India
with an authorized bank, an authorized
 dealer for collecting their funds from local
bonafide transactions in Indian Rupees.
• When a resident becomes an NRI, his
existing Rupee accounts are designated
as NRO.
• These types of accounts can be in the
form of savings, current, savings, recurring
or fixed deposit accounts.
Licensing policy of
Bank
• RBI guidelines for granting of license to
commercial banks are -
» Individual/Group resident in India
confirming to fit a proper criteria, can
promote/establish new banks with the
following criteria:
− Sound credential and integrity
− Sufficient finances
− Successful business track record of at
least 10 years.
• A New Bank could be established only
through a Non-Operative Financial
Holding Company (NOFHC), which
would be registered with RBI as an NBFC.
Its objective is to separate the business
activities of the promoter group from the
New bank. The NOFHC would be holding
company of all the financial business of
the promoter group.
• The paid-up capital should be at least
Rs. 500 crore. Out of which, the NOHFC
has to invest at least 40% which would
be locked in for 5 years. However, the
NOHFC has to reduce its shareholding in
the New bank to 15% or less over the 12
years from the establishment of the bank.
• At least 50% of the directors of New
bank should be independent directors
(Director who do not have any kind of
vested interest in the company)
78
• The foreign investment ceiling in New
bank would be 49% (ceiling for an
existing bank is 74%).
• Within 1 year of licensing, banks should
be established and within 3 years, banks
should be listed in the stock exchange.
Priority Sector
Lending (PSL)
• The RBI requires banks to lend a certain
percentage of their funds to specific
sectors which are recognized as “priority
sector” by the RBI. Ex: Agriculture, MSMEs,
export credit, education, housing, etc.
• The objective of priority sector lending
is to ensure that adequate institutional
credit flows into vulnerable sectors of the
economy.
• Priority Sector comprises the following
categories:
(i) Agriculture
(ii) Export Credit
(iii) Micro, Small and Medium
Enterprises
(iv) Education (Loans to individuals for
educational purposes up to Rs. 10 lakh)
(v) Housing (Housing loans to individuals
loan upto Rs.28 Lakh in Metros, Rs.20
Lakh in other centres)
(vi) Social Infrastructure (Loans up
to ₹5 crores per borrower for building
social infrastructure)
(vii) Renewable Energy (for individual
households, the loan limit will be ₹10
lakh per borrower, Loan up to Rs.15
crore for purposes like solar-based
power generators etc.)
• (viii) Others
• The different targets and sub-targets for
banks under priority sector are as follows
 Domestic scheduled commercial
Foreign banks with less than 20
Categories banks and Foreign banks with 20
branches
branches and above

40% of Adjusted Net Bank Credit

40% of Adjusted Net Bank Credit
or Credit Equivalent Amount of
Total Priority Sector
Off-Balance Sheet Exposure,
whichever is higher.
or Credit Equivalent Amount of
Off-Balance Sheet Exposure,
whichever is higher, to be
achieved in a phased manner by
2020.

18% of ANBC.

Agriculture Within the 18% target for Not applicable

agriculture, a target of 10%
is prescribed for Small and
Marginal Farmers.

Micro Enterprises 7.5% of ANBC. Not applicable

Advances to Weaker Sections 12% of ANBC. Not applicable

PSL does not apply to Regional Rural Banks (RRB) and Small Finance Banks (SFB) because these banks
are already working in the sector which are defined in PSL norms.

• The rate of interest for bank loans under

priority sector will be decided by RBI.
• If the Banks fail to meet its PSL target,
then banks may be required to invest
in the Rural Infrastructure Development
Fund (RIDF).
• Priority Sector Lending Certificates
(PSLCs) are a mechanism to enable
banks to achieve the priority sector
lending target and sub-targets by
purchase of these instruments in the
event of shortfall. This also incentivizes
surplus banks as it allows them to sell their
excess achievement over targets thereby
enhancing lending to the categories
under priority sector. Under the PSLC
mechanism, the seller sells fulfilment of
priority sector obligation and the buyer
buys the obligation with no transfer of
risk or loan assets.
Digital Initiative
National Payments
Corporation of India (NPCI)
• NPCI is the umbrella organization for
entire retail payment systems in India.
• NPCI is an initiative of RBI and Indian
Banks’ Association (IBA) under the
provisions of the Payment and Settlement
Systems Act, 2007.
• Founded in 2008, the NPCI is not-for-
profit organization registered under the
Companies Act 2013.
• Product of NPCI are as follows:
a. RuPay
• RuPay is the first-of-its-kind domestic
Debit and Credit Card payment network
of India.
• RuPay fulfils RBI’s vision of initiating a
‘less-cash’ economy.
• Singapore will be the first nation to issue

79
 RuPay cards in the country.
• RuPay card has been introduced in the
following countries Bhutan, Maldives,
UAE, Bahrain, Saudi Arabia.
b. Unified Payment Interface (UPI)
• UPI is a real-time interbank payment
system for sending or receiving money.
• UPI uses existing systems, such as
Immediate Payment Service (IMPS)
and Aadhaar Enabled Payment System
(AEPS), to ensure seamless settlement
across accounts.
• In 2018, UPI 2.0 was launched which
enabled users to link their Overdraft
accounts to a UPI.
c. BHIM
• Bharat Interface for Money (BHIM) is a
mobile payment app that allows users
to make quick transactions using Unified
Payments Interface (UPI).
• Minimum amount: ₹1, Maximum Number
of Transactions/day: 10.
• Maximum Fund transfer limit: ₹20,000/
transaction, Maximum: ₹40,000 in a 24-
hour period.
d. Bharat Bill Payment System
(BBPS)
• BBPS is an interoperable platform that
allows a customer to pay bills like water,
telephone, gas, direct-to-home (DTH)
and electricity at a single location—
electronic or physical.
e. Aadhaar Enabled Payment
System (AePS)
• It allows people to carry out financial
transactions on a Micro-ATM using the
Aadhaar authentication.
80
• The only inputs essential for a customer
to do a transaction are:
» Aadhaar Number.
» Issuer Identification Number (Finding the
Bank to which the customer is associated).
» Fingerprint captured during their
enrollment.
f. National Financial Switch
• NFS is the largest domestic ATM network
in India.
• NFS is designed, developed and deployed
by the Institute for Development and
Research in Banking Technology (IDRBT).
• NFS facilitates routing of ATM
transactions through inter-connectivity
between the Bank’s Switches, such that
the transactions made at any ATM could
be routed to the connected banks.
Core Banking
Solution (CBS)
• Core banking solution refers to a
centralized system established by a bank
which allows its customers to conduct
their business from any branch of the
bank, regardless of where he maintains
his account.
• CORE is an acronym for "Centralized
Online Real-time Exchange".
• For example, E-Kuber is the Core Banking
Solution of Reserve Bank of India.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) Priority Sector Lending by banks in
India constitutes the lending to: 2013
 (a) Agriculture
(b) Micro and small enterprises
(c) Weaker Sections
(d) All of the above
Ans. (d)
• Explanation: Priority Sector Lending
(PSL) is an significant role given by the
central bank of India (RBI) to the banks
for providing a definite portion of the
bank lending to a certain sectors such
as micro and small enterprises, poor
people for housing, agriculture and allied
activities, students for education purpose
and other low income groups and weaker
sections. This is essentially meant for all-
round development of the economy as
opposed to concentrating only on the
financial sector.
Q.2) ‘Basel III Accord’ or simply ‘Basel
III’, often seen in the news, seeks to: 2015
(a) develop national strategies for the
conservation and sustainable use of
biological diversity
(b) improve the banking sector’s ability
to deal with financial and economic
stress and improve risk management
(c) reduce greenhouse gas emissions but
places a heavier burden on developed
countries
(d) transfer technology from developed
Countries to poor countries to
enable them to replace the use of
chlorofluorocarbons in refrigeration
with harmless chemicals
Ans. (b)
• Explanation: Basel III is an international
regulatory consensus that introduced
a set of reforms intended to improve
the supervision, regulation and risk
management within the banking system.
• In late 2009, the Basel Committee on
Banking Supervision (BCBS) published
the first version of Basel III, providing
banks approximately three years to
satisfy all types of requirements.
81
• Largely in response to the credit crisis,
banks are needed to maintain proper
leverage ratios and meet certain
minimum capital requirements.
Q.3) The term ‘Core Banking Solution’ is
sometimes seen in the news. Which of
the following statements best describes/
describe this term? 2016
1. It is networking of a bank’s branches
which enables customers to operate
their accounts from any branch of the
bank on its network regardless of where
they open their accounts.
2. It is an effort to increase RBI’s control
over commercial banks through
computerization.
3. It is a detailed procedure by which a
bank with huge non-performing assets
is taken over by another bank.
Select the correct answer using the code
given below:
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (a)
• Explanation: Core Banking Solution
(CBS) is the networking of branches,
which allows Customers to operate
their accounts, and avail various types
of banking services from any branch of
the Bank on CBS network, regardless of
where he maintains his account.
• Another interesting fact regarding
CBS is that all CBS branches are inter-
connected with each other.
• Therefore, customers of CBS branches
can avail various banking facilities from
any other CBS branch located anywhere
in the world.
Q.4) Consider the following statements:
2017
1. National Payments Corporation
 of India (NPCI) helps in promoting
financial inclusion in the country.
2. NPCI has launched RuPay, a card
payment scheme.
Which of the statements given above is/
are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (c)
• Explanation: NPCI is an umbrella
institution for operating numerous retail
payments and settlement systems in
India. It is an initiative of Indian Banks’
Association (IBA) and RBI under the
provisions of the Payment and Settlement
Systems Act of 2007, for forming a robust
Payment & Settlement Infrastructure in
India.
• NPCI enables an affordable payment
mechanism to benefit the common man
across the country and finally helps in
fulfilling goal of financial inclusion.
• NPCI has been recognized as a “Not
for Profit” Company under Section 25
of Companies Act,1956 (now Section
8 of Companies Act of 2013), with an
aim to give infrastructure to the whole
banking system in India for physical
along with electronic payment and
settlement systems. The Company is
concentrating on bringing innovations
in the retail payment systems with the
help of technology for attaining greater
efficiency in operations and widening the
overall reach of payment systems.
• RuPay, a indigenous payment card
launched by NPCI for all Indian banks.
Q.5) Which of the following is the most
likely consequence of implementing the
‘Unified Payments Interface (UPI)’? 2017
(a) Mobile wallets will not be necessary
for online payments.
(b) Digital currency will totally replace
82
the physical currency in about two
decades.
(c) FDI inflows will drastically increase.
(d) Direct transfer of subsidies to poor
people will become very effective.
Ans. (a)
• Explanation: Unified Payments Interface
(UPI) is an instant real-time payment
structure developed by National
Payments Corporation of India enabling
inter-bank transactions.
• The interface controlled by the central
bank of India (RBI) and works by instantly
transferring funds amongst two bank
accounts on a mobile platform.
• UPI is a system that powers multiple bank
accounts into a single mobile application
(of any participating bank), merging
several banking features, seamless fund
routing & merchant payments into one
hood.
• It also caters to the “Peer to Peer” collect
request which can be scheduled and paid
as per requirement and convenience.
• Each Bank provides its own UPI App
for Android, Windows, and iOS mobile
platform(s).
• UPI 2.0 was launched on August 16, 2018
which allowed users to connect their
Overdraft accounts to a UPI handle.
• In this users were also able to pre-
authorize transactions by issuing a
mandate for a specific merchant. 2.0
version included a feature to view and
store the invoice for the transactions.
Q.6) Which one of the following links
all the ATMs in India? 2018
(a) Indian banks' Association
(b) National Securities Depository
Limited
(c) National Payments Corporation of
India
(d) Reserve Bank of India
Ans. (c)
• Explanation: In India, National Financial
Switch (NFS) is the largest network of
shared automated teller machines (ATMs).
In 2004, it was developed, designed and
deployed by IDRBT (the Institute for
Development and Research in Banking
Technology), with the objective of inter-
connecting the ATMs in the country and
enabling convenience banking.
• NFS is run by the National Payments
Corporation of India (NPCI). NPCI is an
umbrella organization for entire retail
payments in India.
• It was established with the guidance and
support of the Reserve Bank of India (RBI)
and Indian Banks Association (IBA).
Q.7) Consider the following statements:
2018
1. Capital Adequacy Ratio (CAR) is the
amount that banks have to maintain
in the form of their own funds to offset
any loss that banks incur if the account-
holders fail to repay dues.
2. CAR is decided by each individual
bank.
Which of the statements given above is/
are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (a)
• Explanation: Capital Adequacy Ratio
(CAR) is also called as Capital to Risk
(Weighted) Assets Ratio (CRAR).
• It is the ratio of a bank's capital in relation
to its risk-weighted assets and current
liabilities.
• It is used as a measure of a bank's capital.
• It is expressed in terms of percentage of
a bank's risk-weighted credit exposures.
CAR is not decided by each individual
bank but by RBI on the basis of Basel
Committee recommendations.
83
Q.8) The Chairman of public sector banks
are selected by the 2019
(a) Banks Board Bureau
(b) Reserve Bank of India
(c) Union Ministry of Finance
(d) Management of concerned bank
Ans. (a)
• Explanation: Banks Board Bureau (BBB)
is an autonomous body established
by Indian government with the task to
improve the governance of various Public
Sector Banks (PSBs), recommend the
selection of chiefs of government owned
banks and financial institutions and to
support banks in developing strategies
and capital raising plans.
Q.9) Which of the following is not
included in the assets of a commercial
bank in India? 2019
(a) Advances
(b) Deposits
(c) Investments
(d) Money at call and short notice
Ans. B
• Explanation: Deposits of banks are a
liability not assets
• Commercial Banks hold their assets
largely in the form of -
(i) loans and advances and bills
purchased and discounted, together
constituting bank credit,
(ii) investment, and
(iii) cash.
• Money at Call at Short Notice:
» It is the money lent to other banks, stock
brokers, and other financial institutions
for a very short period of time varying
from 1 to 14 days.
» Banks place their surplus amount of
cash in such loans to earn some interest
without straining their liquidity.
 CHAPTER - 7

INFLATION

• Inflation refers to a sustained increase • It is measured on a year-on-year basis (or

in the general price level of goods and month/week basis). The rate of change
services in an economy over a period of in the price level in a given month vis a
time. vis corresponding month of last year is
• It considers the prices of most goods and known as point to point inflation.
services of daily or common use, such
as food, clothing, housing, recreation,
transport, consumer staples, etc. Types of Inflation
• Inflation measures the average price
change in a basket of commodities and • Depending on the cause, inflation can be
services over time. classified as:
• Rate of inflation is the rate of change in » Demand-Pull Inflation
general price level which is measured as
follows: » Cost-Push Inflation
• Based on rate of increase in price:
Rate of inflation (year X) = Price (year X) - Price (year X-1) * 100
Price (year X-1) » Low Inflation
• Consider a bar of chocolate is priced » Galloping Inflation
at ₹100 in 2019. If all the other factors » Hyperinflation
are constant and the same chocolate is
priced at ₹110 in 2020, the inflation rate
is 10% per annum.
Price (year 2020) - Price (year 2019) Demand-Pull Inflation
Rate of inflation (year 2020) = * 100
Price (year 2019)
• When overall demand for goods and
110-100
=
100
* 100 = 10% services in the economy increases more
rapidly than the economy's production
• With the increase general price level, capacity, then it is called as demand-pull
only fewer goods and services can be inflation.
bought with each unit of currency; This
• It creates a demand-supply gap as the
means inflation reduces the purchasing
demand is higher and supply is less,
power of currency– the currency loses its
which results in higher prices.
real value in medium of exchange and a
unit of account within the economy. • For instance, during the sowing season
demand for fertilizer increases. Because
• Suppose one ₹100 note buys 10 liters of of its higher demand prices go up and
petrol in 1980. In the year 2020, the same
inflation occurs.
₹100 buys 2 liters of petrol. This shows
that although ₹100 note did not lose its
value over time, it has lost its purchasing
power over this time of 30 years. This
example explains how money loses its
value over time when prices rise.

84
 • When the money supply in the economy
AS increases, inflation occurs. As more
amount of money is available with the
consumers, they tend to spend more.
This creates more demand and prices of
goods and services increase.
• Thus, when the demand increases and
supply is low, the purchasing power of
PRICE
money decreases.
LEVEL AD1 • As shown in the graph as demand
AD
increases from AD to AD1 price increases.
NATIONAL INCOME • Causes of Demand-Pull Inflation are:

• Increase in Government Expenditure/

• Increase in Money Supply.
Public Expenditure
• Decrease in Direct Taxes.
• Increase in Exports
• Increase in Population
• Decrease in Imports

Cost-Push Inflation place.

• When there is an increase in prices of • Causes of Cost-Push Inflation are:

factors of production like labour, raw
» Increase in Cost of Production
material, etc., it is called as Cost Push
Inflation. » Decrease in Output
» Hoarding and Speculation
AS 1 » Increase in Indirect Taxes
AS » Defective Supply Chain
» Increase in price of imported Commodity
(like oil)

• As shown in the graph, as the cost of

PRICE production rises, the aggregate supply
LEVEL decreases from AS to AS1, causing an
AD increase in the price level.

OUTPUT
• As the cost of factors production
increases the producers tries to keep the
profit same by increasing the prices or
producers offers good and services at the
same prices but they reduce the quantity.
In such cases cost-push inflation takes
Low Inflation
• Low Inflation used to describe a period
of time when prices are rising slowly.
Such Inflation occurs slowly and can be
predicted.
• This type of Inflation is also called

85
 Creeping Inflation.
• If the prices increase by 3% or less
annually, then such inflation is creeping
inflation.
Galloping Inflation
• When the prices of goods and services in
the economy increases at a double-digit
(i.e. 15% etc.) or triple-digit (i.e. 100%
etc.) rate per annum, then it is called as
galloping inflation.
• Galloping inflation is also called as
Jumping inflation/Running Inflation.
Hyperinflation
• Hyperinflation takes place when the rate
of increase in prices of goods and services
is extremely high and that increase in
price takes place in a short span of time.
• In other words, hyperinflation takes place
when the increase in prices is more than
three-digit rate annually.
• Germany had witnessed hyperinflation
after the First World War in the 1920s.
• The most recent instance of hyperinflation,
Zimbabwe’s currency woes hit a peak in
November 2008 and according to some
Report it reached a monthly inflation
rate of approximately close to 79 billion
percent.
Measures to Control
Inflation
• The government adopts various measures
to control the increase in the price of
goods and services.
Monetary Policy
• There is a close link between the
86
money supply and inflation, Therefore,
controlling money supply with the help
of monetary policy the inflation can be
controlled.
• Using contractionary monetary policy,
the money supply in the economy can
be decreased. This leads to decrease in
aggregate demand in the market and
thereby reduces inflation.
• Decrease in supply of money → rate of
interest increases → Investment decreases
→ Aggregate demand decreases → prices
decline → rate of inflation is lowered
• Similar process follows when CRR, SLR,
Repo Rates are increased and decreased.
• Rates like CRR, SLR, Repo Rate and
Reverse Repo Rate are increased to
impact the money supply in the economy
by the RBI to control inflation.
Fiscal Policy
• Fiscal Policy refers to the revenue and
expenditure policy of the government.
• Contractionary Fiscal Policy can be
useful to tackle high inflation rates. The
process is as follows:
» Increased taxes (keeping government
spending constant) → disposable
personal income decreases→
consumption decreases → aggregate
demand decreases → prices decline →
rate of inflation is lowered
» Similar process follows if government cuts
down on its expenditures without raising
taxes (or reduces its deficit/increases
surplus).
• Some of the fiscal policy measures are as
follows:
» Reducing Import Duties
» Banning exports or Imposing minimum
export prices.
» Suspending the futures trading of
 commodities.
» Raising the stock limit for the commodities
Supply Management Measures
• Supply Management Measures aims
to increase the competitiveness and
efficiency of the supply chain, putting
downward pressure on long-term costs.
• Some of the supply management
measures taken are as follows:
» Restricting exports of commodities in
short supply and increasing their imports.
» Effective implementation of the Essential
Commodities Act, 1952 to prevent
hoarding and speculation.
» Incentivizing the increase in production
of commodities through tax concessions,
subsidies, institutional support etc.
» Higher MSP has been announced to
incentivize production and thereby
enhance the availability of food items
which may help moderate prices.
» Fixing the ceiling prices of the
commodities and taking measures to
control the black marketing of those
goods.
» Reforming the supply chain through
infrastructure development, foreign
investments etc.
Constraints Faced
by the Government
in controlling
inflation
• India imports more than 80 percent of
its oil requirements. Oil prices are volatile
owing to the various geopolitical and
economic events in the international
arena.
87
• Long overdue supply-side reforms.
• Inefficiencies in the monetary policy
transmission.
• Limited control of Government and RBI
in controlling rupee depreciation.
• Political compulsion in reducing
expenditure and fiscal deficit.
• Populist measures of the government.
Impact of Inflation
Positive Impact
• A moderate level of inflation stimulates
economic growth because it increases
profit margins of firms in the short
run, that encourages them to increase
production and supply.
• It indicates that there is no deficiency
of demand in the economy which
improves profitability expectation which
encourages firms to invest and increases
production capacity.
Negative/Adverse Impact
• It deteriorates the standard of living
of people as it reduces income at their
disposable.
• It is regressive, i.e. it affects poor relatively
more because the marginal utility of
money for them is relatively high.
• High inflation may cause shortages of
goods if consumers start hoarding out of
concern that prices will increase in the
future.
• High inflation retards economic growth
as it induces the government to adopt
contractionary fiscal and monetary
policies.
• It deteriorates the balance of payments
situation of the country. It discourages
export and encourages import which
widens creates a deficit and tends to
reduce FOREX reserves.

INFLATION
REAL INCOME CAPACITY TO SAVE
REAL INTEREST RATE WILLINGNESS OF SAVING
Measurement of
Inflation
• Following are two main set of inflation
indices for measuring price level changes
in India:
» Wholesale Price Index (WPI)
» Consumer Price Index (CPI)
Wholesale Price Index (WPI)
• Wholesale Price Index (WPI) measures
the changes in the prices of goods
sold and traded in bulk by wholesale
businesses to other businesses instead of
consumers.
• The index basket of the WPI includes
commodities falling under the three
major groups namely Primary Articles,
Manufactured Products and Fuel &
Power.
• The WPI basket has a total of 697 items
with base year 2011-12:
» Primary Articles: 117 items
» Fuel & Power: 16 items
» Manufactured Products: 564 items
• The prices tracked are mandi price for
agricultural commodities, ex-factory
price for manufactured products, and ex-
mines prices for minerals.
• Weightage given to each commodity
covered in the WPI basket is based on
the value of production adjusted for net
imports.
• WPI basket does not cover services.
• In India, the Office of Economic Advisor
(OEA), Department of Promotion of
88
Industry and Internal Trade, Ministry of
Commerce and Industry publishes the
WPI.
• The WPI is used for the following
purposes:
a. To give the estimates of inflation at
the wholesale transaction levels for
the economy as a whole. It helps in
timely intervention by the monetary
authorities to check the inflation
particularly in essential commodities
before the price increase affects the
retail prices.
b. Global investors also consider WPI
as one of the key macro indicators
for investment decisions.
• The Government reviews and revises the
base year of the WPI as a regular exercise
to capture structural changes occurred
in the economy and improve the quality,
coverage, and representativeness of the
indices.
• The base year of All-India WPI has been
changed from 2004-05 to 2011-12 in 2017
to bring it in line with the base year of
other macroeconomic indicators like
Index of Industrial Production (IIP) and
the Gross Domestic Product (GDP).
• The new series with base year 2011-12=100
was based on the recommendations of
the Working Group which was constituted
in 2012 under the chairmanship of Late
Dr. Saumitra Chaudhuri.
• WPI calculated with 2011-12 base year
does not include taxes in order to remove
the impact of fiscal policy.
Primary Articles Fuel & Power Manufactured Products
63.75 64.97 64.23
14.23 14.91 13.15
22.03 20.12 22.62
1993-94 2004-05 2011-12
I M A G E 7.1: W E I G H T I N G S T R U C T U R E OF WPI
Key Highlights of WPI with 2011-12
as base year
• In the new and present WPI series, there
has been significant improvements in
concept, coverage, and methodology.
• The WPI basket has been updated and
the number of items has been increased
from 676 to 697.
• New definition of Wholesale Price Index
(WPI) does not include taxes to remove
the impacts of fiscal policy. It also brings
new WPI series closer to Producer Price
Index (PPI) and is in consonance with the
global practices.
• The indices are being compiled based
on Geometric Mean as compared to
Arithmetic Mean used in the WPI 2004-
05 series.
Consumer Price Index (CPI)
• Consumer Price Index (CPI) measures the
inflation at retail level.
• Consumer Price Index (CPI) is a measure
of change in retail prices of goods and
services consumed by people in a given
area with reference to a base year.
• The main uses of CPI are the following:
a. It is widely considered
barometer of inflation
b. Tool for monitoring price stability
• The formula for calculating Consumer
Price Index is called as Laspeyres index
and the formula is:
Total cost of a fixed basket of goods and services in the current period
Total cost of the same basket in the base period
• The Reserve Bank of India is now using
CPI(Combined) as the as the benchmark
for its monetary policy tools like Repo
Rate, Reverse Repo Rate.
• According to the Agreement on Monetary
Policy Framework signed between the
89
Government and the RBI in 2015 the sole
objective of the RBI is price stability and
the Consumer Price Index (Combined) is
measured as the target inflation.
• Consumer Price Index compiled for four
groups of consumers in India
» CPI for Industrial workers CPI(IW)
» Consumer Price Index for Urban Non-
Manual Employees (UNME)
» CPI for Agricultural Labourers CPI(AL)
» CPI for Rural Labourers CPI(RL)
CPI for Industrial workers CPI(IW)
• This is the oldest index among the CPI
indices as it was started as early as in
1946.
• Consumer Price Index for Industrial
Workers (IW) measure a change in prices
of a fixed basket of goods and services
consumed by Industrial Workers over a
fixed period of time.
• The target group is an average working-
class family belonging to any of the seven
sectors of the economy- mines, factories,
plantation, motor transport, port,
electricity generation and distribution
and railways.
as a • The Labour and Employment Ministry
revised the CPI (IW) base year from 2001
to 2016 to reflect shifting consumption
patterns, giving more weight to spending
on health, education, leisure, and other
miscellaneous expenses while decreasing
the weight of food and beverages.
* 100
• It is used to decide wages and to fix
the dearness allowance for government
employees.
• The retail prices used in the calculation
of CPI(IW) are collected by the Labour
Bureau, Ministry of Labour.
CPI for Urban Non-Manual
Employees (UNME)
• This index depicts the changes in the
level of average retail prices of goods
and services consumed by the urban
section of the population. The target
group of this index was urban families
who derived a major portion of their
income from non-manual employment in
the non-agricultural sector.
• The index was being released by CSO
with a time lag of nearly two weeks
• Some public and private sector
undertakings, State Governments,
foreign embassies, etc. are using this
index for purposes of regulating Dearness
Allowance.
• The release of all-India linked CPI(UNME)
has been discontinued since January
2011.
CPI for Agricultural Labourers CPI
(AL)
• CPI for Agricultural labourers (AL)
measures the extent of change in the
retail prices of goods and services
consumed by the agricultural labourers.
• CPI (AL) is currently calculated at base
1986-87 = 100.
• CPI (AL) is basically used for revising
minimum wages for agricultural labour in
different States.
• CPI (AL) is compiled by the Labour
Bureau in the Ministry of Labour.
CPI for Rural Labourers CPI (RL)
• CPI for Rural labourers (RL) measures
the extent of change in the retail prices
of goods and services consumed by the
Rural labourers.
90
• CPI (RL) is currently calculated at base
1986-87=100.
• CPI (RL) is compiled by the Labour
Bureau in the Ministry of Labour.
Note: The Labour Bureau has started
the process of revising the base year for
Consumer Price Index for Agricultural and
Rural Labourers CPI (AL/RL) to 2019-20,
from 1986-87.
Revision in CPI
• The CPI (IW) and CPI (Al & RL) pertain
to specific segments of the population.
Since these indices do not cover all
segments of the population, it is difficult
to ascertain the true variations in the
price level.
• To overcome this problem, government
announced a new index with wider
coverage,
» CPI (Urban): Representative of the entire
Urban population
» CPI (Rural): Representative of the entire
Rural population
» CPI (Combined)
• It is compiled by the Central
Statistics Office (CSO) under the
Ministry of Statistics and Programme
Implementation (MOSPI).
• The base year was also revised from
2004-05 to 2010-11.
• In 2015, CPI was again revised by CSO.
» The base year was revised from 2011-12
= 100.
» The number of groups was increased to
six in the new series i.e.
 Groups Rural Urban Combined

Food and beverages 34.18 36.29 45.86

Pan, tobacco and

3.26 1.36 2.35
intoxicants
(newly added )

7.36 5.57 6.53

Clothing and Footwear

Housing ----- 21.67 10.07

Fuel and Light 7.94 5.50 6.84

Miscellaneous 27.26 29.53 28.32

Total 100 100 100

» Consumer Food Price Index (CFPI) will be » The indices are now being computed
compiled as the weighted average of the using Geometric Means (GM) in place of
following indices: Arithmetic Mean (AM) used for the old
series.
− CFPI (Rural)
− CFPI (Urban)
− CFPI (Combined)

Nov.2019 (Provisional) Oct 2019

Indices
Rural Urban Combined Rural Urban Combined

CPI
5.27 5.76 5.54 4.29 5.11 4.62
(General)

CFPI 8.83 12.26 10.01 6.42 10.47 7.89

WPI vs CPI
Wholesale Price Index (WPI) Consumer Price Index (CPI)

CPI measures the average price that households

WPI keeps track of the wholesale price of goods.
pay for a basket of different goods and services.

The prices used for WPI are collected at ex-

factory level for manufactured products, at ex- Retail prices applicable to consumers and collected
mine level for mineral products and mandi level for from various markets are used to compile CPI.
agricultural products.

91
Compiled by Office of Economic Advisor (Ministry Compiled by Central Statistics Office (Ministry of
of Commerce & Industry). Statistics and Programme Implementation).
Goods only.
WPI basket weight of 24.4% (Food articles and
CPI Food group has a weight of 39.1%.
Manufactured Food products).
Price paid by Manufacturers and wholesalers.
Trends in Inflation
• Inflationary trends in India are not
uniform and it has been a mixed bag.
There were years when the annual rate
of inflation was high (due to supply-side
shortfalls caused by drought, price rise
of crude oil), while in other years it was
negative.
• Decadal inflation in India has been as
follows:
12.00%
8.00%
4.00%
0.00%
1940s 1960s 1980s
I M A G E 7.2: I N F L AT I O N TRAIN SCENE
• Between 2009-13, the inflation remained
high due to:
» Food inflation due to the shift in dietary
habit to protein-rich food.
» Increased wages (due to schemes like
MGNREGA etc.)
» Increase in prices of the commodity in
the global market.
• Since 2014 inflation started moderating
due to a decrease in global crude oil
prices, softening in global food prices,
RBI tight monetary policy.
92
Goods and Services both.
Price paid by Consumer.
• In December 2019, retail inflation rose to
five and a half year high to 7.35% primarily
on the account of rising vegetable and
food prices. Food items make up almost
46 per cent of the inflation basket.
• According to the National Statistical
Office (NSO), retail inflation based on
the Consumer Price Index (CPI) was only
2.11% in December 2018 and 5.54% in
November 2019.
• Onion prices were above the Rs. 100 per
kg mark in many major cities due to fall
in production. Along with rise in the price
of vegetables, high prices of pulses, meat
and fish contributed to the spike.
Inflation Targeting in
2000s
India
INDEPENDENT
• Inflation targeting is a monetary policy
measure used by Central Banks (RBI) for
maintaining price level at a certain level
or within a specified range.
• Inflation targeting brings in more
transparency and predictability while
deciding various monetary policy rates.
If the RBI could ensure price stability,
companies and households can plan in
well advance, negotiating wages based
on targeted inflation.
• The Government of India and RBI
signed a Monetary Policy Framework
Agreement in 2015. As per terms of this
agreement, the objective of monetary
 policy framework would be primarily to
maintain price stability, while keeping in
mind the objectives of growth.
• The monetary policy framework is
operated by the RBI. RBI is responsible to
contain consumer price inflation within 4
per cent with a band of (+/-) 2 per cent.
• In case of retail inflation is more than 6%
for three consecutive quarters and less
than 2% for three consecutive quarters
RBI will have to explain the reason for its
failure to meet the target and also give a
time-frame within which it will achieve it.
• The RBI will also be required to publish
a document after every six months to
explain the sources of inflation and
forecast the inflation for the next 6-18
months.
Food Prices Indices
WPI food index
• As a part of revised WPI series, WPI food
index was launched in 2017 with base
year 2011-12.
• WPI food index measures the fluctuations
in prices of food items at the producer’s
level.
• The WPI Food index is calculated by
taking the aggregate of WPI for “Food
Products” under “Manufacture Products”
and “Food Articles” from “Primary Article”
using weighted arithmetic mean.
Consumer Food Price Index
(CFPI)
• Consumer Food Price Index (CFPI) is a
measure of fluctuations in retail prices
93
of food products which are consumed by
a defined group of population in a given
area with reference to the base year.
• The Central Statistics Office (CSO),
Ministry of Statistics and Programme
Implementation (MOSPI), started
publishing Consumer Food Price Indices
(CFPI) under three heads, rural, urban,
and combined, separately on an all-India
basis from May 2014.
• Like Consumer Price Index (CPI), the CFPI
is also calculated on a monthly basis and
methodology remains the same as CPI.
• The base year presently used is 2012.
Note: Globally, the food price index is
being released by the Food and Agriculture
Organization (FAO) of the United Nations.
The FAO Food Price Index calculates the
monthly change in international prices of
a basket of food articles. It consists of the
average of five commodity group price
indices (Vegetable Oil, Cereal, Sugar Meat
and Dairy) weighted with the average
export shares of each of these groups for
2002-2004.
Other Index
Producer Price Index (PPI)
• Producer Price Index calculates the
price of goods as they are sold to the
wholesalers by the producers.
• Producer Price Index calculates price
change from the perspective of the
producers.
• Government of India has established a
committee under the chairmanship of
B.N Goldar to advise methodology for
introducing PPI in the country.
PPI vs WPI
PPI
PPI measures the average change in prices received transactions and may include some taxes levied
by the producer and excludes indirect taxes.
PPI includes Services.
PPI weights are derived from Supply Use Table.
NHB RESIDEX
• NHB RESIDEX, India’s first official
housing price index, an initiative of
the National Housing Bank (NHB) was
launched in 2007.
• NHB RESIDEX is designed in such a way
that it tracks changes in housing prices
at neighbourhood, city and national
levels. Price changes will be measured
over period and across different cities
and various locations within cities.
Housing Price Index of RBI
• Reserve Bank compiles the quarterly
house price index (HPI) (base: 2010-
11=100) for ten major cities i.e., Mumbai,
Delhi, Chennai, Kolkata, Bengaluru,
Lucknow, Ahmedabad, Jaipur, Kanpur,
and Kochi.
Effects of Inflation
Effect
On Creditor Loss
On Debtor Profit
94
WPI
WPI captures the price changes at the point of bulk
and distribution costs up to the stage of wholesale
transactions.
WPI does not cover Services.
Weight of an item in WPI is based on Net Traded
Value.
• HPI is based on transaction data collected
from housing registration authorities in
ten major cities.
• RBI started compiling HPI in 2007 for
Mumbai.
Service Price Index
• Service Price Index would capture the
movement of prices in various services
like insurance, banking, transport,
communication.
• Service Price Index was recommended
by Abhijit Sen Committee.
• The tertiary sector contributes about 60
per cent in the country’s gross domestic
product (GDP), the need for this index
is important because of the growing
dominance of the tertiary sector.
Reason
The interest rate charged by the bank is nominal interest
rate(NIR), which is not same as the Real interest rate(RIR)
paid by the borrower.
RIR = NIR - Inflation
Real interest rate is always lower than the Nominal
interest rate if inflation is taking place.
 Since money supply increases it increases the demand
On Demand Increases
for commodity.

Inflation in the short-run boost investment since it

On Investment Increases indicates higher demand, industries increase production
to match demand.

Inflation reflects a reduction in the purchasing power per

unit of money i.e each unit of currency buys fewer goods
On Saving Reduces and services.
That is why people try to keep the least money with
themselves and hold maximum in the bank.

As indirect tax is imposed on the value of products, with

On Indirect Tax Increases an increase in price of the product, people pay more.
Hence, indirect tax increases.

Due to Inflation, tax-payer income increases, due to

On Direct Tax Increases which, taxpayer is moved in a higher income tax slab.
Hence, direct tax burden increases.

Due to inflation currency of the economy loses its values.

On Exchange Rate Depreciate For example, $1 = Rs50
after inflation $1 = Rs. 60

On Export Increases Export will increase in volume but will decrease in value.

Because of the increase in the costs of imported products,

On Import Decrease
hence, the volume of import decreases.

Inflation increases employment in the short run. But in

On Employment Increases long term, as costs rise it may substitute labour with
other factors, such as new technology.

Inflation increases the nominal value of the wages while

On Salary Increases
their real wages(adjusted for inflation) falls.

If inflation is in the specified range than it is healthy for the economy, otherwise
On Economy
not good.

• This inflation occurs when the supply

Other Variants of falls drastically, and the demand remains

Inflation at the same level. Such situations arise

Structural Inflation/Bottleneck
Inflation
• Structural inflation is inflation that results
from changes in the structure of demand
and supply.
due to supply-side hurdles, hazards, or
mismanagement.
• For example, recent prices of onion prices
rise in recent days because of unseasonal
rains, affecting supply whereas demand
remained the same.

95
Headline Inflation
• Headline Inflation reflects the rate of
change in prices of all goods and services
in an economy over a period of time.
• It includes price rise in food, fuel, and all
other commodities.
• In India, the CPI is used as the headline
inflation as it reflects the prices of
essential consumption goods.
• The headline CPI inflation in India tends
to increase whenever there is a surge in
food and fuel prices.
Core Inflation
• Core Inflation is also called as underlying
inflation. Core inflation is calculated by
excluding items that are vulnerable to
volatile price movement, specifically
food and energy items.
• Thus, Core Inflation is nothing but
Headline Inflation minus inflation caused
by food and energy articles.
• To understand the concept, we can say
that food and fuel prices may rise in the
short term due to some disturbances in
the agriculture sector or oil industry. But,
over the long period they revert to their
normal growth trend. The prices of other
commodities do not fluctuate as regularly
as food and fuel. But as such, an increase
in their prices could be taken relatively to
be much more of a permanent nature.
• Reserve Bank of India and Central Banks
across the World always monitor the
core inflation. Whenever core inflation
increases, Central Banks increase their
key policy rates to reduce excessive
liquidity from the market and vice versa.
It is, thus, a preferred tool for framing
long-term policy.
96
Open Inflation
It is the situation in which price level
increases without any price suppressive
measure by the government.
Government does not suppress inflation
with subsidies and monetary policy.
Suppressed/Repressed
Inflation
• The situation in which aggregate demand
is greater than aggregate supply in the
economy but the government prevents
price level from rising through direct price
control measures like ceiling price etc.
• Repressed inflation is the state in which
there is persistent excess demand for
goods and services.
• Governments in India are not effective in
suppressing inflation because the supply
chain is highly unorganized.
Important Terms
Reflation
• Reflation is a situation in which price
level increases along with an increase
in output, employment etc., when
an economy moves from recession/
depression.
• Reflation refers to the combination of
monetary and fiscal policy initiatives
aimed to combat lower economic growth
and is usually done by increasing the
money supply, lowering interest rates and
tax rate cuts.
Stagflation
• Stagflation is defined as a combination
of economic phenomenon where there
is high inflation along with increasing
unemployment and relatively slow
economic growth or recession.
• It is caused due to cost-push inflation.
• Stagflation is a combination where
economy suffers from high inflation and
low growth.
• In the 1970s oil crisis in the world there
was stagflation in the world economy.
Skewflation
• Skewflation refers to price rise of one
or a small group of commodities over a
sustained period of time.
• In India, food prices went up steadily
during the last few months of 2009 and the
early months of 2010, though the prices of
non-food items continued to be relatively
stable. As it was unusual phenomenon
Skewflation appeared in the Economic
Survey 2009-10, Government of India,
Ministry of Finance.
Misery Index
• Misery Index is the summation of the
inflation rate and unemployment rate.
Inflationary Gap
• The situation in which aggregate demand
is more than the productive capacity of
the economy.
Aggregate Demand >Aggregate Supply Full employment
• Inflation Gap leads to excess demand
which leads to inflation.
Deflationary Gap
• The situation in which aggregate demand
is less than the productive capacity of
the economy.
Aggregate Demand <Aggregate Supply Full employment
97
• Deflation Gap leads to deflation and
recession.
Agriflation
• Increase in the price of agricultural
products.
Disinflation
• Reduction in the rate of inflation. It is a
situation where rate of increase in price
level decreases without any adverse
impact on output, national income,
employment etc.
Deflation
• A persistent decrease in price level i.e.
negative inflation. It is the situation in
which price level reduces along with the
reduction in the output
• It leads to recession (which is never
desirable), unemployment etc.
• Central banks try to keep the overall price
levels stable by avoiding situations of
severe inflation/Deflation. They may ease
the money supply into the economy to
counterbalance the deflationary impact.
• Deflation is different from disinflation as
the disinflation implies a decrease in the
level of inflation while on the other hand
deflation implies negative inflation.
Phillips Curve
• It is a graphic curve which depicts the
relationship between inflation and
unemployment in an economy.
• Phillips Curve depicts that there is an
inverse relation between inflation and
unemployment.
• That is when inflation is high,
unemployment is less in short terms
and higher the inflation lowers the
unemployment.
 in the short term. Phillips curve fails to
justify the situations of stagflation when
both inflation and unemployment are
alarmingly high.
INFLATION • This concept was given by A.W. Philips.

UNEMPLOYMENT RATE
• However, the implications of Phillips
curve have been found to be true only
GDP Deflator
• GDP deflator measures the impact of
inflation on the gross domestic product
(GDP) i.e. how much a change in GDP
relies on changes in the price level.
• It is calculated by dividing nominal GDP
by real GDP and then multiplying by 100.

GDP Deflator WPI

WPI is based on a limited basket of goods and

GDP deflator reflects the prices of all domestically
services, thereby not representing the entire
produced goods and services in the economy.
economy.

GDP deflator also includes the prices of investment

WPI (at present) has no representation of the
goods, government services and exports, and
services sector.
excludes the price of imports.

• If the inflation rate was too low in the

Base Effect
• The base effect refers to the impact of
the rise in the price level (i.e. last year’s
inflation) in the previous year over the
corresponding rise in price levels in the
• For example, the index has increased
current year (i.e., current inflation).
corresponding period of the previous
year, even a relatively smaller rise in the
Price Index will arithmetically give a high
rate of current inflation.
by 20 points in all the three years: 2008,
2009 and 2010. However, the inflation

Price Index Inflation

2007 2008 2009 2010 2008 2009 2010

(120-100) *100=20% (140-120) = 16.67%

April 100 120 140 160 100 120 14.29

rate (calculated on a year-on-year basis) 20 points in the price index in each year
tends to decline over the three years increases the base year price index by an
from 20% in 2008 to 14.29% in 2010. equivalent amount, while the absolute
This is because the absolute increase of increase in price index remains the same.

98
Inflation Indexed
Bond (IIB)
• Inflation-Indexed Bond (IIB) is a bond
issued by the RBI, which provides the
investor a constant return irrespective of
the level of inflation in the economy.
• The main objective of Inflation-
Indexed Bonds is to provide a hedge
and to safeguard the investor against
macroeconomic risks in an economy.
• In the Indian context, inflation was one
of the major macroeconomic concerns
of the economy during the period 2008-
2013 where real interest rates were
consistently negative.
• This leads to huge investment in the
alternate instrument (gold) by the
households, necessitating heavy
import of gold. In order to reduce the
attractiveness of gold for investment and
reduce the CAD, the Government of India
launched Inflation-indexed bonds (IIB) in
2013.
• The Reserve Bank of India auctioned its
first tranche, linking to Wholesale Price
Index (WPI) inflation, as WPI headline
inflation was then used as the key
measure of inflation by RBI.
• Over time, IIB bonds lost its attractiveness,
as there has been significant moderation
in inflation since 2014-15
• Since April 2014, RBI adopted Consumer
Price Index (CPI combined) as the key
measure of inflation for its monetary
policy stance.
• In case RBI issues new IIB bonds in the
near future, it would be based on CPI, as
CPI (combined) has been accepted by
RBI as the key measure of inflation for its
monetary policy stance, since 2014.
99
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) India has experienced persistent and
high food inflation in the recent past.
What could be the reason? 2011
1. Due to a gradual switchover to the
cultivation of commercial crops, the
area under cultivation of food grains
has steadily decreased in the last five
years by about 30%.
2. As a consequence of increasing
incomes, the consumption patterns
of the people have undergone a
significant change.
3. The food supply chain has structural
constraints.
Which of the statements given above are
correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (b)
• Explanation: According to the RBI:
Except few cases of lower inflation, food
price inflation has remained persistently
elevated for over a year now, reflecting
in part the structural demand-supply
mismatches in several commodities.
• The trend of food inflation was pointing
at not only structural demand-supply
mismatches in commodities comprises
the essential consumption basket but
also at changing consumption patterns.
Q.2) A rapid increase in the rate of
inflation is sometimes attributed to the
“base effect”. What is “base effect”? 2011
(a) It is the impact of drastic deficiency
in supply due to the failure of crops
 (b) It is the impact of the surge in
demand due to rapid economic growth
(c) It is the impact of the price levels of
the previous year on the calculation of
inflation rate
(d) None of the statements
Ans. (c)
• Explanation: The base effect is the impact
of the increase in the price level (i.e. last
year’s inflation) in the previous year over
the corresponding increase in price levels
in the current year (i.e., current inflation).
Q.3) A rise in the general level of
prices may be caused by: 2013
1. an increase in the money supply
2. a decrease in the aggregate level of
output
3. an increase in the effective demand
Select the correct answer using the codes
given below.
(a) 1 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2 and 3
Ans. (d)
• Explanation: All the statements are
correct.
Q.4) Which reference to inflation
in India, which of the following
statements is correct? 2015
(a) Controlling the inflation in India is the
responsibility of the Government of India
only
(b) The Reserve Bank of India has no role
in controlling the inflation
(c) Decreased money circulation helps in
controlling the inflation
(d) Increased money circulation helps in
controlling the inflation
100
Ans. (c)
• Explanation: RBI plays a key/primary
role in controlling inflation through its
monetary policy.
• So, option (a) and (b) are out.
• Now increased money supply shall only
add fuel to the fire and send inflation
skyrocketing.
• So, the answer should be the option (c).
Q.5) Consider the following statements:
1. The weightage of food in Consumer
Price Index (CPI) is higher than that in
Wholesale Price Index (WPI).
2. The WPI does not capture changes in the
prices of services, which CPI does.
3. Reserve Bank of India has now adopted
WPI as its key measure of inflation and to
decide on changing the key policy rates.
Which of the statements given above is/
are correct?
(a) 1 and 2 only
(b) 2 only
(c) 3 only
(d) 1, 2 and 3
Ans. (a)
• Explanation: Option 1 is correct: Food
has a much higher weightage in CPI as
compared to WPI. This essentially means
an increase in food prices will cause a
greater spike in the CPI basket than in
the WPI one.
• Option 2 is correct: Other major difference
amongst the two indices is that the
wholesale market is only for goods, you
cannot purchase services on a wholesale
basis. So WPI does not comprise services,
while the retail price index does. WPI,
unlike the Consumer Price Index (CPI),
only tracks the prices of goods bought
by consumers.
• Option 3 is correct: Based on the
recommendations of the Urjit Patel
 committee, monetary policy (MP) in India (a) 1 and 2 only
is to be prepared in reference to the CPI (b) 2 only
(instead of WPI) based inflation. (The
recommendation was accepted in 2014 (c) 1 and 3 only
itself.) (d) 1, 2 and 3
Ans. (b)
• Explanation: Expansionary/Expansionist
Q.6) If the RBI decides to adopt an monetary policy is when the central bank
expansionist monetary policy, which of of a nation increases money supply to
the following would it not do? accelerate the economy. Increase the
1. Cut and optimize the Statutory Liquidity MSF rate of interest will make borrowing
Ratio expensive, and thus is something that
the RBI would not do as part of its
2. Increase the Marginal Standing Facility expansionist monetary policy.
Rate
• Various mechanism of an expansionist
3. Cut the Bank Rate and Repo Rate
monetary policy are cutting and
Select the correct answer using the code optimizing SLR and Cutting bank rate
given below: and Repo Rate.

101
 CHAPTER - 8

FINANCIAL MARKET

• It provides liquidity to the financial

Financial Market commodities i.e., investors can sell their
financial commodities and convert them
• Financial Market is the system consisting into cash in a very short period.
of the financial institution (banks
• It saves the time, money, and efforts of
etc.), instruments (bonds and shares),
investors. The financial market gives a
organisations (stock exchange) and
platform where both the buyers and
regulatory bodies (RBI, SEBI etc.), which
sellers can find each other easily.
facilitates the flow of equity and debt
capital.
• The financial market gives a platform to
the buyers and sellers for trading assets Types of Financial
at the prices determined by the demand
and supply forces.
Market
• There are two types of Financial Markets
Functions of » Money Market

Financial Market Money Market is the market which

• It facilitates mobilization of savings,
where an investor can invest his saving
according to risk and choice assessment.
• It helps in determining the price of
financial commodities based on demand
and supply.
fulfills the requirements of funds for the
period ranging from overnight to one
year.
» Capital Market
Capital Market is the market which
fulfills the requirements of funds for the
period above one year.

Money Market vs Capital Market

Money Market Capital Market

It deals with medium and long term financial

It deals with short term financial transactions.
transactions.

It finances capital equipment to firms i.e. it

It is the source of working capital finance for firms.
promotes capital formation.

It deals with bonds. Example- commercial papers,

commercial bills, certificate of deposit, treasury bill It deals with both bonds and equities.
etc.

102
Usually, it deals with high volume transaction. It deals with both low and high volume transaction.

In India, the participation of the general public is

People participation is significant.
limited.

All types of Financial Instrument participate

Participation is confined to banks.
actively.

RBI is the prime regulator. SEBI is the prime regulator.

It consists of both organized and unorganized

It is mainly confined to organized sector.
sector.

Money Market Instruments

Money Market

Organised Sector Unorganised Sector

Sub Market of
Banks Money Market Moneylender Hundi

Treasury Commercial Commercial Certificate Call Money

Bill Paper Bill of Market
Deposit
I M A G E 8.1: M O N E Y M A R K E T IN INDIA

Commercial Paper » All-India Financial Institutions (FIs):

• Commercial Paper (CP) is a short-term
unsecured money market instrument
issued in the form of a promissory note
(legal instrument).
• In India, it was introduced in 1990 to
enable highly rated corporate borrowers
to diversify their short-term sources of
borrowings and to provide an additional
instrument to investors.
• Commercial Paper can be issued by:
» Corporates (whose tangible net worth is
not less than Rs. 4 crores)
» Primary Dealers (PDs) and
• These can be issued for maturities
between a minimum of 7 days and a
maximum of up to one year from the
date of issue.
• These can be issued in denominations of
Rs.5 lakh or multiples thereof.
Commercial Bill
• It is unsecured security issued by one
merchant firm to another against a credit
transaction.
• These are issued at a discount (investors
pay a price lower than the face value).

103
• Its maturity ranges between 14 days to 1
year.
• It is a source of working capital finance
for small corporations.
• For example: Suppose there are two firms
A and B. Firm B needs to buy raw material
from A worth Rs. 1 Lakh. But firm B does
not have the money to buy raw material.
So firm B will issue a commercial bill to
Firm A as per the guideline of RBI. Firm A
will give the raw material of less than Rs.
1 Lakh. Firm B is liable to pay Firm A.
Certificate of Deposit
• It is the bond/security issued by a bank to
the depositor of the fund.
• It is an agreement to deposit money for a
fixed period of time with a bank that will
pay interest.
• Certificates of Deposit are issued in
multiples of Rs. 1 lakh subject to a
minimum value of Rs. 25 lakh.
• These are issued at a discount.
• Certificate of Deposit are similar to fixed
deposits but are negotiable and tradable
in the money market.
• These can be issued by:
» Scheduled commercial banks {except
Regional Rural Banks and Local Area
Banks}.
» Selected All-India Financial Institutions
(FIs) which are permitted by RBI.
• These can also be issued to Non-Resident
Indians (NRI).
Call Money Market
• It deals with day-to-day lending and
borrowing transactions of banks amongst
themselves.
• It deals in very short loans that have
maturity ranging between 2 - 14 days.
104
• Its objective is to provide liquidity to
banks.
• The interest rate charged on such
transactions is called ‘call money rate’
and is based on market demand.
• It is a very competitive market that
reflects the liquidity position of banks.
Average Daily
Banks Cash Available
Withdrawal
ICICI 50 Lakh 1 Crore
SBI 1 Crore 2 Crore
• For example, If a person comes and
withdraws 90 Lakh from ICICI, it cannot
give withdrawal to other customers on
that day. So ICICI will borrow some huge
amounts from SBI and may return in 2- 3
days (should not take more than 14 days).
The interest may vary from bank to bank.
Government Security (G-Sec)
• Government Security (G-Sec) is a tradable
instrument issued by the Government of
India or the State Governments.
• It acknowledges the debt obligation of
Government.
• Such government securities are either
short term (generally called treasury bills,
with maturities of less than 1 year) or
long term (generally called Government
bonds or dated securities with an original
maturity of one year or more).
• G-Secs have practically no risk of default
and, therefore, are called risk-free gilt-
edged instruments.
• Short term government securities are:
Treasury Bills (T-bills)
• Treasury bills or T-bills are short term debt
instruments issued by the Government of
India and are presently issued in three
maturity periods of 91 days, 182 days, and
364 days.
• Treasury bills are zero-coupon securities
as it does not carry any interest. Rather,
these are issued at a discounted value
and redeemed at the face value at the
time of maturity.
• For example, a 182-day Treasury bill of
₹1000/- (face value) may be issued at
say ₹ 998.20, that is, at a discount of say,
₹1.80 and would be redeemed at the face
value of ₹1000/-
Cash Management Bills (CMBs)
• In 2010, the Government of India, in
consultation with the RBI introduced
a new short-term instrument Cash
Management Bills (CMBs), to fulfill the
temporary cash flow mismatches of the
Government of India.
• The Cash Management Bills have the
generic character of T-bills but are issued
for maturities less than 91 days.
Repo (Ready Forward Contract)
• Repo allows the bank and other financial
institutions to borrow money from the
RBI for the short term.
• The interest rate at which the Reserve
Bank of India (RBI) gives short term loans
to commercial banks is called the Repo
Rate.
Discount and Finance House of
India (DFHI)
• DFHI was set up by RBI in 1998 to
strengthen the money market and provide
liquidity to money market instruments.
• It was established based on the
recommendation of the Vaghul
Committee.
• The main objective of DFHI is to develop
an active secondary market for the
money market instruments.
• DFHI participates in transactions in all
105
the market segments like treasury bills,
call money market etc.
• In 2004, RBI transferred its total holding
to SBI Giltz Limited. Its new name is SBI
DFHI.
LIBOR (London Interbank Offered
Rate)
• It is the interest rate at which major
global banks lend to one another in the
international interbank market for short-
term loans.
• LIBOR is administered by the
Intercontinental Exchange or ICE.
• It is computed for five currencies Swiss
franc, euro, pound sterling, Japanese yen,
and US dollar.
MIBOR and MIBID
• Mumbai Interbank Offer Rate (MIBOR)
and Mumbai Interbank Bid Rate (MIBID)
are the benchmark rates at which Indian
banks lend to each other.
• These rates reflect the short-term funding
costs of major banks.
• Mumbai Interbank Offer Rate (MIBOR)
is the interest rate at which banks are
willing to offer loans to other banks and
MIBID is the rate at which banks would
like to borrow from other banks.
Hundi
• Hundi is an unconditional writing order
made by a person which directs another
person to pay a certain amount of money
to a person mentioned in the order.
• Hundis, being a part of the informal
system have no legal status and are
not covered under the Negotiable
Instruments Act, 1881.
Capital Market
• Capital Market refers to the market where
long-term capital is raised via both debt
and equity instruments such as equity
share, preference share, debenture, etc.
• The demand for long term capital comes
from both the government and the
private sector.
• Every Capital Market has two
complementary market:
» Primary Market:
− Deals with the issuance and sale of
the instrument of capital market to
investors directly by the issuer.
− When a company or corporate entity
issues stock or bonds for the first time
and sells that securities directly to the
investors, that transaction occurs on
the primary market.
» Secondary Market:
− The market where instruments of
the capital market are being traded
among the primary instrument
holders.
− In the secondary market, all the
transactions occur between various
investors, and the proceeds of each
sale go to the selling investor, not to
the company that issued the stock.
It means company is not directly
involved in the transactions of
secondary market.
− Such transactions need a platform for
their trading, stock exchange provides
the platform for the secondary
market.
Means of raising fund in the
primary market
• Following are the different ways through
106
which company can raise the capital
from primary market:
Initial Public Offer (IPO)
• Initial Public Offer is the process of
offering its new securities to the public/
investor for the first time through the
issue of prospectus.
• It is issued only by the unlisted company
(a company whose shares are not traded
on a stock exchange).
Follow on Public Offer (FPO)
• Follow on Public Offer (FPO) refers to the
process where already listed company
offers its securities to the public/investor
to an offer for sale.
• A follow-on offering is the issuance of
additional shares made by a company
after an initial public offering (IPO).
• It is also called as the secondary offering.
Right Issue
• A listed company offers its new securities
only to the existing shareholders in
proportion to their existing shareholding.
• In the Right Issue, shares are issued at a
discount.
Referential Issue
• Under this, a listed company offers its
new securities only to a selected class of
shareholders.
Bonus Issue
• Bonus shares or issues are additional
shares given to the existing shareholders
without any additional cost, in the
proportion of their shareholding in lieu of
distribution of dividend.
Private Placement
• Raising capital by selling the share to a
select group of investors, or individual.
• The advantage of the private placement
is saving in marketing expenses.
• Under this, number of investors who are
issued shares cannot be more than 50.
Sweat Equity
• Under this, the share is allotted to top
management like directors of a company
at a highly discounted price in recognition
of their outstanding contribution.
Secondary market
as a trading
instrument
• Secondary market is used as a trading
instrument in the following ways:
Stock Exchange
• A physical institutional set-up where
capital market instruments (shares,
debenture, etc.) are traded.
• It performs the following major functions:
» Efficient price discovery: A stock
exchange determines the process of
price discovery via constant valuation of
all the securities.
» Liquidity: Stock Market ensures high
liquidity. The securities can be sold at a
short notice and be converted to cash.
» Investor Protection: The government
regulates stock exchanges. This provides
the investor with assurances to transact
in securities.
107
Over the Counter Exchange
(OTC)
• Over the Counter Exchange refers to the
process in which securities are traded
by companies which are not listed on a
formal exchange markets like NSE, BSE
etc.
• Securities that are traded over the
counter are traded via a broker-dealer
network as opposed to on a centralized
exchange market.
• These securities are qualified for listing
on a standard market exchange
• Over the Counter Exchange of India
Limited was established in 1999. It
facilitates trade-in companies having
paid-up capital of Rs. 30 Lakh or more.
Stock Exchanges in
India
• Major stock exchanges in India are:
Bombay Stock Exchange (BSE)
• Bombay Stock Exchange (BSE) was
established in 1875 and is the oldest stock
exchange in Asia.
• On August 31, 1957, the Bombay Stock
Exchange became the first stock
exchange to be recognized by the
Indian Government under the Securities
Contracts Regulation Act.
• Around 5500 companies are listed on
BSE, the largest number of companies
listed in the world (but not the largest
stock exchange in the world).
• It introduced BOLT (BSE online trading
system) in 1995 to promote transparency
and eliminate any errors.
• Presently, there are four Indices
connected with BSE:
» Sensex: Sensex is the stock market index
of 30 well established and financially
sound companies listed in Bombay Stock
Exchange.
» BSE 100: An index of 100 stocks.
» BSE 500: This index represents major
industries and many sub-sectors of the
economy.
• NSE was established on the basis of
the recommendation of “Phirwani
Committee” as the most modern stock
exchange of the country.
• National Stock Exchange is ranked as
the largest stock exchange in India in
terms of total and average daily turnover
for equity shares.

» BSE 200: This is the 200-stock share • Presently, there are two Indices connected
index of the BSE. with NSE:

National Stock Exchange (NSE) » S&P CNX 50 (Nifty Fifty)

• NSE was established in 1992 and started » S&P CNX 500

trading in 1994.

Stock Exchange and Indices

Stock Exchange Indices

New York Stock Exchange Dow Jones

NASDAQ NASDAQ Index

National Stock Exchange (NSE) NIFTY

Korean Stock Exchange Kospi

Shanghai Stock Exchange Composite Index

Bombay Stock Exchange (BSE) Sensex

London Stock Exchange FTSE-100

Hongkong Stock Exchange Hang Seng Index

Singapore Stock Exchange Straits Times Index

Tokyo Stock Exchange Nikkei

108
Important Terms of
Stock Exchange
Bear and Bull
• Bull market is a market which is on
upward trends. It is a sustained increase
in market share prices and subsequent
returns on each share. In such times,
investors often believe that the uptrend
will continue over the long term and
investors infuse more money for better
returns.
• Bear market is a market that is on the
decline. Share prices are continuously
falling, resulting in a downward trend. In
such scenario investors tend to withdraw
their money to reduce their losses. This
causes fall in share market trends.
Speculation
• Speculation refers to buying a commodity/
currency/security with the intention of
selling it in the near future at a higher
price to make a profit.
• Here the sole intention is just to sell when
the price goes up and not to purchase.
• Moderate speculation is good as it checks
prices from going up.
Arbitrage
• It refers to buying a commodity/security
from a cheaper market and selling it
immediately in another market at higher
prices.
• Arbitrage is a trade that generate profits
by exploiting the price differences of
identical or similar financial instruments
available on different markets or in
different forms.
• Arbitrage exists because of market
inefficiencies and would therefore not
exist if all markets were perfectly efficient.
109
Stag
• It refers to a speculator who purchases
security from the primary market like IPO
for selling them in the secondary market.
Buyback of Share
• Under Buyback, a company purchases its
own shares from the investor.
• It reduces the number of outstanding
shares of the company.
• It increases the dividend per share.
Short Selling
• Under this, an investor sells security which
is not possessed by him/her, but such an
investor has to purchase that security
within a specified period of time.
• Short sellers gain with fall in the price of
a security.
Insider Trading
• It refers to buying or selling shares of a
company on the basis of unpublished
price sensitive information.
• It is a criminal offense.
Algorithm Trading
• Under this, securities are traded on
the basis of inference from advanced
mathematical models.
• Algorithmic trading makes use of
complex formulae, combined with
mathematical models and human
oversight. Such algorithm trading is used
to make decisions to buy or sell financial
securities on an exchange.
• It can be used in a wide range of situations
like order execution, arbitrage etc.
• Concerns: Algo trades have been
 criticized for exaggerating market
patterns and causing flash crashes. A
programming flaw or a trader's mistake
may cause stock prices to fluctuate wildly,
potentially collapsing the economy.
• SEBI approves Algo programmes before
they can be used on any of the Indian
exchanges, and stock exchanges must
assign each approved algorithm a unique
identifier and ensure that each order is
marked with it.
• Recently, SEBI has put in place new
framework on order-to-trade ratio (OTR)
of algo orders issued by stockbrokers.
Under the scheme, stock exchanges may
be allowed to introduce additional slabs
up to an OTR of 2,000 (from the current
OTR of 500), and for OTR more than
2,000, such slabs can be announced with
deterrent incremental penalty, which
stock exchanges may decide jointly. It
has also suggested tighter oversight
of these trades to ensure the market's
smooth operation.
Stock Exchange
Regulator
SEBI (Security Exchange Board
of India):
• Initially SEBI was constituted in 1988 as
a non-statutory body to deal with all
the matters relating to regulation and
development of the capital market.
• It was granted statutory status under the
SEBI Act 1992.
• Functions of SEBI are:
» Regulation of Capital Market (both in the
primary and secondary markets).
» To register and regulate intermediaries
in the capital market like brokers, sub-
brokers, trustees, underwriters, mutual
funds.
» To check malpractices in the securities'
110
market, particularly in the Stock
Exchange.
» To promote investor education and
awareness.
» To protect the interest of the investor.
Capital Market
Reforms
• The stock exchange scam of 1992
(Harshad Mehta) and Ketan Parekh
scam in 2000 led to various measures to
protect the interest of the investor.
Circuit Breakers
• It is a mechanism under which trading in
a stock exchange is halted for a specified
period of time, in case of deviation in the
index of Stock Exchange (or share price)
beyond a certain limit.
Dematerialization/Demat
Trading
• Under this, computer records of a Stock
Exchange are maintained instead of
issuing shares/security certificate in the
physical form.
• At present, two public sector depositories
are functioning in India:
» NSDL (National Securities Depositories
Limited)
» CDSL (Central Depositories Services
Limited)
Depository Participants (DP)
• These are agents of depositories that
provide demand service/online security
trading services to the investors.
• Example: India Infoline, ICICI Direct, Axis
Direct etc.
Rolling Settlement
• Badla System: Under this, a spot market
transaction in a stock exchange could be
postponed by the buyers. It leads to over
speculation and defaults in the stock
exchange transaction. So, it was replaced
by rolling settlement.
• Under Rolling Settlement, a spot market
transaction in the stock market must be
completed within a specified period i.e.,
settlement period cannot be shifted.
• It is on the basis of the T+2 system (T=
transaction day; T+2= transaction day +
2 working day).
Corporatization
• Historically, the stock exchange was
formed as a mutual organization i.e.,
formed by trading members themselves
for their common benefits.
• They mainly focus on the interest of
members instead of investors. The
Government of India introduced
corporatization of stock exchange, by
which ownership, management and
trading membership of stock exchange
would be separated from each other.
• Objectives of corporatization of stock
exchange:
» To reduce the scope of manipulation by
brokers.
» To enable the stock exchange to raise
funds from the public through IPO
modernization.
Demutualization
• It refers to separation of ownership,
Management, and brokerage rights in
the stock exchange.
111
• The 1st stock exchange to be corporatized
and demutualized in India was BSE in
2005.
» Ownership = Shareholder
» Management = Directors (Board of
Directors)
» Brokerage = Open to all
Investor Protection and
Education Fund (IPEF)
• It was established in 2001 by SEBI and
the central government for promoting
investor’s awareness and to protect the
interest of investors, especially small
investors.
Introduction of Forward/
Derivative Trading
• To enable investors to hedge (using
financial instruments to offset the risk of
any adverse price movements) market
risks.
Derivative Trading
• Derivative Trading refers to contracts/
transactions of a forward contract.
Derivative
• It is a financial instrument whose value
is derived from the value of one or more
underlying assets which can be precious
metals, commodities, currency, bonds,
stocks indices, stocks etc.
• Following are the four most common
examples of derivative instruments:
Futures, Forwards, Options and Swaps.
Forward Market
• In this market, contracts are made to
 buy/sell a financial instrument at a exposed to counterparty risk.
predetermined price and date (i.e., in » Each contract is custom designed and
future). thus is unique in terms of contract size,
expiration date, and the asset quality
MARKET and type.
» The contract is settled by delivering of
SPOT MARKETF ORWARD MARKET
the asset on the expiration date.

• Benefits of forward are:

FORWARD OPTIONS
» It tends to stabilize the prevailing spot
Market Prices, as it provides future
FUTURE SWAP
reference price.
» It enables farmers, producers, exporters
CALL OPTION PUT OPTION to hedge marketing risk.
I M A G E 8.2: D E R I VAT I V E T R A D I N G

Forward
• A forward is a mutual/bilateral contract
between two parties, where settlement
takes place on a specific date in the
future at a price agreed today.
• Following are the key features of forward
contracts:
» These are bilateral contracts and thus
Future
• These are exchange-traded contracts
to sell or buy financial instruments or
physical commodities in the future at the
pre-determined price.
• In Future contracts, there is an agreement
to buy or sell a specified quantity of
financial instruments commodity in
a designated future month at a price
agreed upon by the buyer and seller.

Difference of Forward vs Future

Basis Futures Forward

Nature Traded on an organized exchange Over the Counter

Contract Terms Standardized Customized

Liquidity More liquid Less liquid

Settlement Follows daily settlement At the end of the period.

Margin Payments Requires margin payments Not required

112
Options
• These are standardized exchange-traded
contracts that provide options/rights (not
the obligation) to an investor to sell and
buy a commodity at a predetermined
date and rate in the future against the
payment of options premium.
• There are two types of options: A call
option provides the holder the right to
buy a stock and a put option provides the
holder the right to sell a particular stock.
» Call Option: option to buy
» Put Option: option to sell
Swaps
• These are bilateral contracts to exchange
a commodity/security with another at a
predetermined date and rate.
• These instruments can be anything, but
most of the swaps include cash, based on
a notional principal amount.
• Swaps are primarily over-the-counter
contracts between companies
financial institutions.
Commodity
Exchanges in India
• Commodity Exchange provides
platform for trading in commodities.
• It determines and enforces rules and
procedures for trading standardized
commodity contracts and related
investment products.
• Commodity Exchange was first regulated
by Forward Market Commission (FMC)
but with the merger of FMC with SEBI in
2015 it is now regulated by SEBI.
• Commodity Exchange in India are as
follow:
113
» MCX (Multi Commodity Exchange):
Largest Exchange in India
» NCDEX (National Commodities and
Derivative Exchange)
» NMCE (National Multi-Commodity
Exchange)
» ICE (Indian Commodity Exchange
Limited)
» UCX (Universal Commodity Exchange)
» ACE Derivatives & Commodity Exchange
Ltd. (ACE)
Spot Market
• In this market, trading is done at the
prevailing price and transactions are
done on the spot.
Spot Exchanges in India
• Spot Exchanges refer to electronic trading
platforms which facilitate purchase and
sale of specified commodities, including
or agricultural commodities, metals,
and bullion by providing spot delivery
contracts (provides for the delivery of
goods and the payment of the price) in
these commodities.
• There are four-spot exchanges currently
operating in the country. These exchanges
are:
a
» National Spot Exchange Ltd (NSEL):
Largest spot exchange in India
» NCDEX Spot Exchange Limited
» Reliance Spot Exchange Limited
» Indian Bullion Spot Exchange Limited
• Advantage of Spot Exchange:
» Creates a National Market
» Shows overall demand-supply of
commodity
» Eliminates Middleman
Depository Receipt
• It is a financial instrument representing
certain securities (e.g., shares, bonds, etc.)
issued by a company/entity in a foreign
jurisdiction.
• DR constitutes an important mechanism
through which issuers can raise funds
outside their home jurisdiction.
• DR is issued for tapping foreign investors
who otherwise may not be able to
participate directly in the domestic
market.
• Securities of a company are deposited
with a domestic custodian in the
company’s domestic jurisdiction, and
a corresponding “depository receipt” is
issued in foreign, which can be purchased
by foreign investors.
• For investors, DRs are the method to
diversify the risks, by getting exposure
to a foreign market, but without the
exchange rate risk as they are foreign
currency denominated. Further, they feel
safer to invest from their home location.
• Depending on the location where these
receipts are issued the Depository
Receipt (DR) are classified as:
American Depository Receipts
(ADRs)/Global Depository
Receipt (GDR)
• If the Depository Receipts are issued
outside India on the basis of the shares/
securities of the domestic (say Indian)
company, it is ADR.
• Hence, ADR or GDR are issued outside
India by a foreign depository on the
back of Indian security deposited with a
domestic Indian custodian (SEBI) in India.
• In India, any company, whether public
limited or private limited or listed or
unlisted, can issue DR.
114
Indian Depository Receipts
(IDR)
• If Depository Receipts are issued in India
on the basis of the securities/shares of
the foreign company.
• Standard Chartered issued the first IDR
in India.
Participatory Note
(PN, P-note)
• P-Notes are instruments used by foreign
investors not registered with the SEBI to
invest in Indian securities market.
• These unregistered foreign investors may
invest in equity, debt, derivatives or may
even be an index.
• As foreign investors are not required to
register with SEBI, the P-notes gained
popularity like FIIs. This allows the
investors to remain anonymous and
speculate on Indian stock markets.
• PN is also called as Equity Linked
Notes, Overseas Derivative Instruments,
Participating Return Notes and Capped
Return Notes, etc.
• The investor in P-notes does not own the
underlying Indian security, which is held
by the FII (Foreign Institutional Investor)
who issues the PN.
• Thus, the investors in PN gains the
economic benefits by investing in the
securities without actually holding them.
They get benefited due to fluctuations in
the price of the underlying security as the
value of the PN is linked with the value of
the underlying Indian security.
• The P-Notes holders also does not have
any voting rights in relation to security/
shares.
• One of the key reasons for the emergence
of an Off-shore Derivative market is
the restrictions on foreign investments
 like capital account convertibility, entry
barrier etc.
• Advantages of PN are:
» Reduces transactions cost
» Lower financing costs
» Enhance portfolio yields
Concerns raised related to
Participatory Notes
• Participatory notes are derivative
instruments and are also freely tradable,
these can be easily transferred to other
entity, which creates multiple layers,
which makes the process complex to
identify the real owner. Because of
these concerns about the identity of the
ultimate beneficial owner and the source
of funds arise.
• As these are issued outside of India, SEBI
does not have full control over them.
• It is also alleged that most of the money
invested through P-Notes is unaccounted
money or black money. P-Notes are also
used for money laundering purposes
which converts the black money into
white money.
• SEBI has been successful in taking action
against FIIs who are non-compliant and
those who have misreported offshore
derivatives.
• SEBI has made it mandatory from
January 2011 that all FIIs have had to
follow KYC norms and submit details of
transactions including P-Notes.
• In 2014, SEBI has made it mandatory for
those FPIs issuing P-Notes to submit a
monthly Report disclosing their portfolios.
115
Financial Sector
Legislative Reforms
Commission
• Financial Sector Legislative Reforms
Commission (FSLRC) was established
by the Government of India as per the
announcement made in Union Budget
2010-11, to help to rewrite and to harmonize
the financial sector legislation, rules, and
regulations to address the contemporary
requirements of the sector.
• The Commission was chaired by retired
Supreme Court Judge B. N. Srikrishna
and included ten members with expertise
from the fields of economics, finance,
law, and other relevant fields.
• The recommendations of the Commission
can be divided into two parts:
» Legislative aspects
» Non-legislative aspects.
• The legislative aspects deal with
revamping the legislative framework of
the financial sector regulatory system
by a non- sectoral, principle-based
approach and by restructuring existing
regulatory bodies and setting up new
bodies wherever needed.
• For this, the Commission has
recommended a seven-agency regulatory
architecture, namely, Reserve Bank of
India, Financial Sector Appellate Tribunal,
Unified Financial Agency, Resolution
Corporation, Financial Redress Agency,
Financial Stability and Development
Council and Public Debt Management
Agency in the Draft law- Indian Financial
Code to replace a number of existing laws.
• The non-legislative aspects of the
FSLRC recommendations are broadly
in the nature of governance enhancing
principles for enhanced consumer
protection, greater transparency in the
functioning of financial sector regulators.
FSLRC’s regulatory architecture

Present Proposed Functions

Monetary policy; regulation and

supervision of banks; regulation
RBI RBI
and supervision of payments
system.

Regulation and supervision of all

SEBI, FMC, IRDA, PFRDA United Financial Agency (UFA) non-bank and payments related
markets.

Securities Appellate Tribunal Hear appeals against RBI, the

FSAT
(SAT) UFA and FRA.

Deposit Insurance and Credit Resolution work across the entire

Resolution Corporation
Guarantee Corporation (DICGC) financial system.

Financial Stability Development Statutory agency for systemic

FSDC
Council (FSDC) risk and development.

An independent debt
Debt Management Agency
management agency.
New entities

Financial Redressal Agency (FRA) Consumer complaints.

116
Financial Stability and Development Council (FSDC)
• FSDC was established on the recommendation of G-20 in 2010.
• The mandate of FSDC Council:
» To monitor macro-prudential supervision of the economy, along with the functioning
of large financial conglomerates.
» It will also address inter-regulatory coordination issues and hence spur the financial
sector development.
» It will also focus on financial inclusion and financial literacy.
• The Chairman of the FSDC is the Finance Minister of India.
• Members include the
» Heads of the financial sector regulatory bodies (i.e., SEBI, IRDA, RBI, PFRDA and
IBBI)
» Finance Secretary
» Secretary, (Department of Financial Services, Ministry of Finance)
» Secretary, Department of Economic Affairs (Ministry of Finance)
» Chief Economic Adviser
• A sub-committee of FSDC has also been constituted under the chairmanship of
Governor RBI.
• Sub-Committee discusses and decides on a range of issues relating to financial
sector development and stability including substantive issues relating to inter-
regulatory coordination.

» Fragmented jurisdiction in public debt

Public management: RBI manages the market

Debt Management borrowing programs of Central and

Agency (PDMA)
• Public Debt Management Agency (PDMA)
is a specialized autonomous independent
body that manages both the internal
and external liabilities of the Indian
Government in a holistic manner and
advises on such matters in return for a fee.
• The agency was proposed to be
established in India through the Finance
Bill, 2015.
• But PDMA was not established due to the
differences of opinion on the matter and
the relevant clauses were dropped from
the Finance Bill, 2015.
• Argument in favor of PDMA:
State Governments. But external debt
was managed directly by the Central
Government. A centralized debt
management agency would consolidate
all debt management functions in a
unified body which will make holistic
management of the internal and external
liabilities.
» Most advanced economies have
dedicated debt management agencies
and thus it is an internationally accepted
best practice. Hence, debt management
should be disaggregated from monetary
policy and taken out of the realm of the
central bank.
» It was recommended by various
committees like the Percy Mistry
committee, Raghurajan committee and

117
 FSLRC.
» There is a conflict of interest between
setting the short-term interest rates using
various tools of monetary policy and
selling the government bonds. If the RBI
tries to be an effective debt manager, it
will sell bonds at very high prices, which
will lower the interest rate. This leads to
an inflationary bias in monetary policy.
Argument against PDMA:
• The scope of conflict of interest has
significantly reduced as FRBM 2003
has prohibited RBI from involving in the
primary auctions of the government
securities (as it would lead to printing
money).
• The RBI has been handling multiple
tasks very efficiently. It has ensured
transparency in managing public debt
in a cost-effective manner (low cost of
raising funds for the government).
• The function of debt management lies
at the crossroad of fiscal and monetary
policies, so it requires some coordinated
approach.
• Some countries like Denmark and Iceland
have reverted the debt management
function back to the central bank.
RBI Autonomy
• Constitutionally, RBI is not autonomous
but practically the government has given
it significantly autonomy/conventional
autonomy.
• Aspect of autonomy:
» Objective Autonomy
− To fix goals of inflation/GDP growth.
− The inflation target is set by the
government and RBI has to maintain
inflation in the target. Ex: Recently
government has decided to retain the
118
inflation target of 4%, with a tolerance
band of +/- 2 percentage points for
the Monetary Policy Committee of
the RBI for the coming five years.
» Instrument autonomy
− Use of instrument of monetary policy.
For example, Repo Rate etc.
− In general, this is the autonomy of
the RBI. Due to political factors, the
government cannot do this work.
Argument in favor of RBI
autonomy
• Expertise and professionalism in
decision making would reduce political
interference.
• Monetary stability is essential for the
efficient functioning of the economic
system which can be achieved if a
professional central bank with a long-
term perspective is given charge.
Argument against RBI
autonomy
• The RBI lacks political legitimacy.
• It may lead to political friction between
the government and the central bank
affecting the coordination between fiscal
and monetary policies.
• Full autonomy of RBI is not desirable as
accountability would be compromised.
Venture Capital
• These are investment funds that manage
the money of investors who seek private
equity stakes in startups and small-
to medium-sized enterprises which
have strong growth potential in the
future. These investments are usually
characterized as high-risk/high-return
 opportunities.
• It is a type of equity financing that gives
entrepreneurial or other small companies
the ability to raise funds.
• Venture capital seeks to invest in firms
that have high-risk/high-return profiles,
based on a company's size, assets, and
stage of product development.
• The money provided by VCF is termed as
Venture Capital.
• In India, the VCF is regulated by the SEBI.
Angel funds
• Angel funds is a money pool created by
high-net-worth individuals or companies
(generally called angel investors), for
investing in business start-ups.
• They are a subcategory of venture capital
funds with a special focus on startups,
whereas venture capitalists generally
invest at a later stage of development of
the company.
• Angel funds can raise funds only by
issuing of units to angel investors which
should have a corpus of at least hundred
million rupees.
• In India, Angel Funds are defined under
SEBI (Alternative Investment Funds)
(Amendment) Regulations, 2013.
• Under this regulation, Angel fund is
defined as a sub-category of Venture
Capital Fund under Category I-
Alternative Investment Fund (AIF) that
raises funds from angel investors.
• Angel funds can make investments only
in investee companies that:
i. Are incorporated in India and should
not be more than 3 years old.
ii. Have a turnover not exceeding Rs.
25 crore.
iii. Are unlisted.
iv. Has no family connection with the
119
investors who are going to invest in
the company.
External
Commercial
Borrowing (ECB)
• In India, an external commercial
borrowing (ECB) is an instrument used
to facilitate Indian companies or big
corporates to raise money outside the
country in foreign currency.
• External Commercial Borrowing is
fundamentally a loan availed by an
Indian company from a non-resident
foreign lender.
• Most of the ECBs are raised by companies
through foreign commercial banks and
other institutions.
• Indian corporations can raise money via
ECB for expansion of existing capacity as
well as for fresh investments.
• ECB can be availed either by automatic
route or by approval route.
» Automatic route: If a company passes
all the prescribed norms specified by the
government, it can raise money without
any prior approval.
» Approval route: For specific sectors, the
borrowers have to take the permission
of the government before borrowing
through ECB.
• Advantage of ECB are as follow:
» ECB provides an opportunity to borrow a
large volume of funds for long term.
» The cost of funds is usually cheaper if
borrowed from economies with a lower
rate of interest.
» ECB allows the borrower to diversify the
investor base.
Terms
Mutual Fund
• It is a professionally managed trust
that collects money from a number of
investors to invest in securities like bonds,
stocks, money market instruments, and
other assets.
• A mutual fund is operated by a group of
qualified persons who form a company,
called as asset management company
(AMC) and the operations of the AMC
are under the guidance of another group
of people, called trustees.
• In India Mutual funds are regulated by
the Securities and Exchange Board of
India (SEBI).
Exchange-Traded Fund (ETF)
• An exchange-traded fund (ETF) is a type
of security that involves a collection of
securities (stocks, commodities, etc.) and
often tracks an underlying index such as
a stock index or bond index.
• Exchange Traded Funds are in many
ways similar to mutual funds; however,
they are listed on stock exchanges and
ETF shares trade throughout the day just
like an ordinary share.
Greenshoe Option
• A greenshoe option is an over-allotment
option.
• Under this, company can issue shares for
the first time (IPO) is allowed to sell some
additional shares to the public.
• Greenshoe Option gets its name from
USA Green Shoe Company which was
allowed such an option.
120
Employee Stock Ownership
Plan (ESOP)
• It is an employee benefit plan which
provides workers ownership interest in
the company.
• Under this, the employer gives certain
stocks of the company to the employee
for negligible or less costs.
• These plans are aimed at improving the
company’s performance and increasing
the value of the shares by involving
stockholders, who are also the employees.
Debenture
• Debentures are a debt instruments used
by companies and the government to
issue the loan.
• Debentures are issued to raise capital
to meet the expenses of an upcoming
project or to pay for a planned expansion
in business.
• The important features of debentures
are as follows:
» A debenture is redeemed after a fixed
period of time.
» Debentures may be either secured or
unsecured.
» Debenture holders do not have any
voting rights.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) What does venture capital mean?
2014
(a) A short-term capital provided to
industries
(b) A long-term start-up capital provided
to new entrepreneurs
 (c) Funds provided to industries at times
of incurring losses
(d) Funds provided for replacement and
renovation of industries
Ans. (b)
• Explanation: Venture capital is financing
that investors provide to startup
companies and small businesses that
are believed to have long-term growth
potential.
• Venture capital generally comes from
well-off investors, investment banks and
other financial institutions.
Q.2) With reference to ‘Financial Stability
and Development Council’, consider the
following statements: 2016
1. It is an organ of NITI Aayog.
2. It is headed by the Union Finance
Minister.
3. It monitors the macro-prudential
supervision of the economy.
Which of the statements given above is/
are correct?
(a) 1 and 2 only
(b) 3 Only
(c) 2 and 3 only
(d) 1, 2 and 3
Ans. (c)
• Explanation: Financial Stability and
Development Council (FSDC) is an
apex-level body constituted by the
government of India and the chairman
of the council is the Finance Minister.
• The idea to create such a super-regulatory
body was first mooted by Raghuram
Rajan Committee in 2008.
• Finally, in 2010, the then Finance Minister
of India, Pranab Mukherjee, decided to
set up such an autonomous body dealing
with macroprudential and financial
regularities in the entire financial sector
of India.
121
• The new body envisages to strengthen
and institutionalize the mechanism of
maintaining financial stability, financial
sector development, inter-regulatory
coordination along with monitoring
macro-prudential regulation of the
economy.
• No funds are separately allocated to the
council for undertaking its activities.
Q.3) Which of the following is issued by
registered foreign portfolio investors
to overseas investors who want to be
part of the Indian stock market without
registering themselves directly? 2019
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Ans. (d)
• Explanation: P-Notes or Participatory
Notes are Overseas Derivative
Instruments that have Indian stocks as
their underlying assets.
• They allow foreign investors to buy stocks
listed on Indian exchanges through FIIs
without being registered.
Q.4) With reference to the Indian economy,
consider the following statements: 2020
1. 'Commercial Paper' is a short-term
unsecured promissory note.
2. 'Certificate of Deposit' is a long-term
instrument issued by the Reserve Bank
of India to a corporation.
3. 'Call Money' is a short-term finance
used for interbank transactions.
4. 'Zero-Coupon Bonds are the interest-
bearing short-term bond issued by
the Scheduled Commercial Banks to
corporations.
Which of the statements given above is/
are correct?
(a) 1 and 2 only
(b) 4 only
(c) 1 and 3 only
(d) 2, 3 and 4 only
Ans. (c)
• Explanation: Statement 1 is correct:
Commercial Paper (CP) is a short- term
unsecured money market tool issued
in the form of a promissory note. This
can be issued for maturities between a
minimum of seven days and a maximum
of up to one year from the date of issue.
• Statement 2 is not correct: Certificate of
Deposit (CD) is a negotiable money market
tool, and it is issued in dematerialized
form against funds deposited at a bank
or other eligible financial institution for a
specified period of time. It is issued by the
Federal Deposit Insurance Corporation
(FDIC) and regulated by the Reserve
Bank of India (RBI), the CD is a promissory
note, the interest on which is paid by the
financial institution.
• Statement 3 is correct: In Call money
rate, short term funds are borrowed and
lent in the money market between banks
on a day-to-day basis. Banks resort to
this kind of loan to fill the asset liability
mismatch, comply with the statutory
CRR and SLR obligations and to meet
the sudden requirement of funds.
• Statement 4 is correct: Bonds are a form
of debt instrument. Zero Coupon Bonds
122
are issued at a discount and redeemed
at par. No interest payment is made on
such type of bonds at periodic intervals
before maturity.
Q.5) In the context of the Indian economy,
non-financial debt includes which of the
following? 2020
1. Housing loans owed by households
2. Amounts outstanding on credit cards
3. Treasury bills
Select the correct answer using the code
given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
Ans. (d)
Explanation: Non-financial debt comprises
credit instruments issued by governmental
entities, households and businesses that are
not incorporated in the financial sector. (The
financial sector includes commercial banks,
non-banking financial companies (NBFC),
cooperatives, pension funds, insurance
companies, mutual funds, and other smaller
financial entities). Non-financial debt
comprises household or commercial loans,
credit card balances and Treasury bills.
They share most of the same features with
financial debt, except the issuers are non-
financial.
 CHAPTER - 9
TAXATION
• A tax is a compulsory financial payment
imposed upon a taxpayer (an individual
or legal entity) by a government in order
to fund various public expenditures.
• Taxes are the primary source of revenue
Income disparity
Person Income between A and B
before tax
A 40,000
10,000
B 50,000
• As shown in the table, the difference
between their income before tax was Rs.
10,000. But after Tax is imposed at 20%
income difference reduced to Rs. 8,000.
• Hence, the imposition of income tax
reduces income disparity between both
A and B.
The purposes that taxation serves are:
• Resource Allocation: When high taxes
are imposed on some industries,
then resources from the high-taxed
industries will shift to the low-taxed
industries.
• Income Distribution: It is meant to
lessen inequalities in the distribution
of income and wealth to enhance the
objective of social equity.
• Stabilization: Tackling issues such
as slowdown, inflation, etc. (through
appropriate fiscal policy). It helps in
maintaining high employment and
price stability.
123
for most governments and works as a
tool for income distribution.
• For Example: Suppose a Government
imposes a rate of income tax i.e., 20%.
Income Disparity
Income after
between A and B
paying tax
after tax
32,000
8,000
40,000
Type of Tax
Direct Tax
• A direct tax is paid directly by the
organization or an individual to the
government.
• It is the type of tax which has incidence
and impact both at the similar point—the
individual who is hit, the same individual
bleeds.
• Examples of Direct Tax are income tax,
poll tax, land tax, and personal property
tax.
Indirect Tax
• The tax which has incidence and impact
at different points is called as the indirect
tax. As, for instance, sales tax, excise duty
etc., are imposed on either the traders or
the producers. However, it is the general
consumers who bear the burden of tax.
Some of the other examples are GST,
Customs duty, service tax and value-
 added tax. • For example, Suppose you buy Shirt from
• It is normally imposed on a manufacturer an online website priced at Rs. 500. At
or supplier who then passes on the tax to the time of the payment additional tax is
the consumer. imposed on the price of the Shirt.

Direct Tax vs Indirect Tax

Direct Tax Indirect Tax

Direct tax is paid directly by liable person

Indirect tax is paid indirectly to government.
or organization to the government.

Imposed on income or profits. Imposed on goods and services.

The burden to pay the tax directly falls on The burden is shifted to the consumer by
the individual. the manufacturer or service provider.

Indirect Tax does not look at the consumer’s

Direct taxes are levied based on the paying
ability to pay but is the same for everyone
capacity of the individual.
who buys the goods or services.

Direct taxes can be evaded if there Indirect taxes cannot be escaped from as
is an absence of proper collection they are charged automatically on goods
administration. and services.

Direct taxation is example of progressive Indirect taxes is example of regressive

taxation method. taxation method.

Income Tax, Wealth Tax, Corporate Tax GST (Goods and Services Tax), Sales Tax
etc. are the examples of direct taxes. etc. are the examples of indirect taxes.

Method of Taxation above Rs. 5 Lakh is charged 20% Income

tax.
There are three methods of taxation
prevalent in economies:

Tax
Progressive Taxation Rate

• A progressive tax imposes a higher

percentage of tax on people with higher
incomes.
• It means that the more a person’s income,
the higher his rate of tax will be.
Taxable Income
• For example, Income Tax increases with I M A G E 9.1: P R O G R E S S I V E T A X AT I O N GRAPH
an increase in personal income. A person
earning below is Rs. 5 Lakh is charged • Progressive Taxation discourages more
5% income tax and the person earning earning by the individual/organization i.e.,

124
 poor is rewarded while rich is punished.
• The progressive tax system is used with
an aim to help reduce inequality. For
instance, taking lower average levels of
tax from low wage earners and taking
more from higher wage earners.
• Progressive taxation is the most popular
taxation method in the world.
Regressive Taxation
• In regressive taxation system people
with low income are levied with higher
tax rates. On the other had people with
higher income attract low tax rates.
Tax
Rate
Taxable Income
I M A G E 9.2: R E G R E S S I V E T A X AT I O N G R A P H
• Regressive Taxation can be utilized to
promote certain sectors- for increasing
production etc.
• There are not any permanent or specific
divisions for such category of taxes. As
a provision of promotion, some specific
sectors might be imposed with regressive
taxes.
• As for instance, to promote the growth and
development of small-scale businesses,
once India had regressive excise duty on
their productions—with growing slabs of
volume they produced, the burden of tax
used to go on reducing.
125
Proportional Taxation
• A proportional tax is a tax where all
taxpayers are taxed at the same rate of
tax, irrespective of their income levels.
• A proportional tax levies the same tax
rate across low, middle, and high-income
taxpayers.
• Proportional Tax is generally not used as
an independent method of Taxation. It is
used as a complementary method with
either progressive or regressive taxation
method.
Tax
Rate
Taxable Income
I M A G E 9.3: P R O P O R T I O N A L T A X AT I O N G R A P H
• It is used as a complementary method
because if progressive tax is not
converted into proportional tax it will go
on increasing and similarly regressive tax
will decrease to zero.
• The table shows the change in the tax
rate in different taxation system.
Value Added Tax
(VAT)
• Value Added Tax (VAT) is a tax collection
method (it is also the name of tax) which is
imposed on each stage of value addition
on each stage of economic activity.
• Every commodity goes through different
stages of production and distribution
before reaching the consumers. Some
value additions are done at each stage
 of the production and distribution chain,
for example, a metal tool is more valuable
than metal.
• Since VAT method of tax collection is
imposed and collected at a different
stage of value addition that is why it is
multi-point tax collection.
• It is called as a consumption tax because
the tax is ultimately paid by the final
consumers. The dealer or producer or
manufacturer acts as a link between
government and people for paying the
tax to the government, but they ultimately
pass this tax to the consumers. VAT is
based on a taxpayer's consumption
rather than their income.
• It is implemented as a destination-
based tax, as the tax rate is based on
the location of the consumer where the
goods and services are consumed.
• VAT is calculated by deducting input tax
(charged to the customer by a dealer)
from output tax (tax paid by the dealer
for purchases).
VAT = Output Tax - Input Tax

Stages Firm/ Product Value of Input Value of Output Value VAT Non VAT
of value Producer Tax addition Method
Input Output Tax (Output
addition (10%) Tax- (For
(10%)
Input Tax)

1 Farmer Wheat 10 1 30 3 20 2 3

2 Mill Flour 30 3 40 4 10 1 4

3 Baker Cake 40 4 90 9 50 5 9

4 Retailer Sale 90 9 100 10 10 1 10

Total 170 17 260 26 90 9 26

Above table shows, stages of value addition Hence, VAT does not have the ‘cascading
from farmer to retailer i.e., Wheat → Flour effect’ on the price of goods. It does not
→ Cake → Sale. increase inflation and is, therefore, more
suitable for developing economy like India.

Cost Tax Market Price

Andhra Pradesh 9 4 13

Tamil Nadu 10 1 11

126
Limitation of VAT In the year 2000, the Prime Minister
introduced the concept of GST and set up a
committee to design a GST model for the
• It is highly resource-intensive that it 2000 conuntry

requires computerization to maintain

records of firms in a specified format,
centralized record of indirect tax, trained
officials etc.
• The process of estimation of VAT is quite
complex.
Announcement by Union Finance Minister,
during budget of 2006-07 that GST world
2006 Introduced from April 2010
First Discussion Paper was released by the
2009
Empowered Committee

Goods and Service

Constitution (115th) Amendment Bill
introduced and subsequeently lapsed
2011

Tax (GST) The Constitution (122nd) Amendment Bill

was introduced in the Lok Sabha
2014
• Goods and Services Tax is the single
unified tax system created by subjugating
The Cosstitution (101st) Amendment
a various Central and State taxes
Aug Act was enacted
presently applicable in India.
2016
• Most of the domestic indirect taxes like
excise tax, service tax, entertainment tax 1st GST Council Meeting
Sep
etc. would be merged into one.
2016
• It is will be levied at different levels like
GST Council Recommends the CGST, SGST,
» Central Government will levy and collect March IGST, UTGST and Compensation Cess Act
2017
Central GST (CGST)
» State Government will levy and collect CGST, IGST, UTGST and Compensation Cess
State GST (SGST) on intra-state supply of April Acts Passed
2017
goods/services.
» Centre Government will levy and collect GST Council Recommends all the rules
Integrated GST (IGST) on inter-state May
2017
supply of goods/services.

• The 101st Constitution Amendment Act 30th June

All State except J&K passed their SGST ACT

in September 2016 added a definition 2017

of GST in Article 366 of the Indian
Constitution by adding a sub-clause 12A. GST Launched
1st
• Since then, the GST Council came into July2017
existence as the Constitutional body to SGST Act passed by J&K; CGST and IGST
decide issues relating to GST. Ordinances promulgated to extend GST to
8th
J&K
• Under GST, firms have to pay taxes on July2017
the basis of their value of output. But the
taxes paid on the input would be offset Amendments to CGST, IGST, UTGST and
1st 1st Compensation to State Acts enacted
(reimbursed) in the form of Input Tax February,
Credit (ITC). 2019

I M A G E 9.4: T I M E LINE OF GST IN INDIA

127
Salient Features of GST
• Following are the salient features of
Goods and Services Tax:
» GST is a Value Added Tax which provides
for input tax credits and taxes are
levied only on the value addition which
happened in the process of production of
good/service.
» GST would be levied on supply of goods/
services as against the previous system
of levying tax on the sale or manufacture
of goods or on provision of services.
» GST is a destination-based tax which
means GST would be applicable at the
location where goods and services are
provided as against the previous system
of origin-based tax where tax is levied at
the point of consumption. So as per new
tax rules, the SGST collected will usually
accrue to the State where the consumer
of various goods or services sold resides
and not to the State where the goods are
produced.
» Central GST and State GST would be
levied at rates to be mutually agreed
upon by the Centre and the States.
» All goods and services, excluding
alcoholic liquor for human consumption,
have already been brought under GST (to
bring alcoholic liquor under GST which is
a major source of revenue for the states,
another constitutional amendment
would be necessary).
» Crude Petroleum and some petroleum
products have already been
Constitutionally brought under GST. But,
128
as of now, petroleum and petroleum
products do not attract GST and its
implementation will start at a future
date on the recommendation of the GST
Council.
» Exports would be zero-taxed. The
exporter has an option to either pay the
tax for the output and claim the refund or
export under bond without tax and claim
refund of Input Tax Credit.
» Import of goods and services are
considered as inter-State trade and
thus, it would attract IGST along with
applicable customs duties.
» GST Council would be a joint platform
where both Centre and states will have
representation.
» The Union Government cannot impose
surcharges on articles which are covered
under GST regime.
» States will be compensated by the
Government of India for loss of revenue
incurred due to implementation of the
GST from July 1, 2017 for a period up to 5
years. The compensation will be given in
the following manner:
− First three years: 100%.
− Fourth year: 75%.
− Fifth year: 50%.
Taxes amalgamated in GST
• Following taxes will be subsumed under
GST which are currently levied by Centre
and States.
 Central Taxes Subsumed
• Central Excise duty
• Additional Excise Duties (Textiles and Textile •
Products)
• Taxes on the sale or purchase of newspapers
and on advertisements published.
• Excise Duty levied under the Medicinal and
Toilet Preparations (Excise Duties) Act 1955,
• Additional Excise Duties (Goods of Special •
Importance)
• Special Additional Duty of Customs (SAD)
• Additional Customs Duty (calledas •
Countervailing duties or CVD) • Taxes on lotteries, betting, and gambling
• Cess and surcharges on the supply of goods •
and services
• State cess and surcharges insofar as they relate
• Service Tax.
Advantages of GST
Advantages for the government
• GST will make India a unified common
national market, which will help attract
foreign investment and “Make in India”
campaign.
• Harmonization of acts, procedures and
tax rates between Centre and States and
across the States.
• Improved tax compliance, as all returns
are to be filed online, input credits to be
verified online, which will create paper
trail of transactions at each level of the
supply chain.
• Greater use of Information Technology
will reduce human interface between the
taxpayers and the government, which
will act as a deterrent for corruption.
• Common registration procedures for
taxpayers, refund of taxes, common
tax base, uniform formats of tax return,
classification of goods and services
under common system will lend greater
certainty to the taxation system.
129
State Taxes Subsumed
• State VAT/Sales Tax
Luxury Tax
• Central Sales Tax (levied by the Centre and
collected by the States)
• Entry Tax i.e., taxes on the entry of goods into a
local area for consumption, use or sale. (other
than those in lieu of octroi)
Octroi
• Entertainment Tax not levied by the local
bodies.
Purchase Tax
Taxes on general advertisements
to the supply of goods or services
1400000
1200000
1000000
800000
600000
400000
200000
0
FY 2017-18 FY 2018-19 FY 2019-20
(Jul-Mar)
I M A G E 9.5: R E V E N U E C O L L E C T I O N IN ₹ CR
Advantages to Trade and Industry
• Reduction in multiplicity of taxes that
existed earlier will lead to simplification
and uniformity in indirect tax regime.
• Elimination of double taxation on certain
sectors such as contracts, software,
hospitality sector.
• Increased ease of doing business:
Simplified and automated procedures for
various processes such as registration,
returns, refunds, tax payments, etc.
• Reduction in compliance costs: No
multiple record-keeping for various
kinds of taxes, thus fewer investment of
 resources and manpower in maintaining
records.
• A leading logistics corporation recently
said that after the implementation of
the E-way bill and GST, heavy transport
vehicles i.e., Trucks are covering around
10-15% more distance as compared to
the previous regime. In previous regime,
heavy transport vehicles were hovering
close to around 300-350 km per day,
but after the implementation of GST, this
distance has improved to 400-410 km
per day.
Advantages to Consumer
• Prices of commodities and goods will
reduce in the long run due to reduction in
cascading impact of taxation. The year-
on-year Consumer price index (CPI) was
more than 6% in July 2016, which now
has decreased to a little over 2 percent in
January 2019.
• Final prices of goods are expected to be
transparent due to the seamless flow of
input tax credit among the manufacturers,
retailers, and service suppliers.
• GST will generate more employment and
more financial resources which will help
in poverty eradication.
Advantages to States
• GST backed up by strong IT infrastructure
will bring the entire supply chain from
manufacturing to retail under the ambit
of indirect tax system. This will help
states to expand their tax base. More and
more suppliers will opt for GST as non-
registered suppliers would not be able
to claim benefits under input tax credit
system.
• Earlier, only central government was
empowered to tax services, but under
GST system states will also levy taxes on
services. This will also boost revenue and
give States access to the fastest-growing
sector of the economy.
• Improve the investment climate in
India which will naturally benefit the
development in the States
• Improved Compliance by the taxpayers
will contribute greatly to improving the
revenue collection of the States.

Pre-GST Indirect Tax structure in India GST Stucture in India

Center State GST

Customs Excise State Levies VAT
Duty Duty
SGST/UTGST CGST IGST
Luxury Tax Electricity Duty
Central Service
Sales Tax Tax Entertainment Entry Tax &
Collected Collected
Tax Octroi by State by Center

Problems
Benefits

Multiple Tax Multiple Multiple Single Single Tax Uniform Uniform

Administration Act & Rules procedures Structure Administration law Procedures
(of centre and (Computerized)
different State )

I M A G E 9.6: GST S T R U C T U R E IN INDIA

130
GST and Revenue Neutral Rate
(RNR)
• Revenue Neutral Rate (RNR) refers to that
single rate, which preserves revenue at
desired (current) levels.
• Revenue Neutral Rate is the rate of GST
at which the amount of taxes currently
collected by the government and the
amount collected by the government in
the pre-GST regime remains the same
i.e., it does not lead to revenue loss or
gain.
• The Government of India constituted a
committee under Arvind Subramanian
which suggested the RNR to be from 15%
to 15.50%.
• The RNR is kept slightly high to ensure no
loss in the revenue generation.
• Currently, the RNR under GST is 15.5%.
GST and Fiscal Autonomy of
State
• States majorly depend on two sources for
their revenue: their own revenue raised
through taxation powers given under
State List of Seventh Schedule of the
Constitution and various central transfers
including revenue share recommended
by Finance Commission.
• With the commencement of GST, many
indirect taxes levied by the states have
been subsumed under GST.
• Earlier states were empowered to decide
their own tax rates, but under GST regime,
tax rates are decided by the GST Council.
• This implies that states have limited
flexibility in making decisions regarding
tax rates on goods and services.
• Therefore, higher reliance on GST receipts
for revenue reduces states’ autonomy
as these receipts depend on tax rates
decided by the GST Council.
131
GST Council
• GST Council is a Constitutional body
which make recommendations to the
Union and State Governments on issues
related to GST.
• According to Article 279A of the
Constitution, the GST Council will be a
joint forum of the Centre and the States,
and consist of the following members:
» Chairman: Union Finance Minister
» Members: Ministers in charge of Finance/
Revenue or Minister nominated by each
of the States & UTs having Legislatures
• Voting powers are divided between Centre
and States with central government
having 1/3rd voting power and remaining
2/3rd with states.
• Decisions are taken only if it has more
than 3/4th majority and such decisions
will be immune from the deficiencies
in the establishment of the Council or
appointment of its members or any
procedural irregularity.
• Functions of GST Council: According to
Article 279A (4), the Council will make
recommendations to the Union and the
State governments on important issues
related to GST, like
» Taxes, surcharges, and cess to be
subsumed under the GST.
» Exempting or bringing goods and services
under GST.
» The upper limit of turnover for application
of GST.
» GST rates.
» Model GST laws, principles related
to place of supply, principles of levy,
apportionment of IGST and principles
related to place of supply.
» Special provisions with regard to the
eight northeastern states, Uttarakhand,
Jammu and Kashmir and Himachal
Pradesh.
» Other related matters.
GSTN
• Goods and Services Tax Network (GSTN)
is a non-profit, non-Government, private
limited company.
• It was incorporated in 2013.
• The Government of India holds 50%
equity in GSTN while states hold
remaining 50% equity in the GSTN.
• It has been established primarily to
provide IT infrastructure and services
to the Central and State Governments,
taxpayers, and other stakeholders for the
seamless implementation of the Goods
and Services Tax.
GST Tax Slab
• GST is currently levied on every product
in five slabs of 0,5, 12, 18 and 28 per cent.

Essential Goods
(For example, cereals, fresh fruits, and vegetables, 0%
salt, natural honey, milk, human blood etc.)

Commonly used Goods and Services 5%

Standard Goods and Services fall under 1st slab 12%

(computer and processed food)

Standard Goods and Services fall under 2nd Slab

(capital goods and industrial intermediaries are 18%
covered in this slab)

Special category of Goods and Services including

luxury (Luxury items such as small cars, premium 28%
cars, cigarettes and aerated drinks)

• Further, a cess will be levied on certain

goods like aerated drinks, luxury cars,
tobacco products and pan masala, over
and above the rate of 28% for payment
of compensation to the States.
• 97.5 per cent articles covered by 18 per
cent or lower GST slab.
• Some of the products are not covered
under GST. These are:
» Alcohol for human consumption
» Tobacco
» Electricity
» Petroleum Product
GST Tax System vs
Non-GST Tax System
• Non-GST Tax System
» Imagine a T-Shirt manufacturer. He buys
raw material worth Rs. 5,000, for which
he pays a sales tax of 10% i.e., Rs. 500.
» He manufactures shirts by adding the
value of Rs. 1000 including profit.
» For the total cost, the manufacturer will
include 5,000 + 1000 + 500 and fix the
price as 6,500.
» The customer buying will pay the final
cost of 7,150 (6,500 + 10% sales tax i.e.,

132
 650).
» So, the total tax liability to the government
is 500 + 650 = 1,150.
• GST Tax System
» Imagine a T-Shirt manufacturer. He buys
raw material worth Rs. 5,000, for which
he pays a tax at 10% i.e., Rs.500.
» He manufactures shirts by adding the
value of Rs.1000 including profit.
» For the total cost, the manufacturer will
include 5,000 + 1,000 and fix the price as
6,000.
» Manufacturer leaves out 500 paid as a
tax because it will be reimbursed by the
government as input tax credit.
» The customer buying will pay the final
cost of 6,600 (6,000 + 10% tax i.e., 600).
» So, the total tax liability to the government
is 600.
Challenges
Associated with the
Implementation of
GST
• Because of the enormous shortfalls in the
tax collection under GST (exacerbated
by the Covid-19 lockdowns), the Union
government and State Governments
have come at loggerheads as Centre has
revealed its incapability to compensate
the States as promised under the
provision of GST Act.
• Comptroller and Auditor General of India
(CAG) noticed that matching invoice
of buyers and sellers, an anti-evasion
measure envisioned in the regime of
indirect tax, was still not in place.
• As per the CAG Report (2018-2019), one
important area where the full potential
of GST (Goods and Services tax) has
133
not been attained is the roll out of the
simplified tax compliance regime.
• The complication and complexity of
return mechanism and the technical
glitches resulted in roll back of invoice-
matching, rendering the system prone
to various ITC frauds. The GST Network
(GSTN) still faces numerous technical
glitches. This is very problematic as it is
required by the businesses to register,
filing GST returns, etc., with the help of
this portal.
• Presently, the Union government charges
14% excise duty on Aviation Turbine
Fuel (ATF), and governments of States
charge nearly 29% of the sales tax on the
same. India is one of the fastest-growing
aviation markets in the world. However,
the aviation businesses are burdened by
growing debt and bankruptcy because
of high fuel cost and depreciation of the
rupee.
Way Forward
• It is very important to give clarity on the
various procedures to be followed while
filing GST and also to repair the present
problems and prevent future ones from
arising for an effective tax regime.
• Though currently the GST may face
certain glitches and weaknesses, it is very
flexible in nature as the implementations
and decisions are based on transparent
conversation within GST Council. This
permits for flexible resolution and
response of the issues related to GST.
• The Central Government must also be
required to lead the country out of its
GST standstill by borrowing more from
different financial markets or directly
from the Central Bank. The Union
Government must appreciate that it is
their legal obligation, and they cannot
abrogate it. State Governments should
respond by settling for a more realistic
compensation for time being while
 exploring the options recommended by
the Central Government.
• The government also should think about
rationalization of the GST slabs.
• The GST base can be increased by
including fuel, alcohol and real estate in
GST and by prevention of ITC fraud.
• GST is a positive step towards shifting
economy of India from the informal
to formal economy. It is very crucial to
utilize experiences from international
economies that have implemented GST
before us, to overcome the impending
challenges.
Direct Tax
• Different types of direct taxes are:
Personal Income Tax
• An income tax is a tax which governments
impose on individuals within their
jurisdiction.
Corporate Tax
• Corporate tax is a tax levied on the net
income of the company.
• Companies, both private and public
which are registered in India under the
Companies Act 1956, are liable to pay
corporate tax.
Dividend Distribution Tax
• The Dividend Distribution Tax is imposed
on dividends that a company pays to its
shareholders out of its profits.
Minimum Alternate Tax
• Minimum Alternate Tax (MAT) was
effectively introduced in India by the
134
Finance Act of 1987. It was introduced
to tax the ‘zero tax companies’. Zero tax
companies are such companies which
show zero or negligible income to avoid
tax nets.
• Under MAT, such companies are taxed a
certain percentage of their book profit as
taxable income.
• MAT has been brought in to reduce tax
avoidance practices followed by some
companies to avoid the income tax,
though they had the “ability to pay”.
• MAT is applicable to all corporate entities,
whether public or private.
• MAT is not applicable to:
» Any income accruing or arising to a
company from the life insurance business.
» Shipping income liable to tonnage
taxation.
Alternate Minimum Tax (AMT)
• It is leviable alternative to normal tax.
• AMT is a tax levied on ‘adjusted total
income’ in a FY wherein tax on normal
income is lower than AMT on adjusted
total income. So, irrespective of normal
tax, AMT has to be paid by taxpayers to
whom AMT provisions apply.
Capital Gain Tax
• Capital gain is any profit that is received
through the sale of a capital asset (Land,
building, house property etc.).
• The tax that is paid on that profit is called
capital gains tax.
• Capital gain tax can either be long term
(individuals own an asset for a duration
of more than 36 months) or short term (In
case assets are held for a duration of 36
months or less).
Securities Transaction Tax (STT)
• Securities Transaction Tax (STT) is a type
of financial transaction tax levied in India
on transactions done on the domestic
stock exchanges.
• The rates of STT are prescribed by the
Central/Union Government through its
Budget from time to time.
• It is categorized as a direct tax.
Commodity Transaction Tax
(CTT)
• Commodities transaction tax (CTT) is a
tax similar to Securities Transaction Tax
(STT), levied in India, on transactions done
on the domestic commodity derivatives
exchanges.
• The concept of CTT was first introduced
in the Union Budget 2008-09.
• CTT aims at discouraging excessive
speculation, which is detrimental to the
market.
Direct Tax Code
(DTC)
• DTC is the proposed legislative reform of
the direct taxation system.
• It seeks to simplify and consolidate all
the direct tax of the central government
like income tax, gift tax, wealth tax etc.
• It seeks to increase tax revenue by
broadening the tax base.
• Features of DTC are:
» Tax laws will be rewritten in simple and
unambiguous language to reduce the
scope of misinterpretation.
» Reduce exemption- deduction debate to
reduce their scope of misuse.
» Flexible tax system to make changes in
135
tax provision without amendment in tax
law.
• In 2017, the Government set up an expert
committee under Akhilesh Ranjan to
draft a new Direct Taxes Code. The task
force submitted its Report in 2019 which
has not been made public.
In 2020, Union Government launched
the ‘Transparent Taxation: Honoring the
Honest’ platform to honour the honest
taxpayers of the Nation.
This platform has important reforms
such as faceless assessment, taxpayers
charter and faceless appeal.
Faceless Assessment: Objective of this
is to eliminate human interface amongst
the taxpayer and the income tax
department.
Taxpayer Charter: It outlines the
responsibilities and rights of both
taxpayers and tax officers.
Faceless Appeal: Under this arrangement,
appeals will be randomly assigned to any
officer in the country. The identity of the
officer deciding the appeal will remain
anonymous.
General Anti-
Avoidance Rule
(GAAR)
• It is a provision under direct tax law which
seeks to check tax avoidance i.e. misuse
of exemption, ambiguous language,
loophole in tax laws etc.
• It provides discretionary power to deny
any tax benefit to a firm in case it made
an arrangement solely for the purpose of
tax avoidance i.e. if there is no commercial
substance.
• A transaction that disguises the value,
 location, source, ownership or control
of funds would also be deemed to lack
commercial substance.
• It empowers tax officials to override certain
provision of domestic tax law as well as
Double Taxation Avoidance Agreement
(DTAA) (a bilateral agreement).
• The provision of GAAR is to codify the
doctrine of ‘substance over form’ where
the real intention of the parties and
purpose of an arrangement is taken
into account for determining the tax
consequences, irrespective of the legal
structure of the concerned transaction or
arrangement.
• India’s general anti-avoidance rule
(GAAR) came into effect on 1 April 2017
for the assessment year 2018-19.
Why GAAR?
• GAAR was brought in to address the tax
avoidance issues and ensure that those in
different tax brackets are taxed correctly.
• In many cases of tax avoidance,
arrangements could take place for
gaining a tax advantage while complying
with the law.
Advantage of GAAR
• To check tax avoidance.
• It would plug loopholes in the taxation
system.
• It would also check misuse of DTAA.
Disadvantage of GAAR
• It may increase the scope of corruption
as it provides discretionary power to
tax officials.
• It may adversely affect domestic
and foreign investment as it
creates uncertainty regarding the
interpretation of tax provision.
136
Parthasarathi Shome Panel
• The Parthasarathi Shome Panel was
set up in 2012 for drawing up the final
guidelines on GAAR.
• Recommendations of the committee are:
» GAAR should be deferred for three
years to 1st April 2016 for safeguarding
and consultation with investors and for
training tax officials.
» It should be invoked by the approving
panel with 5 members.
− Head: High Court Judge
− Two Member: Income Tax Department
− Two Member: Non- government
Members
• The focus of GAAR should be to check
the misuse of tax provision rather than
increase tax revenue.
• It should be imposed only if the sole
objective of an arrangement is tax
avoidance.
• The application of GAAR should be
clarified through an appropriate
illustration.
• Firms should be permitted to clarify the
applicability of GAAR before making
investment/transactions i.e., advanced
ruling.
• The threshold limit for applicability of
GAAR should be fixed at tax avoidance
of at least Rs. 3 crore or more.
• It should not be used to assess the
genuineness of tax residency certificate
issued under DTAA even by tax havens.
• It should not be applied in the case where
Special Anti-Avoidance Rules (SAAR) are
applicable.
Tax Administration
Reform Commission
(TARC)
• The Tax Administration Reforms
Commission (TARC) under the
Chairmanship of Dr. Parthasarathi Shome
was appointed in 2013 by the Government
of India for giving recommendations for
reviewing the public tax administration
system of India.
• TARC made the following
recommendations:
» Consumer Focus:
− A minimum of 10 percent of the tax
administration’s budget must be used
for taxpayer services.
− The decision of the Ombudsman
with respect to grievance redressal of
taxpayers should be binding on tax
authorities.
− Pre-filled tax returns should be
made available to all taxpayers. The
taxpayers will have the option to
accept the tax return or modify it.
» Structure and Governance:
− Central Board of Direct Taxes (CBDT)
and Central Board of Excise and
Customs (CBEC) should be fully
integrated in next ten years. Within
the next five years, they should evolve
into a unified authority as Central
Board of Direct and Indirect Taxes.
− The post of Revenue Secretary should
be discontinued, and its functions
should be assigned to the two Boards.
» Human Resource Development:
− There should be a focus on
specialization by bringing expertise,
including lateral entry of specialists
in the Boards. Indian Revenue Service
137
(IRS) officers should specialize in
particular tax administration areas.
− The Central Vigilance Commission
should have a Member who has been
an IRS officer.
» Dispute Resolution and Management:
− Avoid retrospective laws.
− Currently tax litigations are clogging
the system. Thus, Both Boards should
start a special drive for review and
liquidation of such cases by setting
up dedicated task forces.
» Internal Processes:
− The Permanent Account Number
(PAN) should be made as a Common
Business Identification Number (CBIN),
to be used by other departments such
as excise, customs, etc.
Tax Reform
Committee
• The government of India Constituted
a tax reform committee under Raja J.
Chelliah, Director of National Institute of
Public Finance and Policy (NIPFP) in 1991.
• The major recommendations of the
committee are as follows:
» Reforming the personal taxation system
by reducing the tax rates.
» Reducing the corporate tax rates.
» Reducing the cost of imported inputs by
decreasing the customs duties.
» Integration of excise duties with a Value-
Added Tax (VAT) system.
» Bringing the services sector within a VAT
system.
» Broadening of the tax base.
» Improving the quality of tax
administration.

Task Force on Tax
Reform
• The Government of India constituted a
Task Force on Tax Reform under Vijay
Kelkar with the objective of rationalizing
cumbersome tax structure so as to
reverse the deteriorating trend in public
finances, improve tax-to-GDP ratio by
making the tax administration simple
and meaningful and also to make the tax
base wide with low rates.
» Administration of Direct Tax
− The taxpayer services should be
expanded both in quantity and quality
and taxpayers should get easy access
through the internet and emails.
− Expanding PAN (Permanent Account
Number) to cover all citizens.
− Tax Information Network should be
established to modernize, simplify,
and rationalize tax collection,
particularly TDS and TCS.
− Empower CBDT with appropriate
administrative and financial powers.
» Personal income tax
− Rationalize income tax slabs,
eliminate surcharge on personal
income tax.
− Exemption for senior citizens and
widows.
− Increase deduction under Section
80CCC for contribution to pension
funds.
» Corporate Tax
− The listed companies should be
exempted from dividend tax and
capital gain tax.
− Increase rate of depreciation for
plants and machinery.
138
− Abolish Minimum Alternate Tax.
» Wealth Tax
− Currently there is no wealth tax in
India after it was abolished in the
Union Budget 2015.
− When it was in effect, the tax was
applicable to individuals, Hindu
Undivided Families, companies, etc.
− Under the current direct tax structure,
instead of wealth tax, the tax
authorities apply a surcharge on
those with higher income and this
surcharge was increased in the Union
Budget 2019.
− As of Assessment Year 2019-20, 10%
surcharge on Income Tax is applicable
to individuals with annual income
exceeding Rs. 50 lakh, while this rate
is 15% if total income exceeds Rs. 1
crore.
Double Taxation
Avoidance
Agreement (DTAA)
• Double taxation refers to the imposition
of tax by two or more countries on the
same declared income, asset, or financial
transaction.
• When such income is taxed in two
different countries, the total tax liability
will form a substantial part of total
income.
• This double liability can be avoided in
many ways, one of them being a tax
treaty between the countries in question.
• Double Taxation Avoidance Agreement
(DTAA) is a tax treaty signed between two
or more countries with the aim to help
taxpayers avoid paying double taxes on
the same income.
• It means that there are agreed tax rates
and jurisdiction on specified types of
 income arising in a country.
• A Double Taxation Avoidance Agreement
is applicable in situations where a
taxpayer is a resident of one nation but
earns income in another country.
• For example, Suppose an NRI earns
income both in India and let us say
Singapore, the income earned in India
would be taxed both in India and
15% of its GDP as tax revenue from the
public.
Taxes and GDP are generally related. The
higher the GDP, the more tax a nation
collects. Conversely, countries with lower
taxes produce a lower GDP.
11.9

Singapore. If India has a DTAA in place 11.2 11.2

10.9

with Singapore, NRIs can either avoid

10.6
10.4
10.2 10.1 10

paying tax twice or pay a lower rate of

tax. 2011 -12 2012 -13 2013 -14 2014 -15 2015 -16 2016- 17 2017- 18 2018- 19 2019- 20
(BE) (BE)

I M A G E 9.7: T OTA L T A X TO GDP%

Objective of DTAA?
• To prevent tax avoidance, evasion, grant
relief.
• To improve the cooperation between two
countries taxing authorities.
• To attract foreign investments by
providing relief from double taxation.
• To prevent discrimination between
taxpayers.
India and DTAA?
• India presently has DTAA with 80+
countries. Thus, there are agreed tax
rates and jurisdiction on specific types
of income arising in a country to a tax
resident of another country.
• Some of the countries with which it has
comprehensive agreements include
Australia, Canada, the United Arab
Emirates, Germany, Mauritius, Singapore,
the United Kingdom, and the United
States of America.
Tax to GDP Ratio
• Tax to GDP ratio shows the tax revenue
for a country measured in terms of GDP.
• For example, if India’s tax to GDP ratio is
15%, it means that the government earns
• Tax to GDP ratio has risen consistently in
the past 10 years which can be seen in
the above graph.
• Reasons for the low tax to GDP ratio in
India:
» Tax GDP ratio is lower because of the
narrow tax base. Ex: Top 5% individual
taxpayers contribute nearly two-thirds of
all the taxes collected.
» There are large scale tax evasion and tax
avoidance. Ex: Just the top 5% of tax-
paying firms contribute about 95% of the
total corporate tax collections
» Numerous exceptions and poor tax
paying culture.
» Weaknesses in tax administration.
» Complex taxation structure gives
loopholes for tax avoidance.
Feature of Indian
Taxation System.
• Indian taxation system follows a
progressive method of taxation.
• Indian taxation system is complex and
prone to tax evasion.
• It includes multiple exemptions,

139
 deduction, and rebates.
• Moderately high tax rate (despite a
significant reduction in tax rate).
• Narrow tax base and low tax to GDP
ratio.
Terms
Surcharge
• Surcharge is an additional charge and
not an additional tax.
• A surcharge of 10% on a tax rate of
30% effectively raises the combined tax
burden to 33%.
• Objective of Surcharge is:
» To increase the tax revenue temporarily
(additional fund mobilization).
» To make the tax system more progressive.
Cess
• It is an additional charge (Tax on Tax)
which is imposed to finance a specific
activity.
• Cess does not constitute permanent
source of revenue for the government,
and it is discontinued when its purpose
is fulfilled.
• It can be levied on both direct and
indirect taxes.
• For example, Education Cess, Swachh
Bharat Cess, Clean Energy Cess etc.
• The government can impose any one of
the surcharge or cess or both.
Deduction
• Tax Deduction is the reduction in tax
obligation. Under this, amount of
deduction is subtracted from the total
income to estimate taxable income.
• It reduces taxable income.
140
• For example, Under Section 80C, up to
Rs. 1.5 Lakh can be saved. If a person
income is Rs. 7 Lakh and he invests Rs. 1.5
Lakh under Section 80C now his taxable
income reduces to Rs. 5.5 Lakh (7 Lakh -
1.5 Lakh).
Exemption
• Tax Exemption refers to expenditure,
income, or investment on which no tax is
levied.
• Thus, if a particular income is exempted
from tax, it is excluded from the total
revenue of the government. This reduces
the total taxable income of the taxpayers.
• For example, House Rent Allowance
(HRA), Leave Travel Allowance (LTA) etc.
• Income tax exemptions are provided on
particular sources of income and not on
the total income.
Tax Rebate
• Tax rebate is a refund to the taxpayers if
the taxpayers pay more tax than they are
supposed to.
• Tax rebate helps to lower the tax burden
on the low-income bracket individuals.
• Income tax rebates are supposed to be
claimed from the total tax payable.
Incidence of Tax
• It refers to the point of the imposition of
tax i.e., on person or firm on which tax is
imposed.
• The impact of a tax is on the person or
entity on whom it is imposed first.
Impact of Tax
• The incidence of a tax means the extent
to which an individual or organization
 suffers from the imposition of a tax.
• The tax incidence shows the distribution
of the tax obligations, which must be
covered by the buyer and seller.
• Impact is the initial burden of the tax,
while incidence refers to the ultimate
burden of the tax.
• For Direct tax, impact and incidence is
both at the same point.
• For Indirect tax, impact and incidence is
at a different point.
Tax Expenditure
• Tax Expenditure are special provisions
such as exclusions, deductions, deferrals,
credits etc. given to the taxpayers.
• Tax expenditure indicates how much
more revenue could have been collected
by the Government if not for such
measures.
• It shows the extent of indirect subsidy
given to the taxpayers in the country.
Laffer Curve
• Laffer Curve shows the relation between
rates of taxation and the resulting levels
of government revenue.
Tax
Revenue
Tax Rate
I M A G E 9.8: L A F F E R C U R V E
141
• The shape of the Laffer curve depicts
that as tax rates increase, tax revenue
will also increase. But these increased tax
revenues will only increase until a peak,
and after which, the tax revenues begin
to decline.
• The curve was developed in 1979 by
economist Arthur Laffer.
• The curve starts at 0% tax where revenue
is also zero, gives maximum revenue at
an intermediate rate of taxation which is
also called as optimum tax rate at which
revenue is maximum, and then falls again
to zero revenue at a 100% tax rate.
• The shape of the Laffer curve is uncertain.
Tobin Tax
• A Tobin tax is levied on international flow
of short term capital or hot money which
are very speculative.
• The aim of a Tobin tax was to generate
stability in currency markets.
• The Tobin tax proposed by James Tobin
in 1972 in the form a currency transaction
tax.
Pigouvian Tax
• A Pigouvian tax is a government tax on
activities that create socially harmful
externalities.
• Pollution is a negative externality. For
example, the driver of a non-compliant
vehicle does not necessarily suffer
immediately from the exhaust released
from the vehicle but as the vehicle drives
down the road, everyone behind the
vehicle may suffer. Their exhaust may
also increase pollution for everyone in
the community.
• The government imposes a Pigouvian
tax on non-compliant vehicles to make
the driver take on more of the cost of the
suffering they may cause.
Tax Haven
• A tax haven is defined as a country or
place with very low "effective" rates of
taxation for foreign investors.
• Tax havens also share limited or no
financial information with foreign tax
authorities.
• Tax havens do not typically require
residency or business presence for
individuals and businesses to benefit
from their tax policies.
• A list of some of the popular tax haven
countries includes the Bahamas,
Bermuda, the British Virgin Islands, the
Cayman Islands, Hong Kong, Mauritius,
Lichtenstein, Monaco, Panama, St. Kitts,
and Nevis.
Round Tripping
• It refers to the transfer of illegitimate
money through a foreign company
(through tax haven) to invest back to the
home country.
• The objective of round-tripping is the
conversion of black/illegal money to
white/legitimate money.
Ad Valorem Tax
• Ad valorem tax (Latin word meaning
"according to value") is a tax in which
tax amount is levied on the value of a
commodity or transaction.
• It is imposed at the time of a transaction,
as in the case of a value-added tax (VAT).
• The most common ad valorem taxes are
property taxes levied on real estate.
Specific Tax
• Specific tax is a fixed amount for each
unit of a good or service sold.
142
Tax Buoyancy
• It referred to as the responsiveness of tax
revenue growth to changes in GDP.
• It is the relationship between the changes
in the government’s tax revenue growth
and the changes in GDP.
• It is calculated by dividing the change in
tax collection with GDP growth.
Change in tax revenue
Tax buoyancy =
Change in GDP
• A tax is buoyant when revenues increase
for example by more than 5 per cent for
a 5 per cent increase in GDP.
Tax Elasticity
• Tax elasticity refers to changes in tax
revenue in response to changes in tax
rate.
Base Erosion and
Profit Shifting
(BEPS)
• Base Erosion and Profit Shifting (BEPS)
means tax planning methods used by
multinational companies that exploit
loopholes and mismatches in tax rules to
avoid taxes.
• It is important for developing countries
due to their heavy reliance on
corporate income tax, particularly from
multinational enterprises.
• In recent times, MNCs are developing
sophisticated tax planning practices
to avoid tax by shifting their incomes/
profits across the borders by exploiting
loopholes and mismatches in tax
regulations, to take advantage of lower
tax rates and, thus, avoiding tax payment
in the country where the profit is actually
made.
• The OECD, under the authority of the
G20 countries, has considered ways to
revise tax treaties, stricter rules, and to
share more government tax information
under the BEPS project, and has issued
action plans.
• The BEPS Package provides 15 Action
points that equip governments with the
domestic and international instruments
needed to tackle tax avoidance.
India and BEPS
• India’s involvement in the BEPS initiative
has been intensive. India has played an
active part in working out action plans,
and is also part of various committees,
working groups and task forces that were
set up for examining different aspects of
these action plans.
• Union Budget 2016 announced an
‘equalization levy’ of 6 per cent on
payments exceeding over Rs. 1 lakh to
online ad services from non-resident
entities.
• This affected multinational companies
with Indian subsidiaries, like Google and
Facebook.
• India is the first country to levy such tax,
post the OECD action plan.
• A tax panel has also recommended
expanding the ambit of this levy to
cover a wide range of transactions
including cloud computing, online
marketing, website designing, hosting
and maintenance, platforms for sale of
goods and services, and online use of or
download of software and applications.
Advance Pricing
Agreement (APA)
• An APA is an agreement, usually for
multiple years, between a taxpayer and
CBDT specifying the transfer pricing
143
methodology to forecast the pricing of
future international transactions of the
taxpayer well in advance.
• Transfer price means the price at
which transactions are done between
companies’ part of the same group.
• The key objective of an Advance Pricing
Agreement is to provide certainty to
taxpayers so that predictable and
foreseeable conditions can be expected
regarding transfer pricing practices.
• India has framed a legal framework
which gives a legally binding agreement
between the taxpayers and the Central
Board of Direct Taxes.
• The Finance Act, 2012, introduced
sections 92CC and 92 CD in the IT Act
to provide the legal status for Advance
Pricing Agreement in India.
• These statutory provisions made effective
from 1st July 2012, empowered the CBDT
to enter into an agreement with any
person, with the approval of Central
Government, determining or specifying
the manner of determination of transfer
pricing in relation to an international
transaction.
Tax Regulation
Authority in India
Central Board of Direct Taxes
(CBDT)
• The CBDT is a statutory body functioning
under the Central Board of Revenue Act,
1963.
• CBDT is a part of the Department of
Revenue in the Ministry of Finance.
• CBDT provides significant inputs for
policy and planning of direct taxes, at the
same time, it is also responsible for the
administration of direct tax laws through
the Income Tax Department.
Central Board of Indirect Taxes
and Customs (CBIC) • The existing General Sales Tax Laws were
• The board functions under Department
of Revenue, Ministry of Finance.
• It performs following tasks:
» Formulation of policy regarding levy
and collection of Central Excise duties,
Customs, Central Goods & Services Tax,
and Integrated GST.
» Prevention of smuggling and
administration of issues relating to
Customs, Central Excise, Central Goods
& Services Tax, IGST and Narcotics to the
extent under CBIC's purview.
• CBIC is the administrative body for its
subordinate organizations, including the
Central Revenues Control Laboratory,
Central Excise and Central GST
Commissionerate’s and Custom Houses.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) Which one of the following is not a
feature of “Value Added Tax”? 2011
(a) It is a multi-point destination-based
system of taxation
(b) It is a tax levied on value addition
at each stage of the transaction in the
production-distribution chain
(c) It is a tax on the final consumption of
goods or services and must ultimately
be borne by the consumer
(d) It is basically a subject of the
Central Government and the State
Governments are only a facilitator for
its successful implementation
Ans. (d)
• Explanation: The value-added tax (VAT)
was introduced as an indirect tax from 1
144
April 2005. It is part of State list.
replaced by the Value Added Tax Act
(2005) and subsequent VAT Rules.
• Haryana was the first State in the country
to implement the taxation on 1 April 2003.
Q.2) Under which of the following
circumstances may ‘capital gains’ arise?
2012
1. When there is an increase in the sales
of a product
2. When there is a natural increase in the
value of the property owned
3. When you purchase a painting and
there is a growth in its value due to
increase in its popularity
Select the correct answer using the codes
given below:
(a) 1 only
(b) 2 and 3 only
(c) 2 only
(d) 1, 2 and 3
Ans. (b)
• Explanation: Capital gain is an increase
in the value of a capital asset (investment
or real estate) which gives it a higher
value than the purchase price.
• This gain is not realized until the asset is
sold.
• A capital gain may be short-term (one
year or less) or long-term (more than one
year) and must be claimed on income
taxes.
Q.3) A decrease in tax to GDP ratio of a
country indicates which of the following?
2015
1. Slowing economic growth rates
2. Less equitable distribution of national
income
Choose the correct code:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (b)
• Explanation: Tax GDP ratio shows the
tax revenue for a country measured in
terms of GDP. For example, if India’s
tax GDP ratio is 16%, it means that the
government gets 16% of its GDP as
tax contribution from the public and
entities. Here, tax GDP ratio shows the
richness of the government’s exchequer.
The government’s ability to spend on
socio-economic development programs,
military, salary, pension heads etc.,
depends on tax GDP ratio.
• Lower tax GDP ratio indicates a less
equitable distribution of national
income.
Q.4) The term ‘Base Erosion and profit
shifting’ is sometimes seen in the news in
the context of 2016
(a) mining operation by multinational
companies in resource-rich backward
areas
(b) curbing of the tax evasion by
multinational companies
(c) exploitation of genetic resources of
a country by multinational companies
(d) Lack of consideration of
environmental costs in the planning of
development projects
Ans. (b)
Explanation: Base erosion and profit
shifting (BEPS)
• Base erosion and profit shifting (BEPS)
refers to corporate tax planning strategies
used by multinationals to "shift" profits
from higher–tax jurisdiction to lower–tax
jurisdiction, thus "eroding" the "tax–base"
of the higher–tax jurisdiction.
145
• According to OECD, base erosion
and profit shifting (BEPS) refers to tax
avoidance strategies that exploit gaps
and mismatches in tax rules to artificially
shift profits to low or no-tax locations.
Q.5) What is/are the most likely advantages
of implementing ‘Goods and Services Tax
(GST)’? 2017
1. It will replace multiple taxes collected
by multiple authorities and will thus
create a single market in India.
2. It will drastically reduce the ‘Current
Account Deficit’ of India and will enable
it to increase its foreign exchange
reserves.
3. It will enormously increase the growth
and size of the economy of India and
will enable it to overtake China in the
near future.
Select the correct answer using the code
given below:
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (a)
Explanation: Goods and Service Tax
• Goods and Service Tax is a major
economic reform in India after the 1991
economic liberalization. GST, proposed
to be rolled out from 1st July 2017, will
have a four-tier structure with rates
ranging from 5% to 28%. But regrettably,
a large chunk of the economy, which
includes real estate, electricity, alcohol,
and petroleum products, is out of GST.
• It brings benefits to all the stakeholders
of government, consumers, and industry.
• It will reduce the cost of goods and
services, boost the economy, and
make the goods and services globally
competitive.
• GST aims to make India a common
 market with common tax rates and
procedures and remove the economic
barriers hence paving the way for an
integrated economy at the national level.
• By subsuming most of the Central and
State taxes into a single tax and by
allowing a set-off of prior-stage taxes for
the transactions across the entire value
chain, it would mitigate the ill effects of
cascading, improve competitiveness, and
improve the liquidity of the businesses.
• GST is a destination-based tax.
• It follows a multi-stage collection
mechanism.
• In this, the tax is collected at every stage
and the credit of tax paid at the previous
stage is available as a set off at the next
stage of the transaction.
• This shifts the tax incidence near to
the consumer and benefits the industry
through better cash flows and better
working capital management.
• It will not drastically reduce the ‘Current
Account Deficit’ of India.
• It will not enormously increase the growth
and size of the economy of India and will
not overtake China in the near future.
Q.6) With reference to India's decision to
levy an equalization tax of 6% on online
advertisement services offered by non-
resident entities, which of the following
statements is/are correct? 2018
1. It is introduced as a part of the Income
Tax Act.
2. Non-resident entities that offer
146
advertisement services in India can
claim a tax credit in their home country
under the "Double Taxation Avoidance
Agreements".
Select the correct answer using the code
given below:
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (d)
• Explanation: The government’s decision
to levy an equalization tax of 6% on
online advertisement services offered in
the country by non-resident entities will
impact users, especially start-ups that
rely almost entirely on the online world to
popularize their services. Further, as the
levy is not introduced as part of the Income
Tax Act but as separate legislation under
the Finance Bill, global firms that offer
such services in India cannot claim a tax
credit in their home country under the
double taxation avoidance agreements.
• Finance Minister Arun Jaitley during
Budget speech said that “In order to
tap on income accruing to foreign
e-commerce companies from India,
it is proposed that a person making
a payment to a non-resident (global
advertising platform), who does not have
a permanent establishment, exceeding
in aggregate Rs. 1 lakh in a year, as
consideration for online advertisement
will withhold tax at 6 per cent of gross
amount paid, as equalization levy”.
 CHAPTER - 10
GOVERNMENT BUDGETING
Budget
• It is a quantitative expression of a plan
of action for a specific time span, as
well as a tool for planning, execution,
and evaluation of the plan of action.
It is also a method for determining the
most efficient use of a country's total
resources. Budget can be made for an
individual, a group of people, a business,
a government, or just about anything else
that generates and spends money.
• Government budgeting is an essential
element in the planning and control of
the financial affairs of a nation and is
made necessarily because income and
expenditure do not occur simultaneously.
• The Union Budget of a year is referred
as the Annual Financial Statement
(AFS) under Article 112 of the Indian
Constitution. It is a statement of the
government's projected revenues and
expenditures for a given fiscal year.
Objectives of
Budget
• To stimulate economic growth.
• Redistribution of Income (Reducing
inequalities).
• Optimal allocation of resources.
• Employment generation and poverty
reduction.
147
Rationale of Budget
• To ensure transparency in public finance.
• To ensure accountability of the
government.
• To ensure advance planning.
• To ensure financial control of the
legislation over the executive.
Stages of Budget
In Indian parliament, the budget goes
through 5 steps
• Presentation of budget with Finance
Minister’s speech.
• Budget debate in general. After this,
there is an adjournment of houses for
a month so that standing committees
can examine the demand for grants.
• Voting on demand for grants in Lok
Sabha (LS).
• Passing of appropriation bills.
• Passing of Finance bills.
Receipt and
Expenditure
• Expenditure and receipts form the two
important components of the budget.
• Receipt is accrual/receiving of money
to the government by revenue and non-
revenue sources.
• Expenditure is spending made by the
government in the economy.
• Total expenditure and total receipts in
the balanced budget are equal.
 Budget Receipts

Revenue Receipts Capital Receipts

Tax Non-Tax Recovery Other

Borrowings
Revenue Revenue or loan Receipts
I M A G E 10.1: B U D G E T R E C E I P T S

• Revenue Receipts are further classified

Revenue Budget into:

• The revenue budget includes revenue » Tax revenue

expenditure and revenue receipts. These
receipts and expenditures are related
to the day to day functioning of the
government.
Revenue Receipt
• Non-tax revenue
• These are the government receipts,
which neither create assets nor reduce
any liability nor cause any reduction in
the assets of the government.
• They are regular and recurring in nature.
− Tax Revenue include receipts from
direct and indirect tax.
− The direct tax includes income tax,
corporate tax etc while indirect tax
includes GST, Cess, Custom duty etc.
− Non-tax Revenue include receipts
from the government’s disinvestment
proceeds from the stake sale in
various public sector undertakings.

• Essentially, these are current income
receipts of the government from all
sources.
− Non-tax Revenue will also include
the dividend income which the
government receives as a shareholder
of the various public sector
undertakings.

Non-Tax Revenue

Government earns interest on loans

given by it, be it internal lending (state
governments, union territories etc.) or
Interest external lending (outside the country).
Interest receipts from such loans form an
important source of non-tax revenue.

148
 Government earns profit from the sale
proceeds of the products of public
Profits and Dividends enterprises.
Government also gets dividends from its
investments in other companies.

It refers to charges imposed by the

government to cover the cost of recurring
services provided by it. Such services
Fees
include both fiscal services (currency
printing etc.) and general services
(community service etc.).

They refer to payments that are imposed

on people for breaking the law.
Fines and Penalties
For example, fine for jumping the signal or
penalty for non-payment of tax.

Government receives grants from

foreign governments and international
organizations.
Grants
Such grants are not a fixed source of
revenue and are generally received during
an emergency such as war, flood, etc.

Revenue Expenditure • It is recurring in nature.

• Broadly speaking, the expenditure which
• All expenditures by the government are does not result in the creation of assets
either of a current kind or compulsive
for the Government of India is treated as
kind.
revenue expenditure.
• Revenue expenditure is expenditure for • Revenue expenditure does not create an
the normal running of the government
asset of the government nor it decreases
departments and various services, interest
any liability.
payments on debt, subsidies, etc.

Revenue Expenditure

The interest payment is the payment

Interest by the government on the internal and
external loans taken by it.
These are paid by the government-to-
Salaries, Pension and Provident Fund
government employees.
Subsidies are incentive forwarded to
Subsidies
sectors by the government.

149

Defence
Law & order expenditures
Social services & General services
Grants
Revenue Deficit
• It is the gap between the revenue
expenditure (consumption expenditure)
of the Government (Union or the State
Governments) and its revenue receipts
(current revenues).
Revenue Deficit = Revenue Expenditure -
Revenue Receipt
• It shows the extent of reduction in
assets and/or increase in liabilities of
the government for meeting its current
consumption expenditure.
• Generally, the revenue deficit is shown as
a percentage of the GDP for domestic as
well as international analysis.
• Elimination of the revenue deficit has
always been a priority for Union and State
Governments, as revenue deficit may
divert the resources that otherwise would
be available for capital investments.
Effective Revenue Deficit
• Revenue Budget includes all grants from
the Central Government to the states/
Union territories/other bodies as revenue
expenditure, even if such grants are
utilised for asset creation.
• Such assets are created by the sub-
national governments/bodies and are
owned by them and not by the Union
Government.
• According to the Ministry of Finance,
such revenue expenditures contribute
150
Defence expenditures incurred by the
government.
Expenditure incurred on maintaining law
and order i.e., on police & paramilitary.
Expenditures on social services include
expenditure on education, health, etc. and
other social sectors and general services
include tax collection, etc.
Grants are given by the government to
Indian states and foreign countries.
to the growth in the economy through
asset creation and thus, should not be
considered as unproductive.
• In Union Budget 2011-12 a new
terminology, ‘Effective Revenue Deficit’
has been introduced. It excludes those
revenue expenditures (or transfers) in the
form of grants for the creation of capital
assets.
• The FRBM Act was amended in 2012
to introduce the concept of Grants for
creation of capital assets.
• The FRBM Act defines grants for creation
of capital assets as grants-in-aid given
to state governments, local bodies,
autonomous bodies, and other scheme
implementing agencies by the Central
Government for the formation of capital
assets which are held by these agencies
or governments.
• Thus, Effective Revenue Deficit is the
difference between revenue deficit and
grants for creation of capital assets.
Effective Revenue Deficit = Revenue
Deficit - Grants for creation of capital
assets (GoCA)
• Effective Revenue Deficit implies that
amount of capital receipts that are being
used for actual consumption expenditure
of the Government.
Implications of Revenue Deficit
• It implies the inability of the government
 to meet its regular and recurring
expenditure.
• It implies that the government is
dissaving, i.e., the government is using
savings of other sectors of the economy
to meet its consumption expenditure.
Capital Budget
• Capital Budget includes capital receipts
and capital expenditure.
• This shows the means by which the
capital is arranged and the areas where
capital is spent.
Capital Receipt
• Capital receipts are those receipts which
either create liability or cause a reduction
in the assets of the government.
• They are non-recurring in nature.
• Capital receipts are used for investment
purposes and supposed to be spent on
plan development by a government.

Capital Receipt

Government grants loans to state

governments or union territories and
Recovery of Loans also externally. Recovery of such loans is
measured as a capital receipt as it reduces
the assets of the government.
Borrowing includes all long-term loans
raised by the government through internal
Borrowings borrowings (inside the country) and
through external borrowings (outside the
country).
These include long term capital accruals
like National Saving Certificates, Post
Other Receipts Office Deposits, Kisan Vikas Patras etc.
They are termed as capital receipts as they
are considered as liability of government.

Capital Expenditure • The Union government defines capital

expenditure as the money spent on
• An expenditure which either creates an the acquisition of assets like buildings,
asset or reduces liability is called capital land, machinery, equipment, as well as
expenditure. investment in shares.

Capital Expenditure

Government grants loans to state

governments or union territories and also
Loan Disbursals by the Government
externally (i.e., foreign countries, IMF,
World Bank, etc.).

151

Loan Repayments by the Government
Plan Expenditure
Capital Expenditures on Defence
General Services
Other Liabilities of the Government
It consists of only the capital part of the
loan repayment as interest payment
on loans are included in the revenue
expenditure.
Any expenditure that is done on
programmes which are mentioned in the
current (Five Year) Plan of the center or
center’s advances to state for their plans
is called plan expenditure. (The plan and
non-plan classification was removed from
2017-18).
This consists of capital expenses for
equipment purchase, modernization of
defence forces.
Government spending on providing public
services like railways, education, health,
etc.
This includes repayment by the government
under Other Receipts (capital receipt).

Capital Deficit Deficit Measurement

• When capital disbursements of the
government exceed capital receipts, it
in India
leads to a Capital deficit.
• The broad measures of deficit Reported
• Capital deficit term is not used in public by the government in India may be
finance or in economics. classified, either in terms of the ‘nature
of transactions’ or on the basis of the
‘means of financing’ them.
• The chart given below provides a list of
different types of deficits that have been
and are being used in India.

On the basis On the basis

of fanancing of type of
transactions

Gross Fiscal

I M A G E 10.2: T Y P E OF DEFICIT

152
Budget Deficit
• A budget deficit occurs when a
government spends more than it collects
by way of revenue.
• It is the difference between total
expenditure (Revenue expenditure and
capital expenditure) and total receipts
(revenue receipts and capital receipts).
Budget Deficit = Total Expenditure - Total
Receipt
• From the 1997-98 budget, the practice
of showing budget deficit has been
discontinued in India.
Fiscal Deficit
• The fiscal deficit is calculated by taking
the difference between revenue receipts
plus non-debt creating capital receipts
and total expenditure including loans,
net of repayments.
Fiscal deficit = Total Expenditure -
(Revenue Receipt + Non debt creating
capital receipt)
= Total Expenditure - Total Receipt
except borrowing
= Net borrowing at home + Borrowing
from RBI + Borrowing from abroad
• It calculates the difference between the
government’s consumption expenditure
including repayment of loans and the
expected income from tax and non-tax
revenues.
• It also shows the borrowing needs of the
government from all the sources.
• Thus, if the fiscal deficit is larger, then the
government needs to borrow more from
the market or resort to printing more
currency.
• Its impact on economic development
depends on the use of borrowed funds.
• It is the most comprehensive concept
of the budgetary deficit, as it takes into
account the total resource gap of the
153
government.
• Fiscal Deficit is calculated both in
absolute terms and also as a percentage
of the Gross Domestic Product (GDP) of
the country.
• Net fiscal deficit can be calculated by
deducting net domestic lending from
gross fiscal deficit.
• Implementation of FRBM Act has helped
the Union and State governments
to reduce their fiscal deficits to a
considerable extent.
Adverse Impact of Fiscal Deficit
• It increases public debt which increases
future interest liabilities.
• It deteriorates the fiscal situation of
government which adversely affect
developmental expenditure.
• It creates inflation as it increases
aggregate demand in the economy.
• It leads to crowding out which refers to
a reduction in private investment due to
the increase in interest rate as a result of
excessive government borrowing.
• It increases the vulnerability of the
domestic economy to economic shocks
because it reduces the government’s
capacity to intervene in the economy to
overcome economic shocks.
• It adversely affects the creditworthiness
of the domestic government which may
destabilize the macroeconomic situation
of the country.
Measures to Reduce Fiscal Deficit
• Reducing Subsidies.
• Reducing Expenditure on General
Administration: Government took
some austerity measures to reduce this
expenditure like:
» Reducing five-star hotels meeting.
» Appointed Expenditure Management
Commission.
» Better use of technology like video
conferencing.
• The tax base should be broadened and
exemption and rebate in taxes should be
reduced.
• Tax evasion and tax avoidance should be
effectively checked.
• Restructuring and disinvestment of the
public sector enterprise.
Primary Deficit
• Primary deficit is defined as the fiscal
deficit of current year minus interest
payments of the government during the
financial year.
• It shows the fiscal situation of the
government during the current financial
year ignoring the impact of the debt
burden of the past (borrowing by previous
governments).
Primary Deficit = Fiscal Deficit - Interest
Payment
• This value ideally should be negative.
• A shrinking primary deficit indicates
progress towards fiscal health.
• If the primary deficit is zero, then fiscal
deficit is equal to interest payment.
Thus, zero primary deficits mean that
the government borrows only to make
interest payments.
• The Budget document mentions primary
deficit as a percentage of GDP.
154
Monetized Deficit
• Monetized Deficit measures the
borrowing of the government from the
central bank (RBI) during the financial
year.
Monetized Deficit:
• In India, it is a new term adopted
since 1997–98. The Monetized Deficit
measures how much the Reserve Bank
of India (RBI) assists the government
in its borrowing programme. In other
words, Monetized deficit refers to
the increase in the net RBI credit to
the central government, such that
the monetary requirements of the
government could be met easily.
• In other words, it means the purchase of
government bonds by the central bank
to finance the spending needs of the
government.
• As borrowings from the RBI can be
both short-term and long-term, thus,
the monetized deficit is the addition of
the net issuance of short-term treasury
bills (T-Bills), dated securities (long-term
borrowings from RBI) and rupee coins
possessed exclusively by the RBI, net of
Government’s deposits with the RBI.
• Monetized Deficit leads to the printing
of currency (i.e., increase in M0) which
increases the money supply by multiple
magnitudes. So, it is highly inflationary.
• Unlike the , Indian rupee is not considered
a safe haven. Thus, when there is excess
supply of the currency, it could lead to a
fall in rupee value, leading to an outflow
of foreign investment.
 Term of Financing Type of Financing Type of Deficits

a) Long term financing other

Gross Fiscal deficit (a+b+c+d+e)

than RBI
Long term financing
(a+b)
b) Long term financing from

deficit (b+c)
Monetized
RBI

c) Short term financing from

Taditional budget
deficit (c+d+e)
RBI

Short term financing

d) Long term financing other
(c+d+e)
than RBI

e) Draw down of cash

Deficit Measure Significance

Fiscal Deficit Widely used as a summary indicator of the

macroeconomic impact of the budget in
several industrialized countries.
This measure has been adopted by the
IMF as the principal policy target in their
programs.
In India, the government began to Report
the fiscal deficit only after 1991.
Since the shortfall in receipts over
expenditure must be covered through
borrowing, therefore, Gross Fiscal Deficit,
gives the overall borrowing requirements
of the government over a given financial
year.
And thus shows the net addition to the
level of public debt during a financial year.

155
Monetized Deficit Monetization of deficits, which increases
the money supply, is inflationary if the rate
of growth of money supply is greater than
the rate of increase of the demand for
cash balances arising from the growth of
the economy.
Thus, monetized deficits are an important
indicator of the inflationary impact of the
increase in the government’s budgetary
deficits.
Primary Deficit It excludes the burden of the past debt and
shows the net increase in the government’s
indebtedness due to the current year’s
fiscal operations.
A reduction in the primary deficit is
reflective of the government’s efforts at
bridging the fiscal gap during a financial
year.
Revenue Deficit A positive revenue deficit implies that the
government is resorting to borrowing to
finance current consumption.

Significance of different measures of

deficit
6.6 (% of GDP )
6.1
5.9
6
5.3
4.6 4.9 4.9
4.5
4.5
4.1
3.9 3.8
3.7
3.5 3.5 3.4 3.5
3.2 3.3 3.2
2.6 3.0 2.9
3 2.6 2.7
2.5 2.5 2.4 2.4
2.8 2.1
1.8 1.9 1.9 1.8
1.5 1.5 1.5
1.4
1.8 1.1
0.9 1.0
0.7 0.7
0.4 0.4 0.4 0.4

0
2008-09 2010-11 2012-13 2014-15 2016-17 2018-19 BE 20-21
Fiscal Deficit Revenue Deficit Effective Revenue Deficit Primary Deficit

I M A G E 10.3: D E F I C I T T R E N D S IN INDIA

156
Deficit Financing
• Deficit financing refers to generating
funds to finance the deficit which results
from an excess of expenditure over
revenue.
• Thus, whenever the government
expenditure exceeds its revenue, then the
government contemplates the process of
deficit financing.
• It is a temporary arrangement of the
funds through various methods like sale
of bonds to borrow the money from the
public or printing new currency.
• Two important characteristics of deficit
financing are:
» Financing of the budget deficit.
» This financing is done by the increase in
money supply.
Need of Deficit
Financing
• For developing countries such as India,
higher economic growth is a priority.
Higher economic growth requires greater
spending. Since the private sector will
not make such a huge expenditure.
Therefore, the responsibility to raise
financial resources to finance economic
development rests solely on the
government.
• Deficit Financing enables the government
to obtain the necessary resources for the
development plans.
157
Means of Deficit Financing
• The deficit financing by the government
is done in the following ways:
Borrowing from External Sources
• Borrowing from External Sources includes
borrowing from developed countries and
international institutions like the World
Bank, IMF, etc.
• Advantages of External borrowing are:
» External borrowing brings in foreign
currency and gives government additional
capacity to fulfill its developmental
requirements both inside and outside the
country.
» External borrowing is preferred over
the internal borrowings due to no
‘crowding out effect’. This reduces private
investment due to the increase in interest
rate as a result of excessive government
borrowing.
Borrowing from Internal Sources
• Borrowing from Internal Sources includes
borrowing from RBI, General Public, Ad-
hoc Treasury Bills & government bonds
etc.
• It hampers the investment prospects
of the private and the corporate sector.
It tends to reduce private spending and
leads to “crowding out" effect.
Printing new Currency
• Printing Currency is the last option for the
government in managing its fiscal deficit.
• The biggest drawback of printing
currency is that with it the government
cannot go for the expenditures which are
to be made in the foreign currency and it
increases money supply thus resulting in
inflation.
 Securities against small savings State Provident Fund
Other Receipts (Internal Debt and Public Account External Debt
Draw Down of Cash Balance Market Borrowings

300000 600000

250000
500000
SOURCES OF FINANCING FD (EXCLUDING

200000

MARKET BORROWINGS
400000
MARKET BORROWINGS)

150000

100000 300000

50000
200000
0
2016-17 2017-18 2018-19 RE 19-20 BE20-21
100000
-50000

-100000 0
I M A G E 10.4: S O U R C E S OF DEFICIT FINANCING

Effect of Deficit Financing classes and businessmen to flourish.

• The deficit financing by government has
following effect:
Advantage of Deficit Financing
• Deficit financing does not take away
money from taxpayer pocket and yet
provides massive resources to the
government.
• In India, deficit financing involves
borrowing from the Reserve Bank of India.
Interest payments to the RBI against this
borrowing come back to the Government
of India in the form of a dividend.
• Financial resources that government
needs to mobilize through deficit financing
are certain and known beforehand.
Disadvantage of Deficit Financing
• Rise in inflation because of the increase
in the supply of money in the economy.
• Decrease in average consumption level
due to higher inflation.
But fixed-income earners suffer during
inflation.
• Deficit financing adversely affects
investment. During high inflation,
employees demand higher wages. If the
wages are increased, it raises the cost
of production which demotivates the
investors.
Fiscal Policy
• Fiscal policy is the policy that handles the
use of government revenue collection (taxes
or non-tax) and expenditure (spending) to
influence a country's economy.
• Fiscal policy is the guiding force which
helps the government in deciding how
much money it should spend to support
the economic growth, and how much
revenue it must earn, for the smooth
functioning of the economy.
• Fiscal policy, along with monetary policy,
plays an important role in managing a
country’s economy.

• Increase in income disparities, deficit • Fiscal policy is based on the theories

financing-led inflation helps producing given by British economist John Maynard
Keynes.

158
• Main objectives of Fiscal Policy:
» Economic growth: Fiscal policy helps
maintain the economy’s growth rate
so that the government can achieve its
economic goals.
» Price stability: It controls the price level
of the economy so that when the inflation
is too high, prices can be regulated.
• There are two types of fiscal policy:
» Expansionary Fiscal Policy:
− It stimulates economic growth
because the government either
spends more, cut taxes or both.
− It puts more money into the consumers'
hands, so they spend more which
increases the demand.
» Contractionary Fiscal Policy:
− The contractionary fiscal policy goal
is to slow the economic growth and
stamp out inflation.
− Government increases the tax and
cut its spending.
Importance of Fiscal Policy in
India
• In a country like India, fiscal policy helps
to accelerate the economic growth by
increasing the investment rate in public
as well as private sectors.
• The fiscal policy helps mobilise resources
(through taxation) for financing its
economic activity.
• The fiscal policy encourages the
investment into those productive sectors
which are considered socially and
economically desirable.
159
Fiscal Consolidation
• Fiscal Consolidation means the policies
undertaken by Governments (national
and sub-national levels) to reduce their
deficits and accumulation of debt stock.
• Fiscal consolidation is a process in which
the government’s fiscal health improves
which is indicated by lowering of fiscal
deficit.
• In India, fiscal consolidation or the fiscal
road-map for the government is defined
in terms of the budgetary targets i.e.,
fiscal deficit targets and revenue deficit
targets.
• Measures to achieve fiscal consolidation:
» Improves tax revenue and minimizes tax
avoidance.
» Broadening the tax base and minimizing
tax concessions and exemptions.
» Better targeting of government subsidies
and increasing use of Direct Benefit
Transfer (DBT). This will reduce leakages.
» Reduction of excessive/unnecessary
expenditure.
Fiscal Responsibility
and Budget
Management
(FRBM) Act 2003
• Fiscal Responsibility and Budget
Management (FRBM) Act was enacted in
2003.
• It provides a legal institutional framework
for fiscal consolidation.
• The objectives of the Act are:
» Ensuring Equity in fiscal management.
» Ensuring Macroeconomic stability.
» Ensuring better coordination between
fiscal and monetary policy.
» Bringing transparency in the fiscal
operation of the Government.
• The Government can skip the targets
of fiscal consolidation only in case of
natural calamity, national security and
other exceptional grounds as mentioned
by Central Government.
• The Finance Minister has to discuss the
reasons for skipping the targets and
suggest corrective measures to be taken,
in case of a violation.
• Further, the Act bans borrowing by the
government from the Reserve Bank of
India, thereby, making monetary policy
independent of fiscal policy.
• The Act also mandates the government
to lay before the parliament three policy
statements in each financial year namely
» Medium Term Fiscal Policy Statement
− It sets out three-year rolling targets
for five specific fiscal indicators in
relation to GDP at Market Prices,
namely,
(i) Revenue Deficit
(ii) Effective revenue deficit,
(iii) Fiscal Deficit,
(iv) Tax to GDP ratio
(v) Total outstanding Debt as a
percentage of GDP
» Fiscal Policy Strategy Statement
− It gives the strategic priorities of
Government in the fiscal area for the
financial year relating to taxation,
lending, expenditure, and investments,
administered pricing, borrowings and
guarantees.
» Macroeconomic Framework Policy
Statement
− It contains an assessment regarding
160
the expected rate of GDP growth, fiscal
situation of the Central Government
and the balance of external sector of
the economy.
• To instill the fiscal discipline at the state
level, the 12th Finance Commission
provided incentives to states with the
help of conditional debt restructuring
and interest rate relief for introducing
Fiscal Responsibility Legislations (FRLs).
Every state has implemented their own
FRLs.
Target by FRBM Act 2003
• The FRBM rule specifies a reduction of
fiscal deficit to 3% of the GDP by 2008-
09
• Fiscal deficit annual reduction target
of 0.3% of GDP per year by the Central
government.
• Revenue deficit to be completely
eliminated by 2008-09.
• Revenue deficit has to be reduced by
0.5% of the GDP per annum.
• Total Debt to be reduced to 9% of the
GDP with an annual reduction of 1% of
GDP.
• It bans the purchase of primary issues of
the Central Government securities by the
RBI after 2006.
Amendments to FRBM Act 2012
• Through Finance Act 2012, Fiscal
Responsibility and Budget Management
Act, 2003 was amended. It provided that,
along with the existing three documents,
Central Government shall table another
document, the Medium-Term Expenditure
Framework Statement (MTEF).
• Amendments to the FRBM Act were
introduced as per the recommendations
of the 13th Finance Commission.
• Two important features of the
 amendment to FRBM Act in the direction Government has to take appropriate
of expenditure reforms are: measures to reduce the:

» Effective Revenue Deficit. » Fiscal deficit to 3% of GDP by 2015.

» Medium Term Expenditure Framework:
It will set a 3-year rolling target for
expenditure indicators.
• As per 2012 Amendment, the Central
» Revenue deficit to less than 2% of GDP
by 2015.
» Effective revenue deficit to be eliminated
by 31st of March 2015.

Significance of FRBM Act:

• It provides an institutional and legal structure for fiscal consolidation. It makes
it mandatory for the Central government to adopt measures to reduce fiscal
deficit, to eliminate revenue deficit altogether and to create revenue surplus in the
forthcoming years.
• The Act makes it mandatory not only for the present government but also for the
future government to follow the fiscal consolidation path.
• The FRBM Act has strengthened the fiscal efficiency of both the federal government
and the states.
• During the pre-subprime crisis era, the Act aided in strict adherence to the path
of fiscal contraction, allowing for enough fiscal space to pursue countercyclical
fiscal policy (strategy by government to counter boom or recession through fiscal
measures). In 2007-08, by implementing the act, the government was able to reduce
the fiscal deficit to 2.7 percent of GDP and the revenue deficit to 1.1 percent of GDP.

Limitations of the FRBM act

• Although there has been a substantial reduction in deficits, this has largely been
due to cuts in vital areas of the economy such as education and health care. The
proportion of GDP spent on development by the Union government has decreased
over time.
• An assessment of state revenue account of the development expenditure indicates
that in almost all sectors of development, there has been a decline in the FRBM
period.
• Also, the government has been seen manipulating the revenue and expenditure
accounts to reach deficit targets, such as cutting capital expenditure and demanding
interim dividends from Public Sector Undertakings (PSUs) in advance etc.
• Further, the FRBM Act overlooks the possible inverse link among the bank credit
(monetary expansion) fiscal deficit (fiscal expansion). That is, if credit growth drops,
fiscal deficit may need to increase and if credit increases, fiscal deficit ought to
drop — this is to ensure adequate money supply to the economy.
• Statistics on bank credit, money supply growth, and GDP establishes that both
money supply growth and credit expansion have significantly decreased in relation
to GDP growth. Therefore, the FRBM Act has not only reduced the fiscal deficit
but also starved the growing economy which has been deprived of much-needed
investment.

161
N K Singh Committee Review
of FRBM
• Government of India constituted
the Committee in 2016 to review the
implementation of the FRBM Act under
the Chairmanship of N. K. Singh.
• Recommendation of the committee:
» Public debt to GDP ratio
− It should be considered as a medium-
term anchor for fiscal policy.
− The combined debt-to-GDP ratio
of the Centre and states should
be brought down to 60 % by 2023
(comprising of 40% for the Centre
and 20% for states).
» Fiscal deficit
− The Committee accepted fiscal deficit
as the operating target to bring down
public debt.
− For fiscal consolidation, the centre
should reduce its fiscal deficit from
the current 3.5% (2017) to 2.5% by
2023.
» Revenue deficit
− The Committee also advised that
the central government should bring
down its revenue deficit steadily by
0.25% of GDP per annum, to reach
0.8% by 2023, from a projected value
of 2.3% in 2017.
» Independent Fiscal Council
Year Debt/GDP
2017-18 47.3
162
− It recommended establishing an
independent Fiscal Council.
− The Council will provide several
advisory functions to the government.
− It will forecast key macro variables
like real and nominal GDP growth, tax
buoyancy, commodity prices.
» Escape Clause
− The committee recommends fiscal
flexibilities to go above or below the
fiscal deficit targets in the form of
scape clauses.
− The Committee set 0.5% as escape
clause for fiscal deficit target.
» Fiscal consolidation responsibility for
states
− The Committee observes that the
state government’s fiscal position
is important after greater resource
transfer to them (Fourteenth finance
Commission award).
− State Government should bring down
their debt target to 20% of GDP from
the current 21%.
» Congruence of Fiscal and Monetary
Policy
− The FRBM Review Committee
observed that both monetary and
fiscal policies must ensure growth
and macroeconomic stability.
• Annual targets as recommended by the
committee are as follows:
Fiscal Deficit Revenue Deficit
3.0 2.1
 2018-19 45.5 3.0 1.8

2019-20 43.7 3.0 1.6

2020-21 42.0 2.8 1.3

2021-22 40.3 2.6 1.1

2022-2023 38.7 2.5 0.80

Types of Budget » There is certain expenditure which violates

Zero Based Budgeting
• Under Zero Based Budgeting, Ministries
have to justify expenditure on every
project on the basis of its merit (cost-
benefit analysis) annually afresh.
• Zero-based budgeting starts from
scratch, rather than a traditional budget
that is based on previous budgets.
• Zero Base Budgeting was developed by
Peter Pyhrr in the 1970s. India adopted
this in practice in 1997-99.
• The main benefit of Zero-base budgeting
are:
» Efficient resource allocation, as it is based
on cost and benefits.
» Prioritising allocation of resources is
another feature of ZBB.
» ZBB allows close examination and
scrutiny of each programme and public
spending.
» ZBB helps policymakers to achieve more
cost-effective delivery of public services.
cost-benefit analysis i.e., Defence, foreign
relation etc.
» Zero base budgeting is too complex and
it needs detailed attention and analysis.
» There is certain expenditure upon which
the government/parliament does not
have the power of scrutiny (charged
expenditure in India).
Performance Budget
• Performance-based budget is the
practice of developing budgets in which
budget are based on the relationship
between input cost and expected results.
• The major aim of performance budgeting
is to improve the efficiency of public
expenditure since financial resources are
allocated according to objectives and
purposes.
• From 2007-08 onwards, the Performance
Budget was merged with the Outcome
Budget. There is only one document i.e.,
the Outcome Budget.

• Limitations of Zero-base budgeting are:

163
Outcome Budget
• The Outcome Budget is a report on what
various Ministries and Departments have
done with the outlays provided in the
previous annual budget.
• It measures the developmental outcomes
of all government programmes and
whether the money has been spent for
the purpose it was sanctioned.
• In 2005-06 Outcome Budget was
first introduced in India. Since then,
Government has continued to release
annual Outcome Budget Reports with
incremental changes and without
any reference to the previous year’s
performance.
• All Ministries have to prepare outcome
budgets to make the budgeting target
oriented.
Balanced Budget
• A balanced budget is the budget where
the estimated government expenditure is
equal to expected government receipts
in a particular financial year.
• In this, the budget has no budget deficit
but could have a budget surplus.
Surplus Budget
• A surplus budget is the budget in which
the expected government revenues
exceed the estimated government
expenditure in a particular financial year.
• Surplus Budget is quite rare in modern
economies because of the temptation for
the government to spend more money
and cut taxes.
Deficit Budget
• A deficit budget is the budget in which
the estimated government expenditure
164
is more than the expected government
revenues in a specific financial year.
• It is best suited for developing countries
like India.
• Deficit budget helps create more demand
and boost the economic growth.
• Here, the government incurs excessive
expenditure to improve the demand
for goods and services which helps in
reviving the economy.
Gender Budget
• Gender budgeting is a method for
governments to promote equality
through fiscal policy.
• It involves analyzing a budget’s impacts
on men and women and allocating
resources accordingly.
• The rationale behind gender budgeting
arises from the recognition that the
national budgets affect men and
women differently through the resource
allocation.
• Women constitute 48% of India’s
population, but they fall behind men
on many socio-economic indicators
like education, health, economic
opportunities, skills etc.
• Thus, they require special attention due
to their vulnerability and lack of access
to resources.
• Since 2005-06, the Expenditure Division
of the Ministry of Finance has been issuing
a note on Gender Budgeting every year.
Golden Rules of Budgeting
• The golden rule of budgeting states that
a government must only borrow for its
capital expenditure, not to finance the
revenue expenditure.
• In other words, the government should
borrow only to finance investments that
benefit overall economy, and current
 spending must be covered and funded
by existing taxes.
• The golden rule of budgeting is that the
government's budget should have no
revenue deficit.
Ways and Means
Advances (WMA)
• The Reserve Bank of India (RBI) offers
temporary loan facility to the central
and state governments. This loan facility
is called as Ways and Means Advances
(WMA).
• It was introduced in 1997 to meet the
mismatches in the receipts and payments
of the government.
• The limits for WMA are decided by the
government in consultation with RBI at
the start of each financial year.
• The WMA are given for 90 days only.
• The loans under WMA are currently
charged at the Repo Rate.
• If the loan tenure under WMA goes
beyond 90 days, it would be considered
as an overdraft (such overdraft is charged
at 2% more than the Repo Rate).
• There are two kinds of Ways and Means
Advances:
» Special WMA or Special Drawing Facility
− It is provided against the collateral of
the government securities held by the
state.
− The interest rate for SDF is 1% less
than the Repo Rate.
» Normal WMA
− These are unsecured advances
extended at the bank rate.
− After exhausting the special WMA
limit, the Government is provided with
a normal WMA.
165
Public Debt or
Sovereign Debt
• Public debt is nothing, but the total
amount borrowed by the government.
• Article 292 of the Indian Constitution
states that the Government of India
can borrow amounts specified by the
Parliament from time to time.
• Since the Union government depends
heavily on market borrowing to meet
its operational and developmental
expenditure, the study of public debt
becomes key to understand the financial
health of the government.
• Debt to GDP ratio is used by investors
to measure a country's ability to make
future payment on its debt.
• In India, total Central Government
Liabilities constitutes the following two
categories.
» Internal Debt
− Internal debt or domestic debt is the
sub-part of the total government
debt that is owed to lenders within
the country.
− It is the money that government
borrows from its own citizens.
− Internal debt constitutes more than
93 percent of the overall public debt.
− The major instruments covered under
Internal Debt are as follows:
• Dated Securities
• Treasury-Bills
• Securities issued against Small
Saving
• Market Stabilization Scheme
(MSS) Bonds
» External Debt
− External debt is owed to foreign
creditors.
 − The foreign creditors can be foreign share in total external debt, followed by
governments, International Financial NRI deposit and short-term debt.
Institutions such as the IMF etc. • The share of US dollar denominated debt
− The major instruments covered under has the highest share in external debt
External Debt are as follows: followed by Indian rupee, SDR, Japanese
• Commercial Borrowing Yen and Euro.

• NRI Deposit • Debt to GDP of central government has

been consistently reducing, especially
• Multilateral Debt- debt from after the enactment of the FRBM Act
multilateral institutions like ADB, (2003).
IBRD etc.
• This is an outcome of each fiscal
• Long and Short-Term Debt consolidation attempts as well as
• Commercial Borrowing has the highest relatively strong GDP growth.

60

50
Percent of GDP

40

30
5 6
-0
7 8 9 10 11 -1
2
-1
3
-1
4
-1
5
-1
6 17 18 P)
-0 -0 -0 -0 9- 0- 1 2 3 4 5 6- 7- 19
(
04 05 06 07 08 00 2 0 1
201 01 01 01 01 01 2 01 8-
20 20 20 20 20 2 2 2 2 2 2 1
20

I M A G E 10.5: T R E N D IN C E N T R E ’ S D E B T -G D P R AT I O

Public Debt the total debt within sustainable levels".

• According to the Fiscal Policy Strategy
Management of the Statement of 2012-13, the government’s
public debt management policy
Union Government revolves around gradual reduction of

in India public debt-GDP ratio.

• This is in line with the objective of
• The overall objective of the debt further decreasing the debt servicing
management policy of Central risk and to create more fiscal space for
Government, which was mentioned developmental activities.
in the Central Government's status • On the financing front, the Government
paper (November 2010) is to “meet the policy focuses on the following
financing needs of Central Government principles:
at the lowest possible long-term
borrowing costs and also to maintain » More reliance on domestic borrowings
over external borrowing,

166
» Market borrowings should be preferred
over instruments which carry administered
interest rates.
» Consolidation of the debt portfolios.
» Development of a wide and deep market
for Government securities to improve
liquidity in secondary market.
Institutions responsible for the
management of public debt
• The Indian Constitution empowers
the executive branch of government
to borrow upon the security of the
Consolidated Fund of India.
• RBI as a representative of the Government
(of both Union and the States)
implements the borrowing programme.
• RBI draws the required statutory powers
for debt management from Section 21
of the Reserve Bank of India Act, 1934.
• While it is obligatory for the Reserve
Bank to manage the public debt of the
Union Government, it manages public
debt of the various State Governments
by an agreement.
• The jurisdiction of various authorities
responsible for public debt
management is given below:
» Reserve Bank of India (RBI): Domestic
Marketable Debt which includes cash
management bills, treasury bills and
dated securities.
» Ministry of Finance, Office of Aid and
Accounts Division: External debt
» Ministry of Finance, Budget Division and
Reserve Bank of India: Other liabilities
like deposits, small savings, reserve funds
etc.
167
Fiscal Federalism
• Fiscal federalism deals with the
separation of governmental functions
and financial relations among different
levels of government.
• The objective of fiscal federalism
is to enable the national and sub-
national governments to operate in
such a way that leads to efficiency in
the use of resources and also create
an environment in which all economic
actors use resources efficiently.
• The history of fiscal federalism in modern
India goes back to the Government of
India Acts of 1919 and 1935.
• While 1919 Act provided for a
separation of revenue heads between
the Center and the provinces, the 1935
Act provided for the sharing of Center’s
revenues and for the provision of
grants-in-aid to provinces.
Division of functions and
resource
• The Indian Constitution, under Article
246 and Seventh Schedule, distributed
powers and allotted subjects to the
Union and the states.
• The Indian Constitution has provided
for a certain division of the powers of
taxation between the Union and states,
and also gives the states a share in the
resources available to the Centre.
• Federal transfers to the states in India
are made in three streams, as
» Devolution of states share in Central
Taxes
» Grants from Central to the states: Further
classified as statutory or non-statutory,
and plan as well as non-plan.
 − Non-Plan grants:
i. Statutory grants recommended by
the Finance Commission to cover
the gap in revenue.
ii. Assistance for relief measures
after natural calamities.
− Non-Statutory grants, comprising:
i. Plan grants:
(a) State plan schemes
(b) Central plan schemes
(c) Centrally sponsored schemes
(d) Special schemes for North
Eastern council etc.
» Loans from Centre
a. Plan loans
b. Non-Plan loans including Ways and
Means Advance
• Fiscal relations between the union
government and state governments
have experienced significant changes
in recent years.
• Three landmark changes introduced in
union-state fiscal relations since 2015-16:
» In January 2015, the Union Government
abolished the Planning Commission and
established the NITI Aayog in its place.
» Fundamental changes have been
introduced in the system of revenue
transfers from the centre to the states. The
Centre has devolved higher taxes (from
32% to 42%) to the states from 2015-16
fiscal year onwards as recommended by
the Fourteenth Finance Commission.
» The Goods and Services Tax and the
establishment of the GST Council for
the central and state governments to
deliberate and jointly take decisions.
• In terms of absolute amount, and as a
percentage of GDP, total transfers to
States have risen between 2014-15 and
2019- 20.
168
16
13.91
11.95
11.88
12
9.86
10.85
8
4
0
2016-17 2017-18 2018-19 RE 2019-20 BE 2020-21
I M A G E 10.6 : T OTA L T R A N S F E R S TO S TAT E S & UT ' S
Finance Commission
• The Finance Commission is constituted
under Article 280 of the Constitution
by the President of India once in five
years. It gives recommendations on
centre-state financial relations. Its core
responsibilities are:
» To evaluate the state of finances of the
Union and State Governments.
» Recommend the sharing of taxes
between them.
» Lay down the principles determining the
distribution of these taxes among States.
• The First Finance Commission was
constituted in 1951 and there have been
fifteen so far.
• The Finance Commission is also
required to recommend on the
measures necessary to strengthen
the Consolidated Fund of a State
to augment the resources of the
Municipalities and Panchayats in the
State as per the suggestions of the
Finance Commission of the State.
• The recommendations made by the
Finance Commission are advisory in
nature and hence, not binding on the
Government.
• In 2017, the 15th Finance Commission was
set up under the chairmanship of N.K.
Singh.
Fifteenth Finance Commission
Recommendations
Vertical Devolution (Devolution of
Taxes of the Union to States):
• It has proposed that vertical devolution
be held at 41%, as it was in its interim
Report for 2020-21. It is at the same level
of 42% of the divisible pool as suggested
by the 14th Finance Commission.
14th FC
Criteria
2015-20
Income Distance
Population (1971)
Population (2011)
Area
Forest Cover
Forest and Ecology
Demographic Performance
Tax Effort
Total
Performance Based Grants and
Incentives to the States:
• These grants and incentives revolve
around four major themes.
» The 1st is the social sector, where it has
concentrated on education and health.
» Second is related to the rural economy,
where it has emphasized on agriculture
sector and the maintenance of rural
roads.
» The economy of rural area plays a vital
role in the country as it encompasses
2/3rd of the country's population,
around 70% of the total workforce and
169
• It has suggested the required adjustment
of about 1% because of the changed
status of the erstwhile State of J &K into
the new Union Territories of Ladakh and
Jammu and Kashmir.
Horizontal Devolution:
On the basis of principles of equity, need
and performance, overall devolution
formula is as follows.
15th FC
2020-21
50 45
17.5 -
10 15
15 15
7.5 -
- 10
- 12.5
- 2.5
100 100
approximately 46% of national income.
» Third, administrative and governance
reforms under which it has suggested
grants for judiciary, statistics and
aspirational districts and blocks.
» Fourth, it has created a performance-
based incentive mechanism for the
power sector that is not linked to grants
provides States with a substantial
additional borrowing window.
Fiscal Space for Centre:
• Total 15th Finance Commission transfers
(devolution + grants) comprises around
 34 percent of estimated Gross Revenue
Receipts to the Centre, giving adequate
fiscal space to meet its resource needs
and spending obligations on nationwide
development priorities.
Grants to Local Governments:
• Along with grants and incentives for
municipal public services and local
government bodies, it incorporates
performance-based grants for incubation
of new cities and health grants to local
government bodies.
• Basic grants for urban local bodies are
only suggested for cities/towns with
populations of less than a million people.
For Million-Plus cities, 100% of the grants
are performance-linked with the help of
the Million-Plus Cities Challenge Fund
(MCF).
• The sum of MCF is related to how well
these cities perform in terms of improving
air quality and meeting service level
standards for urban drinking water supply,
sanitation, and solid waste management.
Disaster Risk Management:
• Mitigation Funds should be established
at both the national and State levels, in
compliance with the provisions of the
Disaster Management Act. The Mitigation
Fund should be utilized for those local
level and community-based interventions
which decrease risks and encourage
environment-friendly settlements and
livelihood practices.
Consolidated Fund of India
• As per Article 266 (1) of the Indian
Constitution, all revenues (tax revenue
as well as non-tax revenue) received
by the Union government along with
all loans raised through issuance of
T-bills, external and internal loans
170
and all moneys received by the Union
Government in repayment of loans shall
form a consolidated fund named as the
'Consolidated Fund of India' for the Union
Government.
• The government cannot withdraw the
money from the Consolidated Fund
unless such withdrawal is voted in the
Lok Sabha.
• The CAG (Comptroller and Auditor
General) of India audits these Funds and
Reports to the Union/State legislatures
when proper accounting procedures
have not been followed.
Charged Expenditure
• According to the Article 112 (3) and Article
202 (3) of the Constitution, the following
expenditure does not require to be voted
and such expenditure is charged upon
the Consolidated Fund of India.
• They include:
» Salary, allowances and pension for
the President and Governors of States,
Speaker and Deputy Speaker of the Lok
Sabha, the Comptroller General of India
and Judges of the Supreme and High
Courts.
» Interest and other debt-related charges
of the Government and any sums required
to satisfy any court judgment pertaining
to the Government.
Fiscal Neutrality
• In fiscal neutrality, government's overall
fiscal policy remain neutral with respect
to aggregate demand in the economy.
• Fiscal neutrality is a situation where
demand is neither stimulated nor
diminished by fiscal policy.
• A balanced budget is an example of
fiscal neutrality, where government
expenditure is financed almost exactly by
 tax revenue. In other words, tax revenue
is equal to the government expenditure.
Twin Deficit
• Twin deficit occurs when a country has
both a current account deficit and a
fiscal deficit.
• It is also called a double deficit.
• India is an example of country with twin
deficit.
The Budget 2021-22
• Proposals under Budget 2021-22 will
further strengthen the Sankalp of Nation
First, Strong Infrastructure, Healthy India,
Good Governance, Doubling Farmer’s
Income, Education for All, Women
Empowerment, Opportunities for youth,
and Inclusive Development, among
others. This budget rest on 6 pillars.
» Health and Wellbeing: There is
substantial boost in investment in Health
Infrastructure and the Budget outlay for
Health and Wellbeing is Rs. 2,23,846 crore
in BE 2021-22 as compareed to 2020-
21 BE of Rs. 94,452 crore, an increase of
around 137 percentage.
» Physical & Financial Capital, and
Infrastructure:
− Finance Minister stated that for a USD
5 trillion economy, our manufacturing
segment has to grow in double digits
on a continuous basis.
− To achieve this goal the government
has committed nearly around Rs. 1.97
lakh crore in the next 5 years starting
FY 2021-22.
» Inclusive Development for Aspirational
171
India:
− Under this pillar, the Finance Minister
announced to cover Agriculture and
Allied sectors, farmers’ welfare and
rural India, migrant workers and
labour, and financial inclusion.
− To deliver adequate credit to our
cultivators, Indian Government has
enhanced the agricultural credit
target to Rs. 16.5 lakh crore in FY22.
Likewise, the allocation to the Rural
Infrastructure Development Fund
expanded from Rs. 30,000 crores to
Rs. 40,000 crores. The Micro Irrigation
Fund, with a corpus of Rs.5,000 crore
has been formed under NABARD will
be doubled.
» Reinvigorating Human Capital:
− The Union Government said that
the National Education Policy (NEP)
announced recently has had very
good reception, while adding that over
15,000 schools will be qualitatively
strengthened to incorporate all
components of the NEP.
− Budget also announced that 100
new Sainik Schools will be set up in
collaboration with NGOs/private
schools/states. Budget also proposed
to establish a Higher Education
Commission of India, as an umbrella
body having 4 separate vehicles for
accreditation, regulation, standard-
setting, and funding.
− For accessible higher education in
Ladakh region, Government intended
to establish a Central University in
Leh.
» Innovation and R&D:
 INNOVATION AND R&D
» Minimum Government and Maximum
Governance:
− Union government proposed to
take various steps to bring reforms
in Tribunals in the last few years for
quick delivery of justice and aims to
take further measures to rationalize
the performance of Tribunals.
− Government also introduced the
National Commission for Allied
Healthcare Professionals Bill in the
Parliament, with an aim to ensure
effective and transparent regulation
of the different 56 allied healthcare
professions.
− Government also announced that the
upcoming Census could be the 1st
digital census in the Indian History
and for this mission, Rs. 3,768 crores
allocated in the year 2021-2022.
172
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) In India, deficit financing is used for
raising resources for: 2013
(a) Economic development
(b) Redemption of public debt
(c) Adjusting the balance of payments
(d) Reducing foreign debt
Ans. (a)
• Explanation: Deficit financing is a
practical mechanism for economic
growth that the Indian government has
used to secure the money needed to fund
the five-year plans.
Q.2) With reference to Union Budget,
which of the following is/are covered under
Non-Plan Expenditure? 2014
1. Defence -expenditure
2. Interest payments
3. Salaries and pensions
4. Subsidies
Select the correct answer using the code
given below.
(a) 1 only
(b) 2 and 3 only
(c) 1, 2, 3 and 4
(d) None
Ans. (c)
• Explanation: There are two different
elements of expenditure, plan and non-
plan.
• Of these, plan expenditures are estimated
after consultations with each of the
relevant ministries and the Planning
Commission.
• Interest payments, subsidies (primarily
on food and fertilisers), wage and salary
payments to government workers,
grants to governments of States and
Union Territories, police, pensions,
economic services in different fields,
other general services like tax collection,
social services, and grants to foreign
governments account for non-plan
revenue expenditure.
• Non-plan capital expenditure mainly
consists of defence, loans to public
enterprises, loans to States, Union
Territories, and foreign governments.
Q.3) With Reference to the Fourteenth
Commission, which of the following
statements is/are correct? 2015
1. It has increased the share of States in
the central divisible pool from 32 per
cent to 42 per cent
2. It has made recommendations
concerning sector-specific grants
(a) 1 only
(b) 2 only
173
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (c)
• Explanation: The 14th commission
has recommended to increase the tax
devolution of the divisible pool to states
to 42 percent for the years 2015 to 2020.
This is 10% more compared to 32% target
set by 13th financial commission.
• The 14th commission has recommended
expansion of Interstate council for
cooperative federalism to identify sector-
specific grants to states.
Q.4) There has been a persistent deficit
budget year after year. Which of the
following actions can be taken by the
government to reduce the deficit? 2016
1. Reducing revenue expenditure
2. Introducing new welfare schemes
3. Rationalizing subsidies
4. Expanding industries
Select the correct answer using the code
given below.
(a) 1 and 3 only
(b) 2 and 3 only
(c) 1 only
(d) 1,2,3 and 4
Ans. (a)
• Explanation: Introduction of new welfare
schemes would entail more spending
and it goes just opposite to what we are
aiming to do i.e., decrease the deficit.
• Different policies to reduce a budget
deficit.
1. Cut government spending
2. Increase in taxation
3. Economic growth
4. End tax breaks and subsidies for big
oil, gas, and coal companies.
Q.5) Which of the following is/are
included in the capital budget of the
Government of India? 2016
1. Expenditure on acquisition of assets
like roads, buildings, machinery, etc.
2. Loans received from foreign
governments.
3. Loans and advances granted to the
States and Union Territories.
Select the correct answer using the code
given below.
(a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (d)
• Explanation: Under Article 112 of the
Indian Constitution, the Annual Financial
Statement (AFS) has to separate
expenditure of the Government on
revenue account from other expenditures.
• Therefore, Government Budget includes
the Revenue Budget and Capital Budget.
• Capital Budget comprises capital
payments and capital receipts.
• The capital receipts include loans
raised by Government from the public,
known as market loans, borrowings by
Government from central bank and
other parties through the sale of Treasury
Bills and loans obtained from foreign
Governments and entities, disinvestment
receipts and recoveries of loans from the
governments of State and Union Territory
and other parties.
• Capital payments comprise capital
expenditure on acquisition of assets such
as buildings, machinery, land, equipment,
as also investments in shares, etc., and
advances and loans granted by the
Union Government to the Governments
of State and Union Territory, Government
companies, Corporations, and other
parties.
174
Q.6) Consider the following statements:
2017
1. Tax revenue as a per cent of GDP of
India has steadily increased in the last
decade.
2. Fiscal deficit as a per cent of GDP of
India has steadily increased in the last
decade.
Which of the statements given above is/
are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (d)
• Explanation: Tax revenue as a % of GDP
of India has not steadily increased in the
last decade.
• Fiscal deficit as the per cent of GDP of
India has not steadily increased in the
last decade.
Q.7) Consider the following statements
2018
1. The Fiscal Responsibility and
Budget Management (FRBM) Review
Committee Report has recommended
a debt to GDP ratio of 60% for the
general (combined) government by
2023, comprising 40% for the Central
Government and 20% for the State
Governments.
2. The Central Government has domestic
liabilities of 21% of GDP as compared
to that of 49% of GDP of the State
Governments.
3. As per the Constitution of India, it
is mandatory for a State to take the
Central Government’s consent for
raising any loan if the former owes any
outstanding liabilities to the latter.
Which of the statements given above is/
are correct?
 (a) 1 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (c)
• Explanation: The FRBM Review
Committee (chaired by Mr N.K. Singh)
introduced a draft Debt Management
and Fiscal Responsibility Bill, 2017 to
replace the Fiscal Responsibility and
Budget Management (FRBM) Act, 2003.
• Key suggestions of the Committee and
important features of the draft Bill are
briefly summarised below.
» Debt to GDP ratio: The Committee
suggested using debt as the primary
focus for fiscal policy. Debt to GDP ratio
of 60% should be the target, with a 40%
limit for the centre and 20% limit for the
states. By 2023, the target debt-to-GDP
ratio should be met.
» Deviations: The Committee pointed out
that FRBM Act allows the government
to deviate from the targets in case of a
national security, national calamity or
other exceptional conditions notified by
it. Permitting the government to notify
these grounds weakened the 2003 Act.
The Committee recommended that
grounds in which the government can
deviate from the goals should be clearly
stated, and the government should not be
permitted to notify other circumstances.
175
Q.8) Consider the following statements:
2019
1. Most of India’s external debt is owed by
governmental entities.
2. All of India’s external debt is
denominated in Rs.
Which of the statements given above is/
are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (d)
• Explanation: The external debt of India
is the overall debt the country owes to
foreign creditors.
• The debtors can be the Union government,
state governments, corporations, or
citizens of India.
• The debt consists of money owed to
foreign governments, private commercial
banks, or international financial
institutions such as World Bank and the
International Monetary Fund.
• Commercial borrowings continued to be
the largest part of external debt with a
share of 37.4%, followed by NRI deposits
(24.1 per cent) and short-term trade credit
(19.9 per cent).
• U.S. Dollar denominated debt continued
to be the largest component of India’s
external debt, followed by the Indian
rupee, SDR, yen and euro.
 CHAPTER - 11

EXTERNAL SECTOR

• The rise in FOREX reserves was mainly on

External Sector account of an increase in foreign currency
assets(dominated by dollar), which rose
• The external sector of a country’s to $427.949 billion, gold reserves rose to
economy includes all international $28.058 billion, country's reserve position
economic transactions between residents with the IMF increased to $3.703 billion,
of the country (both public and private special drawing rights(SDR) were up to
sector) and the rest of the world. $1.447 billion.
• All economic activities that take place in • Hence, FCA > Gold > Reserve Position
foreign currency fall in the external sector with IMF > SDR.
like import, export, capital account,
foreign investment, the balance of
payment etc.
ECONOMIC
SURVEY
FOREX RESERVES
2019-20 In US $ billion
461.2
424.5 412.9
FOREX Reserve 370.0

• Foreign exchange reserves are the foreign

currency assets held by a country's
central bank (RBI). $
• They are also known as foreign currency
reserves or foreign reserves.
• In the context of India, foreign exchange 2016-17 2017-18 2018-19 2019-20
reserves include:

» Foreign Currency Assets (FCAs)- Largest

component of the FOREX Reserves
» Gold
» Special Drawing Rights (SDRs)
» Reserve position of RBI with International
Monetary Fund (IMF)
• FOREX reserves are used to back
liabilities (meets its foreign obligations)
and influence monetary policy.
• India’s foreign exchange reserves touched
a record high of US$ 461.157 billion, in
January 2020, according to the RBI data.
I M A G E 11.1: FOREX R E S E R V E S IN INDIA
Exchange Rate
• Exchange rate refers to the value of one
currency calculated in terms of another
currency.
• For example, at present approximately
Rs. 71 is exchanged for the US $ 1. Hence,
the value of one US Dollar is equal to 71
Indian rupees.

176

Exchange Rate
System
• An exchange rate system, establishes
the way in which the exchange rate is
determined, i.e., the value of the domestic
currency with respect to other currencies.
• There are many ways in which the
country's exchange rate is determined.
Floating Exchange Rate System
• In Floating or Flexible Exchange rate
system, exchange rate of currencies is
determined based on demand-supply
in the FOREX market relative to other
currencies.
• Thus, if the demand for the currency
is high and supply is low, the value will
increase. If demand is low and the supply
is high, this will drive that currency price
lower.
• A currency which uses a floating exchange
rate is known as floating currency.
• Most of the world's currencies are floating
and include the most widely traded
currencies: The United States Dollar, the
Swiss Franc, the Euro, the Japanese Yen,
the Pound Sterling, and the Australian
Dollar.
• However, even with floating currencies,
central banks often participate in the
markets to attempt to influence the value
of floating exchange rates.
Fixed Exchange Rate System
• In the Fixed or Pegged Exchange rate
system, the Exchange Rate of currencies
is determined by the central bank of the
country (RBI for India).
• The intention of a fixed exchange rate
system is to keep a currency's value
within a narrow limit.
177
• Most of countries switched to a floating
exchange rate in the early 1970s after
using a fixed exchange rate for decades.
• A fixed exchange rate system may
minimize instabilities in real economic
activities by reducing volatility and
fluctuations in the currency.
Devaluation
• It refers to the reduction in the value of
the domestic currency in terms of foreign
currency by the central bank.
• Countries that have a fixed exchange
rate use this monetary policy tool.
• RBI devalued Rupee three times in 1949,
1966, 1991.
Revaluation
• It refers to an increase in the exchange
rate of domestic currency by the central
bank.
Managed Exchange Rate
System
• A managed exchange rate is a hybrid
or mixture of the fixed and floating
exchange rate systems.
• Under this exchange rate, the domestic
currency is determined based on demand
and supply subject to the central bank
intervention in the FOREX market.
• The central bank cannot fix the exchange
rate, but it can affect currency exchange
rate both directly (by buying and
selling currencies) or indirectly (through
monetary policy).
• But in case of extreme fluctuations, the
central bank under managed floating
exchange rate system intervenes in the
FOREX market with the objective to
minimize the fluctuation in the exchange
rate of the currency.
• India adopted this form in 1993.
• Today most of the economies are
following a managed exchange rate
system for determining the exchange
rate of the currency.
Wider Band Exchange Rate
System
• Under this, the central bank (RBI) fixes
exchange rate bands (lower and upper
limit) for the domestic currency within
which it is permitted to fluctuate.
Crawling Peg Exchange Rate
System
• Under this central bank (RBI) fixes the
exchange rate band which is periodically
revised.
• It is a type of fixed exchange rate system
and is followed in China.
Foreign Exchange
Market
• The Foreign Exchange Market (also called
as FOREX) is a market where different
currencies can be bought and sold.
• Foreign Exchange market determines
foreign exchange rates for every currency.
• Foreign exchange markets are made
up of central banks, commercial banks,
brokers, exporters and importers,
immigrants, investors, tourists.
• Floating exchange rate system and
Managed exchange rate system used this
institutional framework for determining
the exchange rate of the currency.
178
Depreciation
• It refers to a reduction in the exchange
rate of a currency due to a change in
its demand and supply in the FOREX
market.
• Depreciation happens under a flexible
exchange rate system or under a
managed floating exchange rate system.
• For Example, if in previous month 1$ = Rs.
40 now 1$ = Rs. 50, hence rupee loses its
value in front of a dollar.
Impact of Depreciation/
Devaluation
Positive Impact
• It promotes export as it reduces the cost
of a country's exports, rendering them
more competitive in the global market.
• It discourages import as it increases the
cost of imports, so domestic consumers
are less likely to purchase them, further
strengthening domestic businesses.
• It helps in reducing the trade deficit and
current account deficit (CAD).
• It promotes inward foreign remittances
and foreign tourism.
Negative Impact
• It creates inflation as it increases FOREX
reserve which increases the money supply
and aggregate demand.
• It may adversely affect economic
growth as it creates cost-push inflation
due to increase in the prices of inflated
commodities in terms of domestic
currencies.
• It increases the burden of external debt
in terms of domestic currencies.
• It deteriorates terms of trade (it measures
the purchasing power of export of a
country in terms of quantity of imports).
Reasons for rupee depreciation
in recent years
• Supply of Rupee increased, and demand
of the Rupee decreased leading to a
demand-supply mismatch.
• Increase in crude oil prices which
increases total import cost. India is the
third-largest crude oil importing country
in the world.
• High Trade Deficit and High Current
Account Deficit (CAD).
• The protectionist policy adopted by the
major economies.
• A hike in the fed rates (as was observed
twice in 2018), strengthens the US Dollar,
which in turn leads to a depreciation of
the Indian currency.
Government/RBI measures to
check depreciation of Rupee?
• Restriction of Imports.
• Contractionary monetary policy.
• Liberalization of Foreign Investment
Policy.
• Sale of the dollar in the FOREX market
by RBI.
• Interest rate on NRI deposits increased
by RBI.
Appreciation
• It refers to the increase in the value of a
currency due to a change in its demand
and supply in the FOREX market.
• Appreciation happens under a flexible
exchange rate system or under a
managed floating exchange rate system.
• For Example, if in previous month 1$ = Rs.
65 now 1$ = Rs. 50, hence rupee gains its
value in front of a dollar.
179
Exchange Rate in
India
• Exchange rate policy in India has
undergone many changes over time
because of the opening of the economy
as part of the broader macroeconomic
reforms and liberalization since the early
1990s.
70
60
50
40
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19
I M A G E 11.2: E XC H A N G E R AT E $ RS
TO
• In the post-independence period,
exchange rate policy has been shifted
from a par value system to a basket-
peg and later to a managed floating
exchange rate system.
• The Bretton Woods System was finally
ended in 1971 due to dollar crisis in 1960s,
and the rupee was linked with the pound
sterling.
• It was necessary to overcome the
weaknesses associated with a single
currency peg and to ensure the stability
of the exchange rate. Thus, in September
1975, the rupee was pegged to a basket
of currencies which was continued till the
early 1990s.
• The initiation of economic reforms, India
moved to a floating currency regime
which involved the dual exchange rate
system (one official and other market-
determined).
• In March 1993, a unified exchange rate
system was introduced in place of the
dual exchange rate system.
Effective Exchange
Rate
• The effective exchange rate takes into
account the value of the domestic
currency against the weighted value of a
basket of foreign currencies. The weights
reflect the foreign countries’ share in the
domestic country’s trade.
• It measures the strength of domestic
currency with respect to currencies of
major trading partners.
• These are of two types:
» Nominal Effective Exchange Rate (NEER)
» Real Effective Exchange Rate (REER)
• Nominal Effective Exchange Rate (NEER)
and Real Effective Exchange Rate
(REER) are utilized to gauge the external
competitiveness of an economy.
Nominal Effective Exchange
Rate (NEER)
• Nominal Effective Exchange Rate (NEER)
is the weighted average of bilateral
nominal exchange rates of the home
currency in terms of foreign currencies.
• It is the exchange rate of the domestic
currency with respect to the basket
currencies (36 currencies), weighted by
the share of the basket country’s trade in
the domestic country’s trade.
• The nominal exchange rate is the amount
of domestic currency needed to purchase
foreign currency.
Real Effective Exchange Rate
(REER)
• Real Effective Exchange Rate (REER)
is a weighted average of nominal
exchange rates adjusted for relative price
180
differential (inflation rate) between the
domestic and foreign countries, it relates
to the purchasing power parity (PPP)
hypothesis.
• The REER considers the relative inflation
levels in two economies and thus
incorporates the concept of purchasing
power parity.
• An increase in REER implies that exports
become more expensive and imports
become cheaper; therefore, an increase
indicates a loss in trade competitiveness.
Current Account
• The current account keep records of
country’s transactions with the rest of
the world i.e. tracks the overall inflow
and outflow of goods, services, transfer
payments and investment incomes.
• It is called as the current account because
goods and services are usually consumed
in the current period.
• The current account is a significant
indicator of an economy's health.
• A positive current account balance
(current account surplus) indicates
the nation is a net lender to the rest
of the world thus increases a nation's
net foreign assets. A negative current
account balance (current account deficit)
indicates that it is a net borrower from
the rest of the world thus it decreases a
nation's net foreign assets.
• The current account represents the net
income of the country.
• Current account deficit is shown either
numerically by showing the total
monetary amount of the deficit, or in the
percentage of the GDP of the economy
for the concerned year.
• The main components of the current
account are:
» Trade in goods (visible balance)
» Trade in services (invisible balance)
 » Investment incomes: It includes which cause the changes in the assets
dividends, interest, and remittances. or liabilities of the residents or its
» Net transfers: It includes International government.
aid etc. • Capital Account includes the following:
» Foreign Direct Investment (FDI),
Current Account Deficit (CAD) » Foreign Portfolio Investment (FPI),
• Current Account Deficit calculates the » External Lending and Borrowing,
difference between inward and outward » Foreign Currency Deposits of banks,
flow of money on account of the trade
» External Bonds Issued by the Central
of goods and services and the transfer of
Government.
money from domestically owned factors
of production abroad. • Capital account shows the change in
• CAD includes the trade deficit along with ownership of assets, both within the
some other important factors like net country and outside.
income and transfer payments. • It gives a summary of the net flow of both
• Lower Current Account Deficit (CAD) private and public investment into an
reflects reduced external indebtedness of economy.
the country making domestic economic Capital Account = Foreign Direct
policy increasingly independent of investment + Foreign Portfolio
external influence. Investment + External Lending and
• Foreign Direct Investment (FDI) provides a Borrowing + Other Investments.
more stable source of financing the CAD • A capital account deficit shows that more
as compared to external borrowings. money is flowing out of the economy
• The primary reasons behind high CAD in along with an increase in its ownership
India are crude oil and gold imports. of foreign assets and vice-versa in case
• The Current Account Deficit can be of a surplus.
checked by boosting exports and
reducing non-essential imports such as
gold, mobiles and electronics. Balance of Payment
(BoP)
3.5
Annual
3.0

2.5
(per cent)

• It is the systematic record of entire

2.0

1.5

1.0 economic transactions of a country/

0.5
resident of a country with the rest of the
0.0
world throughout a financial year.
2009-10 to

Q1:16-17

Q2:16-17

Q3:16-17

Q4:16-17

Q1:17-18

Q2:17-18

Q3:17-18

Q4:17-18

Q1:18-19

Q2:18-19

Q3:18-19

Q4:18-19

Q1:19-20

Q2:19-20
2014-15 to
2018-19
2014-14

• The components of the balance of

I M A G E 11.3: C U R R E N T A C C O U N T D E F I C I T AS
P E R C E N TA G E O F GDP
payment are:

» Current account: It includes all kinds

Capital Account of current financial transactions of the
economy.

• Capital account records all the » Capital account: It includes all kinds
transactions between the residents of of capital financial transactions of the
the country and the rest of the world, economy.

181
» Official reserve transactions: It is
conducted by the central bank in case of
the BoP deficit or BoP surplus.
» Errors and omissions: It refers to the
balancing items reflecting the inability
to record all the international financial
transactions
• A country's balance of payments tells
you whether it saves enough to pay for
its imports or not.
• Balance of Payment account is
maintained as per the provision of the
double-entry bookkeeping system. Under
Current
Account
Visible
Import Export Services
I M A G E 11.4: B A L A N C E
Importance of BoP
• It provides detailed information related
to the demand and supply of a country's
currency.
• For example, India imports more than it
exports, then this means that there will
be more outflow of foreign currency from
domestic market. Thus, Rupee would be
under pressure to depreciate against
other currencies (other things being
constant).
• It examines all the export and import
transactions of goods and services.
• It can be used to evaluate the country’s
performance in international economic
competition.
182
this, every entry shown either as a credit
(inflow) or debit (outflow) are made in the
account for every transaction i.e. debit
and credit are always equal.
• If Balance of Payment is a positive at the
end of the financial year, the surplus is
automatically transferred to the FOREX
reserves of the country.
• And if there is any negative outcome, the
same foreign exchange is drawn from the
country’s FOREX reserves. If the FOREX
reserves are not capable of fulfilling the
negative BoP balance, it is known as a
BoP crisis.
Balance of
Payment
(BoP)
Capital
Account
Invisible Investment Loan Bank
Account
Incomes Transfers
OF P AY M E N T
• It helps the government to analyze the
export potential of a particular sector
and formulate policy to support its export
growth.
Convertibility
• It is a situation in which domestic
currency can be converted into a foreign
currency and vice versa at the prevailing
exchange rate without the government
intervention.
• There are two types of convertibility:
» Current account Convertibility
 − The freedom to convert domestic
currency into a foreign currency
with respect to the current account
transaction of BoP.
− Example: Import/Export of goods and
services, Remittances etc.
» Capital Account Convertibility
− The freedom to convert domestic
financial assets/liabilities and vice-
versa.
− Example: FDI, Loans, borrowing etc.
Impact of Convertibility/
Current Account Convertibility
Positive Impact
• It promotes foreign investment as it
enables foreign investors to withdraw
FOREX at will.
• It promotes inward remittances and non-
residential deposits.
• It supplements domestic capital
formation which increases output and
employment in the economy.
• It enables domestic investors and
companies to invest abroad.
• It enables domestic firms to borrow
from abroad at a relatively lower rate of
interest.
• It reduces the scope of illegal trade and
financial transactions like smuggling,
hawala etc.
Negative Impact
• Flight of capital i.e. withdrawal of huge
FOREX within a short period of time
(South Asian crisis 1997).
• It increases the vulnerability of the
domestic economy to external shocks.
• It increases volatility in domestic financial
markets.
183
• It increases the scope of speculation in
domestic currencies and securities.
Introduction of Convertibility
in India
• The budget 1992-93 replaced the fixed
exchange rate system with the Liberalized
Exchange Rate Management System
(LERMS) i.e., dual exchange rate system.
• The budget 1993-94 replaced the
LERMS with the managed exchanged
floating rate system. It also introduced
convertibility of Rupee for trade account
transactions.
• In August 1994, the government
introduced current account convertibility
[ it is mandatory as per Article 8 of IMF,
in case BoP situation of the member
country is stable].
• Since 1994 government and RBI has been
gradually liberalizing capital account
convertibility (CAC) norms i.e.
» The External Commercial Borrowing
(ECB) ceiling has gradually been raised.
» NRI deposit has been made fully
convertible.
» Outward remittance ceilings are
gradually being raised.
Committee on Capital Account
Convertibility
Tarapore Committee (1997)
• The Reserve Bank of India established
Committee on Capital Account
Convertibility (CAC) or Tarapore
Committee in 1997 for suggesting a
roadmap on full convertibility of Rupee
on Capital Account.
• The key highlights of the Report including
the preconditions to be achieved for the
full floating of money are as follows:
» Gross Fiscal Deficit to GDP ratio to be
reduced from a budgeted 4.5% in 1997-
98 to 3.5% in 1999-2000.
» Inflation rate should remain between
3-5% for the 3-year period between
1997-2000
» External sector policies should be framed
to raise current receipts to GDP ratio and
reduce the debt servicing ratio from 25%
to 20%.
» A consolidated sinking fund should be
constituted to meet debt repayment
needs of the government. The fund
should be financed by increasing RBI's
profit transfer to the government and
disinvestment proceeds of public sector
undertakings.
» Four indicators should be used for
evaluating the adequacy of foreign
exchange reserves to safeguard against
any emergency. Also, a minimum net
foreign asset to currency ratio of 40 per
cent should be prescribed by law in the
RBI Act.
Second Tarapore Committee on
Capital Account Convertibility
(2006)
• Reserve Bank of India set up the second
Tarapore committee to set out the
framework for Fuller Capital Account
Convertibility in relation to the progress
made in economic reforms, the stability
in the external and country’s financial
sectors, accelerated growth and
integration with global economy.
• Some important recommendations of
the committee are:
» The committee suggested 3 phases for
adopting the full convertibility of rupee
in capital account.
− First Phase in 2006-07
− Second phase in 2007-09
184
− Third Phase by 2011.
» The upper limit for External Commercial
Borrowings (ECB) should be raised for
automatic approval.
» NRI should be permitted to invest in
capital markets
» NRI deposits should be given tax benefits
» Existing P-Notes holders should be given
an exit route to phase out completely the
PN notes.
» Improvement of the Banking regulation.
• As of now, the rupee is fully convertible
on the current account, but only partially
convertible on the capital account.
• Tarapore Committee has given the
following benefits of capital account
convertibility to India:
» Availability of large funds to supplement
domestic resources and thereby promote
economic growth.
» Improved access to international
financial credit markets and a reduction
in the cost of capital.
» Incentive for Indians to acquire and hold
international securities and assets
» Improvement of the financial system in
the context of global competition
Foreign Investment
• Foreign investment includes capital flows
from one country to another country.
• With globalization, more and more
companies have branches in countries
around the world because of the
attractive opportunities for cheaper
production, labour and lower or fewer
taxes.
• Foreign investment in a country is a good
sign that often leads to the increase of
jobs and income.
• As more foreign investment comes into a
country, it can lead to greater investments
 because individuals/companies see the
country as economically stable.
• Foreign investments can be divided into:
» Foreign Direct Investment (FDI)
» Foreign Portfolio Investment (FPI)
Foreign Direct
Investment (FDI)
• The foreign direct investment (FDI) is
an investment made by an individual or
a firm located in one country into the
company located in another country.
• Under FDI, a foreign investor establishes/
acquires the business entity in the host
country along with the management
rights.
• Definition of FDI by the IMF:
“An investment through which an
investor acquires lasting and substantial
management control (at least 10%
equity or voting rights) in the foreign
affiliates”.
• FDI are usually made in open economies
which offer a skilled labour and growth
potential for the investors, as opposed to
strictly regulated economies.
Components of FDI
• Foreign direct investment has the
following component as mentioned by
IMF:
» Equity Investment: Foreign direct
investor’s purchase of shares of an
enterprise.
» Retained Earnings/Reinvested Earning:
Earnings not distributed as dividends.
» Intra Company Debt Transfer: Short/
long-term borrowing & lending between
direct investors.
185
Method of FDI
• There are multiple methods through
which foreign direct investor may acquire
voting power of an enterprise in an
economy:
» By acquiring shares in an enterprise.
» Mergers and acquisitions
» Establishing a subsidiary of a domestic
company in a foreign country
» Joint ventures with foreign corporations
Advantage of FDI
• FDI supplements domestic capital
formation which creates employment
and stimulates economic growth in the
host country.
• They bring modern technologies,
managerial and entrepreneurial skills,
marketing strategies etc. along with the
foreign capital in the host country.
• They promote competition by suppressing
domestic monopolies.
• They provide a wide variety of quality
products to people at competitive prices.
It increases the standard of living of
people.
• They promote industrial diversification in
host countries.
• They promote the development of
infrastructure by directly investing in
infrastructure projects as well as by
creating demand for such services.
• They provide significant tax revenue to
the host government.
• They promote globalization of the host
economies.
• They tend to reduce the factor price
differential across nations i.e., they tend
to increase wage rate and decrease
interest rate in underdeveloped countries
and developing countries and vice-versa
to developed countries.
Disadvantages of FDI
• They adversely affect domestic
companies especially MSME. It may
worsen unemployment in the host
(developing) countries due to export
substitution and reimports than
employment through additional exports
to host countries.
• It can be the new wave of imperialism
reflected by use of power and economic
influence to dominate smaller countries.
• They may intervene in the domestic
economic policy of the host government.
• They aggravate income and regional
inequalities.
• They induce dualism (the sharp difference
between traditional and modern sectors)
in the host (developing) countries.
• They repatriate huge FOREX reserves
in various forms like high dividend,
interest, royalties etc. In the long run, they
deteriorate the current account deficit
(CAD) of host (developing) countries.
• They promote excessive consumerism by
indulging in excessive advertisement and
superficial product differential.
• It leads to escalation in prices of assets
which may lead to local resentment
(Asset Price Bubble).
India’s FDI Policy
• FDI policy comes under the Ministry of
Industry and Commerce (Department
for Promotion of Industry and Internal
Trade (DPIIT)).
• The 1991 Balance of Payment (BoP) crisis
led to major reform in FDI policy. Some of
them are as follows:
» New Industrial Policy,1991
− Industrial licensing was abolished
except for a few important sectors.
− Many sectors are open to foreign
186
participation.
− Major bodies set up to promote and
facilitate FDI inflows, such as the
Foreign Investment Promotion Board
(FIPB).
» Liberalization of Exchange Rate System
(LERMS)
− The initiation of economic reforms,
India moved to a floating currency
regime which involved the dual
exchange rate system (one official
and other market-determined).
− In March 1993, the unified exchange
rate system was introduced by
replacing dual exchange rate system.
» Introduction of partial capital account
convertibility (CAC).
» Foreign Exchange Regulation Act (FERA)
was replaced by the Foreign Exchange
Management Act (FEMA) in 1999.
» Press Note 18 was abolished in 2005
− Under PN18, the foreign investor
having joint ventures in India needed
No Objection Certificate from their
Indian joint venture partner for
investing any business in India.
» FDI in Multibrand Retail 2012
− Allowing 100% FDI ownership in
single-brand retail trading and up to
51% FDI in multi-brand retail.
Recent FDI Reform
• In the coal sector, 100% FDI under
automatic route for coal mining along
with the activities associated with
processing infrastructure will attract
international players to create an efficient
and competitive coal market.
• 100% FDI under automatic route has
been allowed in contract manufacturing
to give a big boost to domestic
 manufacturing. • During Q2 2019-20, India received
• In single-brand retail trading (SBRT), the the maximum FDI equity inflows from
definition of 30 per cent local sourcing Singapore, followed by Mauritius,
norm has been relaxed and online sales Netherlands, USA, and Japan.
permitted without prior opening of brick • An increase in net FDI inflow also gives
and mortar stores. a more stable source of funding than
• 100% FDI is allowed in the Defence the Current Account Deficit and in
industry; wherein 49% is allowed under that sense provides greater stability
automatic route and beyond 49% to the improvement in BoP position as
through Government route. compared to other capital inflows.

• 100 % FDI is permitted for insurance

intermediaries.
Foreign Portfolio
India and FDI
Investment (FPI)
• As per the Department for Promotion of • Foreign Portfolio Investment (FPI) is
Industry and Internal Trade (DPIIT), FDI the investment by non-residents in
equity inflows in India stood at US$ 446.11 Indian financial assets including shares,
billion during March 2000 to September government bonds, corporate bonds,
2019, indicating that the government's convertible securities, infrastructure
efforts and initiatives to improve ease of securities etc.
doing business climate and relaxation in • The class of investors who make an
FDI norms is yielding results. investment in these securities are known
• Data for Q2 2019-20 indicates that as Foreign Portfolio Investors.
the service sector attracted the • Foreign Portfolio Investor (FPI) was
highest FDI equity inflow, followed by created based on the recommendation
the telecommunications sector, and of K. M. Chandrasekhar Committee
computer software and hardware. by merging the existing three investor
40.0
classes

35.0
» FII (Foreign Institutional Investor)
» Sub Accounts
30.0
» Qualified Foreign Investors (QFI)
• Foreign Portfolio Investment (FPI) is more
25.0

20.0
liquid than foreign direct investment
because FPIs can be sold off quickly and
15.0 FPIs are seen as short-term attempts to
make money, rather than a long-term
10.0 investment in the economy.
Apr-Nov: 19-20

Apr-Now: 18-19

2018-19

2017-18

2016-17

2015-16

2014-15

• Portfolio Investment by any single

investor or investor group cannot exceed
10% of the equity of an Indian company,
I M A G E 11.5: FDI I N F L OW S IN INDIA beyond which it will now be treated as
FDI.

187
 Net FDI inflows Net FPI infows
15.0

10.0
(US$ billon)

5.0

0.0
Q1:17-18

Q2:17-18

Q3:17-18

Q4:17-18

Q1:18-19

Q2:18-19

Q3:18-19

Q4:18-19

Q1:19-20

Q2:19-20
-5.0

-10.0

I M A G E 11.6: FDI & FPI I N F L OW

• An increase in net FPI inflows improves and QFIs to be merged into FPIs.
the BoP position and arises on account » Portfolio investments to be defined as
of cross-border transactions involving investment made by any single investor
debt or equity securities, other than those or group of investors, which shall not
included in direct investment or reserve surpass 10% of the equity of an Indian
assets. company or a firm. Any investment
• Portfolio investment is generally referred beyond the limit of 10% to be termed as
to as “hot money” because of its tendency FDI.
to flee at the first signs of trouble in the » The aggregate investment threshold
economy or improvement in investment of FPIs to be 24 % (being the present
attractiveness elsewhere in the world. default aggregate limit for FIIs, which
can be increased by the company up to
the sectoral cap).
Committee on Rationalization » Know Your Client ("KYC") checks are
of Roots of Portfolio based on risk categorization of FPI.
Investment
− Low Risk (Category I): Government
• To rationalize/harmonize, and thereby, and Government-related entities.
ease the entry routes for various foreign − Medium Risk (Category II): Regulated
portfolio investors into India, SEBI set entities such as Banks, Asset
up a Committee in 2014 under the Management Companies, Broad-
Chairmanship of K.M. Chandrasekhar. Based Funds such as Mutual Funds
• The major recommendations of the etc.
committee are as follow: − High Risk (Category III): All other FPIs
» A new investor type, "Foreign Portfolio not qualified to be included in the
Investor" ("FPI"), by replacing FIIs and above two Categories to be included
QFIs. Existing FIIs, their sub-accounts in Category III (High Risk) FPI.

188
» FPIs under the Category III to be not » SEBI should do away with the additional
allowed to issue Offshore Derivative Know Your Customer (KYC) requirements
Instruments ("ODI")/Participatory Notes for the beneficial owner in case of
("PN"). government related FPI’s.
» The panel also recommended that the
new rules should be equally applied to
HR Khan Committee on the investors using participatory notes
Foreign Portfolio Investment (P-notes).

• SEBI constitutes H R Khan Committee in » The committee recommended that

2014 to review FPI norms and concerns
raised by the investors.
• The major recommendations of the
committee are as follow:
» NRIs, overseas citizens of India and
resident Indians should be permitted to
hold stakes in the non-controlling nature
in FPIs and there should be no restriction
on them to manage non-investing FPIs or
SEBI-registered offshore funds.
» NRIs will be permitted to invest as FPIs
if the single holding is under 25% and
group holding under 50% in a fund,
according to the panel.
erstwhile PIOs (Person of Indian Origin)
should not be subjected to any restrictions
and clubbing of investment limits should
be allowed for well-regulated and publicly
held FPIs that have common control.
» Time for compliance with new norms
should be extended by six months after
they are finalized and also the non-
compliant investors should be given
further 180 days to wind down their
existing positions.
» The panel also recommended for
changes in the norms for identifying the
senior managing officials of FPIs and for
beneficial owners of listed companies.

Difference Between FDI vs FPI

Basis for Foreign Direct Investment (FDI) Foreign Portfolio Investment
Comparison (FPI)

Definition FDI is the investment made by FPI referred to as investing in

the foreign investors to gain
a substantial interest in the
company located in a different
country.
Role of investors Active
the financial assets of a foreign
country, such as bonds, stocks
etc.
Passive

Type Direct Investment Indirect Investment

Investment Invests in financial & non- Invests only in financial assets.

financial assets.
Term Long term investment Short term investment

Volatility Stable Highly Volatile

189

Foreign Trade
• Foreign trade includes all imports and
exports to and from India.
• At the level of Central Government,
it is administered by the Ministry of
Commerce and Industry.
• The inflow of goods is called as import
trade whereas the outflow of goods is
called as export trade.
• The trade balance is the gap between the
monetary value of exports and imports
in the economy, it is one of the most
significant macroeconomic indicators.
Foreign trade Policy
There are various types of foreign trade
policy.
Free Trade Policy
• It is a trade policy with least restriction
on trade i.e. trade takes place without
barriers such as quotas, tariff, and foreign
exchange controls.
• Thus, under free trade, goods and services
flow freely between countries.
• Free trade implies absence of
governmental intervention on
international trade among different
countries of the world.
• It is also termed as outward-oriented
trade policy.
Protectionist Trade Policy
• It is a trade policy with a restriction on
trade through various trade barriers.
• It is always termed as inward-oriented
trade policy.
• Trade barrier: Government policy to
restrict trade. It includes:
» Tariff Barriers
190
− It is a custom, duty or a tax imposed
on products that move across borders.
− It includes Import duty, Export duty
etc.
» Non-Tariffs barriers
− These are non-tariff restrictions
such as government regulation and
policies with respect to overall trade.
− It includes Quotas, Subsidies, Sanitary
and Phytosanitary requirements etc.
− A number of times Alphonso mangoes
from Maharashtra are rejected by
European countries on grounds
of not meeting the Sanitary and
Phytosanitary requirements.
Export Promotion
Schemes
• Duty Drawback Schemes:
» Under this scheme, custom/excise duty
paid by exporters of selected products is
partially or wholly reimbursed.
• Export Promotion Capital Goods
(EPCG)
» Under this scheme, exporters can import
capital goods at zero or concessional
custom duty subject to an export
obligation.
• Focus Market Scheme
» Exporters are provided duty credit scripts
equivalent to 3% of Free on Board (FOB)
value of exports if they are exporting to
selected destinations/countries.
• Focus Product Scheme
» Under this exporter of selected labour
intensive product (e.g. handicraft) are
provided duty credit script equivalent to
2% of FOB value of exports.

India’s Medium-
Term Export Policy:
Foreign Trade
Policy, FTP (2015-20)
• It was announced on 1st April 2015 by the
Ministry of Industry and Commerce.
• It seeks to enhance the competitiveness
of export by adopting systemic reforms
rather than incentivizing exports through
subsidies.
• It seeks to focus on higher-value addition
and technology in future with a focus on
quality and standard.
• It seeks to rectify the inverted duty
structure. It is a situation in which higher
custom duties are imposed on imports of
input/raw material vis-a-vis on import of
finished or final goods.
• It is drafted in consonance with other
initiatives of the government like Make
in India, Ease of doing business, Digital
India, Skill India etc.
Objective
• To increase India’s Share in world export
to 2% to 3.5% by 2020.
• To double the export of goods and
services by 2020.
Features
• Merchandise Exports Incentive Scheme
(MEIS)
» The Government of India has introduced
the Merchandise Exports Incentive
Scheme (MEIS), which replaced five
other incentive schemes of Foreign Trade
Policy 2009-14.
» The schemes which are replaced by the
MEIS scheme are:
191
− Focus Product Scheme (FPS)
− Focus Market Scheme (FMS)
− Market Linked Focus Product Scheme
(MLFPS)
− Agri. Infrastructure incentive scheme
− Vishesh Krishi Gramin Upaj Yojna
(VKGUY)
» The scheme provides incentives in the
form of duty credit scrip (entitles the
bearer to receive something in return) to
the exporter to compensate for his loss
on payment of duties.
» The incentive is paid as a percentage of
the realized FOB value (in free foreign
exchange) for notified goods sold in
notified markets
• Service Exports from India Scheme
(SEIS)
» The Government has also introduced the
Service Exports from India Scheme (SEIS)
under the Foreign Trade Policy (FTP)-
2015-20. It replaced the earlier scheme
'Served from India Scheme’ under Foreign
Trade Policy, 2009-15.
» The key objective is to make our services
globally competitive in terms of price.
» These SEIS scrips are transferable and
can also be used for payment of a
number of Central taxes/duties including
the basic customs duty.
• Export Promotion Capital Goods (EPCG)
» Under this scheme, the export obligation
has been reduced to 75%.
• Trade Facilitation
» Online filling of document/application in
a 24*7 environment.
» CA/CS can file digitally signed documents.
» Exporter/Importers profiles will be
created to eliminate multiple submission
of the document.
» The FTP to be reviewed after two and
half years instead of annual reviews.
Critical Appraisal of FTP Policy »
(2015-20) » Development of infrastructure facilities.
• Subsidies have been reduced.
• Gave more flexibility to exporters and
importers.
• Aligned with Make in India.
Special Economic
Zones (SEZ)
• A special economic zone is a region
in the country that is subject to unique
economic rules and regulations that
differ from other regions of the same
country.
• Traditionally the biggest deterrents to
foreign investment in India have been
high tariffs and taxes, red tape and
strict labour laws. The SEZ regulations
were made conducive to foreign direct
investment (FDI).
• These areas have developed
infrastructure, liberal economic policy,
and concession tax rates for the firms.
• SEZ Policy was introduced to India in
2000. Prior to SEZ introduction, India
relied on export processing zones (EPZ)
which failed to make an impact on
foreign investors.
• To instill confidence in investors and
highlight the Government's commitment
to a stable SEZ policy regime. In May
2005, parliament passed The Special
Economic Zones Act, 2005.
• The key objectives of the SEZ Act 2005
include:
» Creation of additional economic
activities.
192
» Promoting exports of goods and services.
» Promoting investment from domestic
and foreign sources.
Creation of employment opportunities.
• SEZ can be set up by:
» Public/State government or its agencies
» Private/Joint sector
» Foreign agency
• According the SEZ Act there are four types
of SEZs in India, classified according to
their size:
» Multi-sector (1,000+ hectares).
» Sector-specific (100+ hectares).
» Free Trade & Warehousing Zone (FTWZ)
(40+ hectares).
» Tech, handicraft, non-conventional
energy, gems & jewellery (10+ hectares)
• Presently, 351 SEZs are notified, out of
which 232 SEZs are operational.
Reverse Special
Economic Zones
(R-SEZ)
• Reverse SEZ is an import-oriented area,
located outside the country’s border in
order to get cheap, import duty-free/
exempt raw materials.
• Under this, Indian chemical and Petro-
chemical companies will set up plants
in other countries which have abundant
and cheap feedstock for importing back
their output.
• The Ministry of Chemical and Fertilizers
is exploring options to set up R-SEZ in
Iran, Myanmar.
• The 1st R-SEZ is proposed to be
 established in the Chabahar Port area of
Iran.
• Objective: To ensure the supply of
cheap industrial chemicals for the
domestic chemical, petrochemical, and
fertilizer industry in order to enhance its
competitiveness and increase its export
potential.
International
Financial Service
Centre (IFSC)
• Financial center that caters to clients
outside their own jurisdiction are called as
international (IFCs) or offshore Financial
Centers (OFCs).
• All such centres are ‘international’ in
the sense as they deal with the flow of
finance and financial products/services
across borders.
• An IFSC is therefore a jurisdiction that
provides world-class financial services to
non-residents as well as residents, up to
the extent permissible under the current
rules and regulations, in a currency other
than the domestic currency of the place
where the IFSC is situated.
• The objective of IFSC are:
» To increase tax revenue.
» To create a high-value job.
» To create an avenue for financial
globalization.
GIFT City
• Gujarat International Finance Tec-
City (GIFT City) multi-services special
economic zone (SEZ) has established
the first International Financial Service
Centre in India (IFSC) under the provisions
of SEZ Act 2005 (SEZ Act), SEZ Rules
2006 in Gandhinagar, Gujarat.
193
• The IFSC in GIFT City (IFSC-GIFT) will
be developed as a global financial
and information technology services
hub which be at par with globally
benchmarked financial centres such
as London, Hong Kong, Singapore, and
Dubai.
• An IFSC strives to bring those types of
financial services and transactions to India
which are currently performed outside
India by overseas financial institutions
and overseas branches/subsidiaries of
Indian financial institutions.
• IFSC has been designated as a 'deemed
foreign territory' for all practical purposes
which would have the same ecosystem
as other offshore locations, but which is
physically on Indian soil.
• Any financial institution (or its branch) set
up in the IFSC is
» Treated as a non-resident Indian located
outside of India,
» Expected to carry out business in such
foreign currencies and with such entities,
regardless of resident or non-resident,
which will be decided by the Regulatory
Authority,
» No other regulations shall apply to a
unit located in IFSC, subject to certain
provisions.
• The financial regulators such as the
Reserve Bank of India (RBI), Securities
and Exchange Board of India (SEBI), the
Department of Financial Services and the
Insurance Regulatory and Development
Authority of India (IRDAI) issued the
following regulations and guidelines to
operationalize IFSC-GIFT in India under
the provisions of the SEZ Act.
Globalization
• It refers to the integration of an economy
with the world economy. It is achieved
by removing the restriction on the flows
 of goods and service, foreign capital,
technology transfer and movement of a
natural person across the nations.
• It is a multidimensional concept, i.e. it
includes integration of nations in terms
of social, cultural and political etc.
Advantage
• It enables the allocation of resources on
the basis of comparative advantage of
various nations. Each country specializes
in the production of these commodities
in whose it is most efficient. It increases
productivity and production at the global
level.
• It enables economic entities to specialize
and achieve economies of scale (benefit
of large-scale production).
• Globalization enables worldwide
access to cheap raw materials, labour,
technology, and this enables firms to be
cost-competitive in their own markets
and in overseas markets.
• Globalization has increased flows of inward
investment between countries, which has
resulted in benefits for recipient countries.
Disadvantage
• During the globalization process,
multinational companies have become
more powerful and influential.
• The threat of loss of jobs in domestic
markets because of unfair, free trade
and structural changes arising from
globalization.
• The over-standardization of products
through global branding chain of
multinationals is a common criticism of
globalization.
• Globalization has made the economies
of the world interdependent on each
other. Failure of economy of one country
creates ripples in number of countries.
Other Terms
J-Curve Effect
• It refers to a phenomenon wherein the
trade balance of a country worsens
following the depreciation of its currency
before it improves mainly because higher
prices on imports will be greater than the
reduced volume of imports.
• It has a short-run effect.
Free on Board (FOB)
• Free on Board (FOB) takes into account
cost incurred on export/import till the
port of loading.
• Cost Insurance Freight (CIF) takes into
account cost incurred on export/import
until the port of destination.
Hard Currency
• Hard currency or strong currency is any
globally traded currency that serves as a
reliable and stable store of value.
• It is a currency that everybody trusts
because they expect it will maintain its
value and not suffer from frequent, sharp
exchange rate fluctuations.
• Hard currencies are widely accepted
across the world since it is stable,
convertible, and enjoys the confidence of
investors, traders, and tourists.
• Basically, the economy with the large and
diversified exports which are compulsive
imports for other countries will create
high demand for its currency in the world
and become the hard currency.
• Some of the best hard currencies of the
world today are, Euro (€), Japanese Yen
(¥) and Pound Sterling (£).

194
Soft Currency
• Soft currency is very sensitive and
fluctuates more often. Such currencies
react very sharply to the economic and
political development of a country.
• It is also referred as weak currency due to
its unstable nature.
• Soft currency is easily available in any
economy in its FOREX market.
• For example, the rupee is a soft currency
in the Indian FOREX market.
Hot Currency
• Hot Currency is the flow of funds (or
capital) from one country to another in
order to earn a short-term profit.
• Hot Currency continuously shifts from
countries where interest rates are low to
those countries where interest rates are
higher.
• Such sudden withdrawal of foreign
currency from the market adversely
impacts the exchange rate and potentially
impact a country's balance of payments
• As international investors run behind
profits, they substantially gain from
higher interest rates in different markets.
Cheap Currency
• Cheap Currency refers to money in which
loans and advances are made available
on the low-interest rate and on easy
terms.
• If a Government starts re-purchasing its
bonds before their maturities (at full-
maturity prices) the money which flows
into the economy is known as the cheap
currency.
Dear Currency
• Dear money is hard to obtain because of
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high-interest rates.
• It is often referred to as tight money
because it occurs in periods when central
banks are tightening monetary policy.
• When a government issues bonds, the
money which flows from the public to the
government or the money in the economy,
in general, is called dear currency.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) Consider the following actions
which the Government can take: 2011
1. Devaluing the domestic currency.
2. Reduction in the export subsidy.
Which of the above action/actions can help
in reducing the current account deficit?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (a)
Explanation: Devaluation means
deliberate reduction in the value of a
country's currency. If currency is devalued,
the price of imported goods then increases,
therefore, the quantity demanded of
imports falls. Currency devaluation makes
the exports cheap, thus consequently
exports are increased, and FOREX also
rises.
Protectionism: This policy is enforced by
imposing direct controls on imports by
enforcing barriers against imports or by
providing assistance to exporters.
Specific measures taken to implement
the policy is increasing tariffs of quotas,
subsidies to domestic firms, Reduction in
the export subsidy, discrimination against
imports and favouritism of domestic
firms. This then reduces imports and may
improve the current account. Yet this policy
leads to retaliation, resulting in decreased
exports and domestic industries may
become uncompetitive as they have no
incentive. The short-term gains will then be
eroded away proving that this policy is not
an effective long-term solution.
Reduce domestic consumption and
spending on imports (e.g. tight fiscal
policy/higher taxes).
Q.2) Both Foreign Direct Investment (FDI)
and Foreign Institutional Investor (FII)
are related to investment in a country.
Which one of the following statements
best represents an important difference
between the two? 2011
(a) FII helps bring better management
skills and technology, while FDI only
brings in capital
(b) FII helps in increasing capital
availability in general, while FDI only
targets specific sectors
(c) FDI flows only into the secondary
market, while FII targets primary market
(d) FII is considered to be more stable
than FDI
Ans. (b)
• Explanation: FDI is an investment by
a parent company in other businesses
located in foreign countries. On the
other hand, FII is an investment made by
an investor in the markets of a foreign
nation.
• It is much easier for FIIs to enter and exit
the stock market which is not the case
with FDI.
• Foreign Direct Investment targets a
specific enterprise. The FII increasing
capital availability in general.
• The Foreign Direct Investment is more
stable than Foreign Institutional Investor
as FDI gives long term returns.
Q.3) Which of the following would include
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Foreign Direct Investment in India? 2012
1. Subsidiaries of companies in India
2. Majority of foreign equity holding in
Indian companies
3. Companies exclusively financed by
foreign companies
4. Portfolio investment
Select the correct answer using the codes
given below:
(a) 1, 2, 3 and 4
(b) 2 and 4 only
(c) 1 and 3 only
(d) 1, 2 and 3 only
Ans. (d)
• Explanation: FDI can be made in a
number of ways, such as opening of a
subsidiary or associate company in a
foreign country, controlling or acquiring
an interest in an existing foreign company,
or by way of a merger or joint venture
with a foreign company.
• FDI is an investment done by a firm
or individual located in one country
into business interests located in other
country.
• Mostly, FDI takes place when an investor
establishes foreign business operations
or acquires foreign business assets,
comprising establishing ownership or
controlling interest in a foreign company.
• FDIs are distinguished from portfolio
investments in which an investor merely
purchases equities of foreign-based
companies.
Q.4) Consider the following statements:
2012
The price of any currency in the
international market is decided by the
1. World Bank
2. demand for goods/services provided
by the country concerned
3. stability of the government of the
 concerned country
4. economic potential of the country in
question
Which of the statements given above are
correct?
(a) 1, 2, 3 and 4
(b) 2 and 3 only
(c) 3 and 4 only
(d) 1 and 4 only
Ans. (b)
• Explanation: Price of any currency in
the global market is determined by the
demand for goods/services produced by
the country.
• If the demand for the commodity is high,
then the currency would be strong. The
current depreciation of the Indian Rupee
is due to rising oil prices.
• The stability of the government in the
concerned country plays an important
role in determining the prices of currency.
Q.5) The balance of payments of a country
is a systematic record of 2012
(a) all import and transactions of a
country during a given period normally
a year
(b) goods exported from a country
during a year
(c) the economic transaction between
the government of one country to
another
(d) capital movements from one country
to another
Ans. (a)
• Explanation: The balance of payments
is a record of all transactions between
parties in one country and the rest of the
world over a specified time period, such
as a quarter or a year.
• The balance of payments categorizes
transactions in two accounts: the current
account and the capital account.
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• The current account involves transactions
in goods, services, investment incomes
and current transfers.
• The capital account includes transactions
in financial instruments and central bank
reserves.
• The current account is incorporated in
calculations of national output, while the
capital account is not.
• If a country cannot pay its import bills
through export earnings, then import
bills are paid though FOREX reserves.
• This condition is generally called as a
balance of payment deficit, using the
narrow definition of the capital account
that excludes central bank reserves.
Q.6) Which of the following constitute
Capital Account? 2013
1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment
Select the correct answer using the codes
given below.
(a) 1, 2 and 3 only
(b) 1, 2 and 4 only
(c) 3 and 4 only
(d) 1, 2 and 3
Ans. (b)
• Explanation: The two key components
of a nation's balance of payment are the
capital account and the current account.
• Whereas the current account reflects a
nation’s net income, the capital account
reflects the net change in ownership of
assets.
• Thus, it is clear that private remittances
are part of the current account.
• On the other hand, foreign Loans, FII
(Foreign Institutional Investor) and FDI
Foreign Direct Investment are part of the
 capital account.
• Remittances fall under Current Account.
Q.7) Which one of the following
groups of items are included in India’s
foreign-exchange reserves? 2013
(a) Foreign-currency assets, Special
Drawing Rights (SDRs) and loans from
foreign countries
(b) Foreign-currency assets, gold
holdings of the RBI and SDRs
(c) Foreign-currency assets, loans from
the World Bank and SDRs
(d) Foreign-currency assets, gold
holdings of the RBI and loans from the
World Bank
Ans. (b)
• Explanation: Foreign-exchange reserves
(also known as FOREX reserves) are, in
a strict sense, only the foreign-currency
deposits held by central banks of the
country and monetary authorities
(excluding gold).
• But, in popular usage it also comprises
gold reserves, special drawing rights
(SDRs) and reserve status of International
Monetary Fund (IMF) because this total
figure, which is generally more accurately
termed as official reserves or official
international reserves or international
reserves, is more readily available and
also arguably more meaningful.
Q.8) With reference to Balance of
Payments, which of the following
constitute the Current Account? 2014
1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Right
Select the correct answer using the code
given below.
(a) 1 only
198
(b) 2 and 3
(c) 1 and 3
(d) 1, 2 and 4
Ans. (c)
• Explanation: The two key components
of a nation's balance of payment are the
capital account and the current account.
• Whereas the current account shows a
nation’s net income, the capital account
reflects the net change in ownership of
assets.
• Thus, it is clear that private remittances
are part of the current account.
• On the other hand, foreign Loans, FII
(Foreign Institutional Investor) and FDI
Foreign Direct Investment are part of the
capital account.
• Remittances fall under the Current
Account.
Q.9) Convertibility of rupee implies: 2015
(a) being able to convert rupee notes
into gold
(b) allowing the value of the rupee to be
fixed by market forces
(c) freely permitting the conversion of
rupee to other currencies and vice versa
(d) developing an international market
for currencies in India
Ans. (c)
Explanation:
• Rupee convertibility refers to a
mechanism in which any sum of rupee
can be converted into any other currency
without the need to specify the intent of
the foreign exchange.
• Non-convertibility is typically specified
in terms of transactions for which foreign
exchange cannot be legally purchased
(for example, the import of consumer
goods) or transactions that are regulated
and authorized on a case-by-case basis
(like regulated imports etc.).
Q.10) The problem of international liquidity
is related to the non-availability of: 2015
(a) goods and services
(b) gold and silver
(c) dollars and other hard currencies
(d) exportable surplus
Ans. (c)
• Explanation: The concept of
international liquidity is related with
international payments. These types
of payments arise out of international
trade in goods and services and also
in connection with capital movements
among one country and another.
• International liquidity refers to the
commonly accepted official means of
settling imbalances in international
payments which is basically dollars and
hard currencies.
Q.11) In the context of India, which
of the following factors is/are
contributor/contributors to reducing
the risk of a currency crisis? 2019
1. The foreign currency earnings of India’s
IT sector
2. Increasing the government expenditure
3. Remittances from Indians abroad
• Increasing government expenditure
contributes to the rise of fiscal deficit.
Q.12) Which one of the following is not
the most likely measure the Government/
RBI takes to stop the slide of Indian
rupee? 2019
(a) Curbing imports of non-essential
goods and promoting exports
(b) Encouraging Indian borrowers
to issue rupee denominated Masala
Bonds
(c) Easing conditions relating to external
commercial borrowing
(d) Following an expansionary monetary
policy
Ans. (d)
Explanation: To prevent the slide of the
rupee against the dollar, we need to
improve inflow of FOREX and increase
its supply and control domestic currency
money supply.
• Is a correct step as it will bring more
FOREX.
• Is a correct step as it will bring more
FOREX through FPI.
• Is a correct step as it will bring more
FOREX through Debt.

Select the correct answer using the code • Is not a correct step, as it increases money
given below. supply.

(a) 1 only
Q.13) With reference to Foreign Direct
(b) 1 and 3 only
Investment in India, which one of
(c) 2 only the following is considered its major
(d) 1, 2 and 3 characteristic? 2020
Ans. (b) (a) It is the investment through capital
instruments essentially in a listed
• Explanation: If there is foreign exchange company.
inflow through the earning of India’s IT
(b) It is a largely non-debt creating
sector then, the risk of currency crisis risk
capital flow.
is not much
(c) It is the investment which involves
• Similarly, remittances from Indians
debt-servicing.
abroad reduces the risk of a currency
crisis. (d) It is the investment made by

199
 foreign institutional investors in the
Government Securities.
Ans. (b)
• Explanation: A non-debt creating capital
flow is the one in which there is no direct
repayment obligation for the residents.
FDI is basically a non-debt creating
capital flow.
Q.14) With reference to the international
trade of India at present, which of the
following statements is/are correct?
1. India's merchandise exports are less
than its merchandise imports.
2. India's imports of iron and steel,
chemicals, fertilizers, and machinery
have decreased in recent years.
3. India's exports of services are more
than its imports of services.
4. India suffers from an overall trade/
current account deficit.
Select the correct answer using the code
given below:
(a) 1 and 2 only
(b) 2 and 4 only
(c) 3 only
200
(d) 1, 3 and 4 only
Ans. (d)
• Explanation: Statement 1 is correct:
Merchandise trade deficit is the largest
part of India’s current account deficit.
As per RBI’s statistics, during April-
August 2019- 2020, India’s Merchandise
exports was around USD 133.14 billion, as
compared to about USD 210.39 billion of
imports during the same time period.
• Statement 2 is not correct: Commodity-
wise structure of imports between 2011-12
and 2018-19 indicates that imports of iron
and steel, organic chemicals, industrial
machinery have recorded positive growth
rates as % of share in imports.
• Statement 3 is correct: Net services
(service exports - service imports) of India
has been in surplus. During April-August
2019- 2020, India’s Service exports was
around USD 67.24 billion, as compared to
about USD 39.25 billion of imports during
the same time period.
• Statement 4 is correct: Trade deficit
or Current Account Deficit (CAD) is the
shortfall between imports and exports.
According to Economic Survey 2019-20,
CAD of India was around 2.1% in 2018-19,
and 1.5% of GDP in H1 of 2019-20.
 CHAPTER - 12
ECONOMIC PLANNING
Planning
• Economic activities of any modern
society are directed towards satisfying
human requirements with limited/scarce
resources and the economic planning
helps in allocation of scarce resources
to satisfy human wants in a manner that
brings maximum satisfaction.
• Thus, economic planning refers to the "act
with a purpose, to choose, and choice is
the essence of economic activity”.
• Planning has appeared as an important
function of the modern government and
involves its purposive intervention to
affect socially desired changes in the
structure and course of the economy.
Types of Planning
• Corresponding to the political ideologies
and institutional framework of the
country, varied planning types are
observed in the world.
• Some of them are as follows:
Imperative Planning
• In imperative planning economic
decisions are made through a central
planning authority instead of a market
system. This type of planning lays down
objective and policy framework for each
sector of the economy which is followed
rigidly.
• Under this planning, it is the responsibility
of the state to provide required supplies
like raw material, machines, manpower
and entrepreneurs as all the resources
201
are owned by the state.
• It is also known as Directive Planning or
Authoritative Planning.
Indicative Planning
• In indicative planning, the government
set time-bound targets for the economy
and seeks to achieve them by providing
incentive and disincentive to economic
entities.
• It is also known as soft planning, facilitator
planning or planning by inducement.
• This planning is usually followed in the
capitalist economy.
• India by initiating Economic reform in
1991 started following indicative planning
before the reform India was following
imperative planning.
Objectives of
Planning
• The long-term objectives of planning in
India have been more or less the same
in most of the plans and these objectives
are interconnected with one another:
» Economic Growth:
− The most important objectives of
all the plans is to raise the level of
national and per capita income in
real terms.
» Self-Reliance:
− It implies a reduction in the
dependence on foreign aid and
concessional foreign capital as the
 donor country can have political
influence on the decision-making
process of the recipient country.
− The planners realize that self-reliance
is a vital requirement for economic
growth and accordingly have aimed
at making India self-reliant.
» Employment Generation:
− One of the aims of planning has been
to provide jobs to the unemployed and
efficiently utilize India’s demographic
dividend.
» Promotion of Social Justice:
− It includes removal of poverty and
reduction in inequalities of income and
wealth by redistribution measures.
Evolution of
Economic Planning
in India
• Thinking on economic planning started
quite early in India i.e. immediately after
the Russian Revolution.
• There were several plan proposals
submitted by Individuals as well as
political parties and economic groups
for the development of the national
economy.
The Visvesvaraya Plan
• In 1934, M. Visvesvaraya had published a
book titled “Planned Economy in India”,
in which he presented the first blueprint
of Indian planning.
• He laid a plan to shift labour from
agriculture to industries and double up
National income in 10 years.
202
National Planning Committee
• In 1938 the NPC (National Planning
Committee) was set up under the
chairmanship of Jawaharlal Nehru.
• Its objective of planning for development
“was to ensure an adequate standard of
living for the masses, i.e., remove poverty.
• It advocated industrialization and setting
up heavy industries that were essential for
setting other industries and for making
India self-reliant.
The Gandhian Plan
• It was formulated by S. N. Agarwala in
1944, which aim to create self-contained
villages.
• It emphasized the economic
decentralization with more focus on rural
development by developing the cottage
industries.
The Bombay Plan
• In 1944 Eight Industrialists of Bombay
working together prepared “A Brief
Memorandum Outlining a Plan of
Economic Development for India”.
• This plan aimed doubling the per capita
income in fifteen years and tripling the
national income during same period.
• The Bombay Plan was not officially
accepted, yet many of the ideas of the
plan were inculcated in other plans which
came later.
People Plan
• People’s plan was drafted by M. N. Roy.
• The plan was inspired by the ideals of
Marxist socialism and advocated the
need for providing the people with the
‘basic necessities of life’.
• Nationalization of all agricultural
 production and other production
methods were the main features of this
plan.
Sarvodaya Plan
• Sarvodaya Plan was drafted by Jai
Prakash Narayan in 1950.
• Sarvodaya plan was inspired by
Gandhian Plan and Sarvodaya Idea of
Vinoba Bhave.
• Major ideas of the plan were highly
similar to the Gandhian Plan like the
emphasis on agriculture, agri-based
small and cottage industries, self-reliance
and almost no dependence on foreign
capital and technology, land reforms
and decentralized participatory form of
planning.
Five Year Plans in
India
• They are centralized and integrated
national economic development
programmes.
• After the independence, First FYP was
launched in 1951, under the socialist
influence of first Prime Minister Pandit
Nehru.
• The process started with establishment
of Planning Commission in March 1950 in
pursuance of declared objectives of the
Government to
» Promote a rapid increase in the standard
of living,
» Efficient utilization of the resources of the
country,
» Increasing production and
» Creating employment opportunities for
all.
• The Planning Commission was invested
203
with the responsibility of making the
assessment of all resources of the
country, augmenting deficient resources,
formulating plans.
First Five-Year Plan (1951-56)
• The First Plan was based on the Harrod-
Domar Model.
• The influx of refugees from Western and
Eastern Pakistan, severe food shortages
& high inflation were some of the
challenges in front of the country at the
onset of the first five-year plan.
• The Plan focused on agriculture, price
stability, power, and transport.
• An important feature of the first plan was
the spread of community development
projects throughout the country with the
objective of raising the level of living of
the people through improved agricultural
efficiency.
• The plan was successful primarily
because of good harvests during the last
two years of the plan.
• Objectives of rehabilitation of refugees,
food self-sufficiency & control of prices
were more or less achieved.
Second Five Year Plan (1956-61)
• The second plan was conceived in an
atmosphere of economic stability.
• The Second Plan was based on the
Mahalanobis two-sector (consumer's
goods and producer’s goods) model,
which emphasizes the physical aspects
of planning and investment.
• The Plan was focused on rapid
industrialization by developing heavy &
basic industries.
• It advocated huge imports through
foreign loans and accorded lower priority
to agriculture.
• Acute shortage of FOREX led to the
pruning of development targets, the
prices were increased by about 30% as
compared to the earlier Plan & the 2nd
FYP was only moderately successful.
Third Five Year Plan (1961-66)
• It was felt that the first two Five Year
Plan had moved the Indian economy
into the "take-off stage". Consequently
the basic goal of the Third Five Year Plan
was to make India self-reliant and self-
generating economy.
• The plan aimed to:
» Achieve more than 5% growth rate in
national income.
» Achieve self-sufficiency in food grains
production.
» Expand basic industries like chemicals,
steel; power and fuel etc.
» Generate substantial employment
opportunities in the country.
» Provide greater equity of opportunity.
» Reduce economic disparities among the
masses.
• On the basis of the experiences obtained
from the first two plans (agricultural
production was seen as a limiting factor
in economic development of the country),
agriculture was given highest priority to
support the exports and industry.
• The Plan was a complete failure
in achieving the targets due to
the unforeseen events like Chinese
aggression in 1962, Indo-Pak war in 1965,
severe drought of 1965-66.
• Due to conflicts with China and Pakistan,
the resources meant for socio-economic
development were diverted towards
defence sector. Thus socio-economic
sectors were suffered due to shortfalls of
resources.
204
Three Annual Plan (1966-69)
• Fourth Plan was postponed due to the
failure of the third plan. The Third Plan
was failed due to the devaluation of rupee
(to boost exports) along with inflationary
recession. Three Annual Plans were
launched in place of five year plans.
• These three annual plans (1966–67, 1967–
68 and 1968–69) came under the Plan
Holiday scheme.
• Prevailing agricultural crisis and serious
food shortage made it necessary for
the government to focus on agriculture
during the Annual Plans. During these
plans, a whole new agricultural approach
was implemented.
• The Green Revolution experiment in India
started in 1966.
• It included the distribution of high-
yielding varieties of seeds on wide scale,
extensive use of chemical fertilizers,
reaping the benefits of irrigation and soil
conservation.
• These Annual Plans helped the economy
to absorb the shocks generated during
the Third Plan which paved the path for
the planned growth in coming years.
Fourth Five Year Plan (1969-74)
• Refusal of supply of essential equipment
and raw materials from the allies during
the Indo-Pak war resulted in twin
objectives of:
» Growth with stability
» Progressive achievement of self-reliance
for the Fourth Plan.
• The basic strategy of the Fourth Plan has
been called the Gadgil strategy.
• The main emphasis was on the growth
rate of agriculture to enable other sectors
to move forward.
• Implementation of Family Planning
 Programmes to control the population
was amongst the major targets of the
Plan.
• The Indian fourth five-year plan laid its
emphasis on the "Weaker Sections" of
society but still did not have an integrated
plan for providing for minimum or basic
needs.
• First 2 years of the plan saw record
agricultural production. But in last three
years of the plan production was declined
due to the failure of monsoon.
• The influx of refugees from Bangladesh
before and after Indo-Pak war of 1971
was the major problem along with
price situation deteriorating to crisis
proportions and the plan is considered
as a big failure.
Fifth Five Year Plan (1974-79)
• The final draft of the fifth plan was
drafted and launched by D. P. Dhar in
the backdrop of economic crisis resulting
from run-away inflation caused by a hike
in oil prices and failure of the Government
takeover of the wholesale trade in wheat.
• It proposed to achieve two main
objectives:
» Removal of poverty (Garibi Hatao)
» Attainment of self-reliance
• High growth rate, better distribution
of income and significant growth in
the domestic savings were seen as key
instruments for economic growth.
• Because of high inflation, the Plan outlay
proved to be completely wrong and the
original public sector outlay had to be
increased.
• After the imposition of national
emergency in 1975, the focus shifted to the
implementation of 20 Point Programme
of Prime Minister.
• This FYP was relegated to the background
205
and when Janta Party came to the power
in 1978, the Plan was terminated.
Rolling Plan (1978-80)
• The Janata Party government shelved the
Fifth Five-Year Plan and launched Sixth
Five-Year Plan (1978–1983) emphasizing
on employment, in contrast to the
Nehru Model which the Government
criticized for the concentration of power
and authority, increasing inequality
& for exacerbating poverty. But, the
government survived for only 2 years.
• The Congress Government returned to
power in 1980 and launched a different
plan aimed at directly attacking the
problem of poverty by creating conditions
of an expanding economy.
Sixth Five Year Plan (1980-85)
• The objective of "Improving the quality of
life of people" i.e., with a special reference
to the socially and economically deprived
section of the population through a
minimum needs programmes.
• In the Sixth Five Year Plan, the
Minimum Needs Programme had eight
components, namely:
» Elementary education
» Rural Health
» Rural Water Supply
» Rural Roads
» Rural electrification
» Environmental improvement of urban
slums
» Housing assistance to rural landless
labourers
» Nutrition
• The Plan focused on Increase in national
income, modernization of technology,
ensuring a continuous decrease in poverty
 and unemployment through schemes
like TRYSEM, NREP, IRDP, controlling
population growth etc.
• Broadly, the sixth Plan could be
considered as a success as most of the
targets were achieved though during the
last year (1984-85) many regions of the
country were gripped with severe famine
situations and agricultural output was less
than the record output of previous year.
Seventh Five Year Plan (1985-
90)
• The aims of the Seventh Plan:
» Accelerating food production,
» Boosting employment opportunities, and
» Raising the productivity with focus on
‘food, work & productivity’.
• The Jawahar Rojgar Yojana (JRY) was
launched in 1989 with the motive to
create wage-employment for the rural
poor.
• The plan became successful as the GDP
grew at 6% against the targeted 5%
growth.
Eighth Five Year Plan (1992-97)
• The plan was postponed by 2 years
because of political uncertainty at
the Centre. Balance of Payment crisis,
widening budget deficits, rising debt
burden, inflation and recession in
industry were the key challenges during
the launch of the plan.
• The Eighth Plan (1992–97) was launched
in a typically new economic environment.
This was the first plan which went on
for introspection of the macroeconomic
policies which the country had been
pursuing for many decades.
• The plan undertook strong policy
measures to deal with the bad economic
206
condition and to undertake a yearly
average growth of 5.6% through the
introduction of fiscal & economic
reforms including liberalization under the
leadership of PM P V Narasimha Rao.
• The major suggestions which this plan
suggested are as follows:
» Re-definition of the state’s role in the
economy,
» Market-based Economy with a greater
role for the private sector,
» Increase investment in the infrastructure
sector,
» Subsidies need restructuring and
refocusing,
» Decentralized planning,
» Special emphasis on ‘co-operative
federalism’,
» Greater focus on ‘agriculture’ and other
‘rural activities’
• Some of the key economic outcomes
achieved during the eighth plan were:
» Rapid economic growth (highest annual
growth rate was 6.8 %).
» The high growth of agriculture & allied
sectors, and manufacturing sector.
» Growth in exports and imports,
development in trade and improvement
in current account deficit.
• The high growth rate was achieved
even though the share of the public
sector in total investment had declined
considerably to about 34 %.
Ninth Five Year Plan (1997-
2002)
• The Ninth Plan (1997–2002) was launched
when there was an all-round ‘slowdown’
in the economy led by the South East
Asian Financial Crisis (1996–97).
• The Plan prepared under the United
 Front Government focused on Growth
with Social Justice and Equality.
• The key objective of the Ninth Plan was to
reduce historical inequalities and boost
the economic growth in the country.
• Ninth Plan predominantly focused on
the private sector (Indian as well as
foreign) for the economic growth and
development.
• The state was envisaged to act a facilitator
& involve itself with social sectors like
health, education, law, and order etc.
and creation of infrastructure where
private sector participation was likely to
be limited due to lack of resources.
• It gave priority to agriculture sector &
rural development to generate adequate
productive employment and eradicate
poverty.
• Social sectors of the economy got the
strong support which helped in complete
elimination of poverty.
• The issue of fiscal consolidation became
a top priority of the governments for the
first time, which resulted in:
» Sharp decline in the revenue deficit of
the government, including center, states,
and the PSUs
» Cutting down subsidies, interest, wages
etc.
» Decentralized planning with greater
reliance on states and the PRI (Panchayati
Raj Institution).
Tenth Five Year Plan (2002-
2007)
• Recognising that economic growth can’t
be the only objective of the national
plan, the Tenth Plan had set ‘monitorable
targets’ for a few key indicators of
development besides 8 % growth target.
• The targets were improvement in literacy,
reduction in gender gaps in literacy and
207
wage rate, reduction in maternal & infant
mortality rates, cleaning of major polluted
rivers, access to potable drinking water,
etc.
• The Tenth Plan focused on regional
approach rather than a sectoral approach
to bring down regional inequalities.
• Governance was considered a factor of
development & agriculture was declared
as the prime moving force of the economy.
• The Tenth Five Year Plan sought to
increase the role of states in planning
with greater involvement of Panchayati
Raj Institutions.
• State-wise break up of targets for
growth and social development sought
to achieve balanced development of all
states.
Eleventh Five Year Plan (2007-
2012)
• The Eleventh Plan was aimed “Towards
Faster & More Inclusive Growth” after
UPA formed the government at the
Centre on the plank of helping Aam
Aadmi (common man).
• India had emerged as one of the fastest-
growing economies by the end of the
Tenth Plan.
• The savings and investment rates were
increased, the industries had responded
well to face competition in the global
economy and foreign investors were
looking forward to invest in India.
• The broad vision for 11th Plan involved
several interrelated components like
» Rapid growth for reducing poverty &
creating employment opportunities for
masses.
» Access to essential services in education
& health, especially for the poor people
» Employment opportunities using the
National Rural Employment Guarantee
 Programme (NREGP).
» Environmental sustainability.
» Reduction of gender inequality etc.
• The Eleventh Plan kick started well with
the first year achieving 9.3% growth rate,
however the growth decelerated to 6.7%
in 2008-09 following the global sub-
prime crisis.
• However, the second bout of a global
slowdown in 2011 caused by the sovereign
debt crisis in Europe along with domestic
factors such as tight monetary policy
and supply-side bottlenecks, resulted in
a deceleration of growth to 6.2 percent
in 2011-12.
• As a result, GDP grew at 8% during the
Eleventh Plan, which was lower than the
target but performed well as compared
to the Tenth Plan achievements.
• Since the period saw two global crises
of 2008 and 2011, the 8% growth can be
considered as satisfactory.
Twelfth Five Year Plan (2012-
2017)
• The Twelfth Plan started at a time when
the global economy was going through
a second financial crisis, fueled by the
sovereign debt crisis of the Eurozone in
the last year of the Eleventh Plan. The
crisis affected all countries including
India.
• The broad vision and aspirations of the
12th Plan are reflected in the subtitle:
‘Faster, Sustainable, and More Inclusive
Growth’.
• Poverty alleviation, promoting equality
and regional balance, empowering
people, reducing inequality are some
of the mechanisms through which
inclusiveness is to be achieved.
• Sustainability comprises ensuring
environmental sustainability,
development of human capital with
208
the help of improved health, education,
nutrition, skill development, information
technology etc. and development of
institutional capabilities, infrastructure
such as power telecommunication, roads,
transport etc.
• Monitorable Targets of the Plan are as
follows:
» Economic Growth
− Real GDP Growth Rate of 8.0 percent.
− Agriculture Growth Rate of 4.0
percent.
− Manufacturing Growth Rate of 10.0
percent.
» Poverty and Employment:
− Decrease Head-count ratio of
consumption poverty by 10% over
the preceding targets by the end of
Twelfth Plan.
− Create 5 crore new work opportunities
in sectors other than agriculture and
provide skill certification by enhancing
skill sets of workforce.
» Education:
− Increase Mean Years of Schooling to
7 years.
− Improve access to higher education
by creating 20 Lakh additional seats
for each age group to meet the skill
needs of the various sectors.
− Eliminate social and gender gap in
school enrolments.
» Health
− Reduce MMR to 1 and IMR to 25 per
1,000 live births and improve Child
Sex Ratio (0–6 years) to 950.
− Reduce Total Fertility Rate to 2.1.
− Reduce under-nutrition among
children of 0–3 years’ age group to
half of the NFHS-3 levels.
» Environment and Sustainability
− Increase the forest cover by 1 million
hectares every year.
− 30,000 MW of additional renewable
energy capacity
− Reduce emission intensity of GDP up
to 20% to 25% reduction over 2005
levels by 2020.
» Infrastructure, Comprising Rural
Infrastructure
− Increase investment in infrastructure
sector as a percentage of GDP to 9
%.
− Connect all villages with all-weather
roads.
− Upgrade all national and state
highways to the minimum two-lane
standard.
− Increase rural tele-density to 70 per
cent.
− Ensure 40 litre per capita per day
(lpcd) piped drinking water supply to
at least 50% of the rural population,
and 50% gram panchayats achieve
Nirmal Gram Status.
• Table below show Every Five-year plan
growth target set by particular five-year
plan and the growth achieved during
that plan.

Target Growth Actual Growth

First Five-Year Plan (1951-56) 2.1% 3.6%

Second Five-Year Plan (1956-61) 4.5% 4.3%

Third Five Year Plan (1961-66) 5.6% 2.8%

Fourth Five Year Plan (1969-74) 5.7% 3.3%

Fifth Five Year Plan (1974-79) 4.4% 4.8%

Sixth Five Year Plan (1980-85) 5.2% 5.7%

Seventh Five Year Plan (1985-90) 5.0% 6.0%

Eight Five Year Plan (1992-97) 5.6% 6.8%

Ninth Five Year Plan (1997-2002) 6.5% 5.4%

Tenth Five Year Plan (2002-2007) 8% 7.6%

Eleventh Five Year Plan (2007-12) 9% 8%

Twelfth Five Year Plan (2012-17) 8% 6.8%

209
Twenty Point
Programme
• The Twenty Point Programme (TPP) was
initiated by the Government of India in
1975.
• The primary objective of the 20-Point
Programme was poverty alleviation and
to improve the quality of life of the poor
and the underprivileged population.
• The Programme was meant to provide
a thrust to schemes relating to poverty
1. Poverty Eradication
2. Power to People
3. Support to Farmers
4. Labour Welfare
5. Food Security
6. Housing for All
7. Clean Drinking Water
8. Health for All
9. Education for All
10. Welfare of Scheduled Castes, 19. Development of Backward Areas
Scheduled Tribes, Minorities and OBCs 20. IT Enabled e-Governance
• Twenty Point Programme (TPP)-2006
originally consisted of 20 Points and 66
items being monitored individually by
Central Nodal Ministries concerned.
• From 1st April 2008, Sampoorna
Grameen Rojgar Yojana (SGRY) has been
merged with National Rural Employment
Guarantee Act, thus, SGRY has been
dropped from the list of 66 items and
only 65 items are now monitored under
TPP-2006 since 2008-09.
• For the purpose of ranking, the
performance of States on a monthly basis
in respect of 20 identified parameters
has been evaluated.
210
alleviation, employment generation
in rural areas, education, housing,
protection of environment, family welfare
& health and many other programmes
having a bearing on the quality of life,
particularly in rural areas.
• TPP was restructured in 1982 and 1986. As
new policies and programmes have been
launched it has been finally restructured
in 2006 and it has been in operation at
present.
• The programmes/schemes covered under
TPP-2006 are as under:
11. Women Welfare
12. Child Welfare
13. Youth Development
14. Improvement of Slums
15. Environment Protection and
Afforestation
16. Social Security
17. Rural Roads
18. Energization of Rural Area
Planning
Commission
• Government of India passed a resolution
in March 1950 to establish the Planning
Commission in pursuance of the
Government’s objectives to promote a
rapid increase in the standard of living
of the people by efficient utilization of
the resources of the country, raising the
production and offering employment
opportunities to all.
• The responsibilities of the Planning
Commission were
» Assessment of all the resources of the
country.
» Drafting plans for the most effective
and balanced utilization of resources
and deciding priorities while allocating
resources.
» Augmenting deficient resources.
• Planning Commission's work was three
dimensional:
» Frame policy direction and suggest
required programmes/schemes.
» Influence the resource allocation
through the budget.
» Monitor and record the performance on
a standard framework for comparative
analysis of all the states from time to
time.
• The Prime Minister acted as the ex-officio
chairman of the Planning Commission,
which works under the overall guidance
of the NDC (National Development
Council). Pandit Nehru, being the Prime
Minister, was the first Chairman of the
Planning Commission.
• The Deputy Chairman and the full-time
members of the Commission give advice
and guidance to the subject Divisions
for the formulation of Five-Year Plans,
Annual Plans, State Plans, Monitoring
Plan Programmes, Projects and Schemes.
• The National Development Council
co-ordinates between the Planning
Commission and the various States.
• The Planning Commission was replaced
with NITI Aayog on 1st January, 2015.
National
Development
Council (NDC)
• On 6th August 1952, the National
211
Development Council (NDC) or the
Rashtriya Vikas Parishad was constituted
to strengthen and mobilize the overall
effort and resources of the country
in support of the plan, to encourage
common economic policy in all important
spheres, and to ensure the balanced and
rapid development of all sectors and
regions of the country.
• This Council, which was re-constituted
on October 7, 1967, is the main decision-
making authority in India related to area
of development matters.
• NDC is a constitutional body with
representation from both the Union and
States.
• This Council is headed by the Prime
Minister and all Union Cabinet Ministers,
State Chief Ministers, representatives of
Union Territories are its members.
• The functions of NDC are:
» To prescribe guidelines for the drafting
of the National Plan and assessing
resources for the Plan.
» To consider the National Plan as drafted
by the Planning Commission.
» To consider important matters of socio-
economic policy affecting national
development.
» To review the working of the Plan
periodically and to recommend measures
necessary for achieving the aims and
objectives of the National Plan.
• It is a platform not only for discussion of
plans and initiatives, but also economic
and social matters of national importance
are discussed in this forum before policy
formulation.
• The NDC ordinarily meets twice a year.
• It is a democratic platform where the
States can openly put forward their views
and opinions. No resolution is passed by
the Council.
NITI (National
Institution for
Transforming India)
Aayog
• It is the non-statutory and extra-
constitutional body set up on 1st
January, 2015 by replacing the Planning
Commission.
• NITI Aayog is the premier policy ‘Think
Tank’ for the Government of India, which
provide both directional and policy inputs.
• At the core of NITI Aayog’s creation are
two hubs:
» Team India Hub: leads the engagement
of states with the Central government
» Knowledge and Innovation Hub: builds
NITI Aayog think-tank capabilities.
Objectives
• Objectives of the NITI Aayog are:
» To develop a shared vision of national
developmental priorities, sectors and
strategies with the active participation
of States for achieving the national
objectives.
» To nurture cooperative federalism
through structured support mechanisms
and initiatives with the States on a
continuous basis, identifying that strong
States make a strong nation.
212
Functions of
NITI Aayog
DESIGN POLICY
FOSTER COOPERATIVE
& PROGRAMME
FEDERALISM
FRAMEWORK
MONITORING AND
ACT AS A
RESOURCE CENTRE
EVALUTION
& KNOWLEDGE HUB
I M A G E 12.1: F U N C T I O N S OF N ITI A AYO G
» To develop mechanisms to design
credible plans at the village level and
aggregate these plans progressively at
higher levels of government that is at the
state level and ultimately at the national
level.
» To frame strategic and long-term policy
and programmes and initiatives and
monitor their progress and their efficacy.
» To offer a forum for resolution of inter-
sectoral and inter-departmental issues
to accelerate the implementation of the
development agenda.
» To actively oversee and analyse the
implementation of programmes and
various initiatives
» Technology up-gradation and capacity
building for the implementation of
programmes and initiatives.
Composition of NITI Aayog
• The NITI Aayog will comprise the
following:
» Chairperson: Prime Minister of India.
» Governing Council includes the Chief
Ministers of all the States and Lt.
Governors of Union Territories.
» The full-time organizational structure
will comprise of, in addition to the
Chairperson:
− Vice-Chairperson: Will be appointed
by the Prime Minister.
 − Chief Executive Officer: appointed by
the PM for a fixed term and he should
be qualified to be appointed as the
Secretary to the Government of India.
− Members: Full-time.
− Part-time members: Maximum of two
from leading universities, research
organizations and other relevant
organizations in an ex-officio capacity
on the rotational basis.
− Ex Officio members: Maximum of
four members of the Central Council
of Ministers which will be nominated
by the PM.
» Regional Councils will be set up to
solve specific issues and contingencies
impacting more than one state or a
region.
− These will be established for specific
time period.
− Prime Minister is empowered to
convene Regional Councils and will
include Chief Ministers (CMs) of States
and Lt. Governors of Union Territories
(UTs) in the region.
− These are chaired by the Chairperson
of the NITI or any other person
nominated by him.
» Specialists, practitioners and experts with
relevant domain knowledge are invited
to NITI as special invitees nominated by
the Prime Minister
NITI Aayog role till now
• The NITI Aayog framed the Make in India
Strategy for Electronics sector, National
Energy Policy, a Model Land Leasing
Law.
• Prepared a detailed Roadmap for
Revitalizing Agriculture sector, designed
a Developmental Strategy for North East
region and Hilly areas and undertook an
appraisal of the Twelfth Five Year Plan.
213
• NITI Aayog recommended closure of
sick PSUs, strategic disinvestment of
other CPSUs and pushed for reforms in
the Medical Council of India and the
University Grants Commission.
• In April 2017, the Governing Council of
NITI Aayog approved the Three Year
Action Plan agenda aimed at changing
the expenditure pattern by allocating a
larger proportion of resources to high
priority sectors, like health, education,
agriculture, rural development, defence,
roads and railways.
• Three sub-groups of Chief Ministers
were formed on Centrally Sponsored
Schemes (CSS), Skill Development and
Swachh Bharat.
• The Atal Innovation Mission was
launched by NITI to seed innovations to
teach young minds new skills.
NITI Aayog vs Planning
Commission
• NITI Aayog is a Planning Commission
with an expanded scope but without its
financial powers.
• The financial powers like designing
the schemes and programmes, setting
sectoral priorities, estimating the grants
to State development programmes (other
than tax devolution), and influencing
the annual allocations according to the
priorities etc. now directly come under
the Ministry of Finance, Budget Division/
Department of Expenditure.
• Planning Commission’s influence and
impact were measured, felt, and perceived
through annual plan allocations,
discretionary grants. But, NITI Aayog does
not have the same ability to influence the
annual allocations and influence on the
annual budget proposals.
• Like the planning commission, NITI
Aayog is also without legal support or
any constitutional foundation.
NITI Aayog Planning Commission

Full time and Part-time Members. Only Full-Time Members.

Chief Ministers represented directly in Chief Ministers were represented through

the Governing Council. NDC.

Fund Transfers to States is through

Finance Ministry. It has no financial Used to transfer funds to states.
powers.

Increased flexibility to states in designing

and implementing development Imposition of central sponsored schemes.
programmes.

Prepared national agenda for

Prepared five-year Plans.
development.

Achievements of » Self-reliance refers to the lack of

dependence on external assistance.
Economic Planning » India has made tremendous achievement
towards self-reliance in food grain
in India production, basic industries etc.

• Increase in National Income and Per • Development of Social Infrastructure

Capita Income:
» Social infrastructure includes such
» During the planning period, national services as education, health facilities,
income has increased manifold. etc. In this area also, five-year plans are
able to achieve desired success.
• Development of Basic and Capital
Goods Industries:

» With the adoption of the Nehru- Failure of Economic

Mahalanobis model of development
during the Second Five Year Plan, some
Planning in India
basic and capital goods industries such
• Inequality in Distribution of Income and
as iron and steel industry witnessed
Wealth.
spectacular growth.
• Failure to control inflation.
• Development in Agriculture: • Regional Imbalance.
» Agricultural productivity has also marked • Inadequate Development of
an upward trend during the plan period. Infrastructure.
» The production of food-grains which • Increase in Unemployment.
was 510 lakh tones in 1950-51 increased • Standard of Living of masses have not
to 176.4 million tonnes in 1990-91 and improved substantially.
further to 283.37 million tonnes in 2018-19.
• Huge Amount of Deficit Financing.
• Self-Reliance:

214

Resource
Mobilization
• It refers to the policy, mode, means of
raising funds by the government for
various plan programmes/projects.
• The objective of the resource mobilization
is the optimal utilization of the resources.
• Means of resource mobilization:
» Internal Resource
» External Resource
13.1. Internal Resource
• Internal resources can be defined as the
economic resources that are present
within the territory of any country.
• Internal Resources includes:
» Balance from Current Revenue (BCR)
− It is the access of the Revenue Receipt
of government over its non-planned
expenditure.
− BCR = Revenue Receipt-Non Planned
Expenditure.
» Additional Resource Mobilization
− It includes revenue collected from
surcharge, cess etc.
» Surplus of public sector
» Borrowing and Miscellaneous capital
receipt
» Deficit Financing
External Resource
• External Resource means a generation
resource located outside the country.
• External Resources includes:
» Bilateral Assistance
215
− Grants and loans from a foreign
government.
» Multilateral Assistance from International
Institutions.
Economic Planning
Strategy
• Indian planning strategies can be divided
into two phases: the pre-reform phase
era and post-reform phase era.
Pre 1991 Phase/Pre-reform
Phase
• During the pre 1991 phase, India followed
the Inward-looking economic planning
strategy.
• Following strategies are followed during
1951-91 phase:
» Heavy Reliance on Public Sector
» Regulated Expansion of Private Sector
» Protection of Small-Scale Industry and
Cottage Industries
» Restriction on Foreign Capital
» Adherence to Centralized Planning
Post-1991 Phase/Post-reform
Phase
• India's Economic planning strategy
witnessed a shift toward market
economies in the year 1991.
• Main changes under NEP (new economic
policy) are:
» Reorientation of Fiscal policy and
monetary policy according to market.
» Foreign capital in the form of FDI and FII
are encouraged.
» Import trade restrictions are at a
 minimum, while export promotion has
been accorded a high priority. Amartya Sen Vs
» Direct participation of the government is
restricted only to strategic industries like
Jagdish Bhagwati
atomic energy etc. Debate
» Convertibility of Indian Rupee.
• The debate on economic policy between
» Sustainable development.
Amartya Sen and Jagdish Bhagwati is
between economic growth and economic
development.

Amartya Sen Jagdish Bhagwati

Economic growth is just a means. Economic growth is crucial for achieving

social ends.

Achieve intervention of government . Supported LPG (market-oriented

approach).

Bottom-Up Approach (rejected trickle- Top-Down Approach.

down completely).

First redistribution and then growth. First growth and then redistribution.

Kerala and Sri-Lanka model supported. Gujarat Model supported.

Gujarat Model » Strengthening of Road Network through

• The period from 2002-03 to 2011-12 during
which Gujarat experienced a quantum
jump in its growth rate.
• The policies followed by the Gujarat
government are:
» Business Friendliness
» Economic Freedom
» Good Governance (e-Governance)
− Inter-departmental Coordination.
− Stable tenure of bureaucrats
» Infrastructure Development
» Power Reform
» Restructuring of Irrigation sector (drip
irrigation and minor dam construction)
PPP model
» State Public sector enterprises were
strengthened.
Kerala Model
• It is characterized by achievements in
social indicators such as healthcare,
education, low infant mortality and low
birth rate, high life expectancy, developing
productive social infrastructure instead
of materialistic infrastructure.
• The policies followed for development
are:
» High spending on Social Service like
Health, Education etc.
» Land Reforms.

216
» Effective Decentralization to empower
the local bodies.
» Promotion of Trade.
» Rule of left domination, people awareness.
» Work of missionaries.
Other Terms
Centralized Planning
• In centralized planning, the whole
economy is administered by a single
planning authority of the central
government.
Decentralized Planning
• In Decentralized Planning, plans are
developed and implemented at different
levels i.e., from the national to sub-
national to the village level.
Democratic Planning
• In Democratic Planning, people/
representatives of various sections/
sectors are involved in all the stages of
preparation and implementation of the
plan.
Physical Planning
• In Physical Planning, resources are
estimated and allocated in physical
terms like manpower, natural resource,
stock of capital etc.
Financial Planning
• In Financial Planning, resources are
estimated and allocated in money terms.
• For example, Tax revenue, Profit of PSU
etc.
217
Fixed Planning
• In Fixed Planning, the terms targets/
objective of economic planning are
seldom changed i.e. it remains fixed.
Rolling Plan/Continuous
Planning
• In Rolling Planning, a medium-term plan
is prepared annually i.e. every year targets
and policies are determined for the next
four to five years and assessment is made
of previous four to five years.
• There are three types of rolling plans:
» Short term: One year (like annual budget).
» Medium term: Four to Six years (specific
targets and policies)
» Long Term: Ten to Thirty years (Broad
policies and strategies)
• India followed the rolling plan from 1978-
80.
Perspective Planning
• Perspective Planning takes into account
the implication of the medium-term
targets and policies of a plan over a
period of 10-30 years.
Comprehensive Planning
• Comprehensive Planning encompasses
all the sectors of the economy.
Partial Planning
• In Rolling Planning, policies are prepared
for selected sectors of the economy.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) The main objective of the
12th Five-Year Plan is: 2014
(a) inclusive growth and poverty
reduction
(b) inclusive and sustainable growth
(c) sustainable and inclusive growth to
reduce unemployment
(d) Faster, sustainable and more
inclusive growth.
Ans. (d)
• Explanation: The objective of the Twelfth
Five Year Plan was to achieve “faster,
sustainable and more inclusive growth”.
• For this purpose, it sought to achieve10%
in the manufacturing sector and 4%
growth in the agriculture sector.
• The total budget of the plan had been
estimated at Rs.47.7 lakh crore which was
135% more than that for the 11th Plan
(2007-12).
Q.2) The Government of India has
established NITI Aayog to replace the
2015
(a) Human Rights Commission
(b) Finance Commission
(c) Law Commission
(d) Planning Commission
Ans. (d)
• Explanation: NITI Aayog replaced the
erstwhile Planning Commission.
Q.3) With reference to India’s Five-Year
Plans, which of the following statements
is/are correct? 2019
1. From the Second Five-Year Plan, there
was a determined thrust towards
218
substitution of basic and capital goods
industries.
2. The Fourth Five-Year Plan adopted the
objective of correcting the earlier trend
of increased concentration of wealth and
economic power.
3. In the Fifth Five-Year Plan, for the first
time, the financial sector was included as
an integral part of the Plan.
Select the correct answer using the code
given below.
(a) 1 and 2 only
(b) 2 only
(c) 3 only
(d) 1, 2 and 3
Ans. (a)
• Explanation: Rapid industrialization, with
particular emphasis on the development
of basic and heavy industries, is one of
the objectives of the 2nd Five-year plan.
• Nationalization of 14 major Indian Banks
was a key during the 4th five years plan.
This boosted the confidence of the
people in the banking system.
• Fifth Five-year plan was proposed to
achieve two main objectives: Removal of
poverty' (Garibi Hatao) and Attainment
of self-reliance
Q.4) Atal Innovation Mission is set
up under the: 2019
(a) Department of Science and
Technology
(b) Ministry of Labour and Employment
(c) NITI Aayog
(d) Ministry of Skill Development and
Entrepreneurship
Ans. (c)
• Explanation: The Atal Innovation Mission
(AIM) is a flagship initiative of the NITI
Aayog to promote innovation and
entrepreneurship across the country at
universities, schools, MSME and industry
 levels and research institutions.
Q.5) With reference to the Indian economy
after the 1991 economic liberalization,
consider the following statements: 2020
• Statement 2 is not correct: According
1. Worker productivity (Rs. per worker at
2004 -05 prices) increased in urban areas
while it decreased in rural areas.
2. The percentage share of rural areas in
the workforce steadily increased.
3. In rural areas, the growth in non -farm
economy increased.
4. The growth rate in rural employment
• Statement 3 is correct: Around 2/3rd
decreased.
Which of the statements given above is/
are correct?
(a) 1 and 2 only
(b) 3 and 4 only
(c) 3 only
• Statement 4 is correct: After 2004 -05,
(d) 1, 2 and 4 only
Ans. (b)
• Explanation: Statement 1 is not correct:
The absolute level of income per worker
i.e. worker productivity has grown for
both rural and urban regions. For rural
219
regions it was increased from Rs. 37273
in 2004 -05 to Rs. 101755 in 2011 -12, while
for urban regions it was increased from
Rs. 120419 in 2004 -05 to Rs. 282515 in
2011 -12.
to 2011 Census, around 68.8 percent of
population of India and 72.4 percent
of workforce resided in rural regions.
But over the years, steady transition to
urbanization has led to a decrease in the
rural share in the workforce, from 77.8
percent in 1993 -94 to 70.9 percent in 2011
-12.
of rural income is now generated in
non -agricultural activities. Non -farm
economy has increased in rural regions.
The total share of agriculture in rural
economy has decreased from 57% in
1993 -94 to 39% in 2011 -12.
the rural regions have observed negative
growth in employment in spite of high
growth in output. The growth rate of
rural employment was 1.45% during 1994
-2005, which dropped to -0.28 percent
between 2005 -12.
 CHAPTER - 13
INDUSTRIES
Introduction
• Industrial development has been a
major factor in economic development.
Thus, the industrial development of the
country will be guided and fostered by
the industry policy.
• Before 1947 the industrial base of the
economy was very small and the industries
were based with many problems like
shortage of raw materials, deficiency of
capital, poor industrial relations, etc.
• The government of India launched the
process of industrial development after
independence in 1947.
Evolution of
Industrial Policies of
India
Industrial Policy Resolution of
1948
• The Industrial Policy Resolution of
year 1948 marked the beginning of the
evolution of the Indian Industrial Policy.
• The Resolution emphasized the economic
importance of securing a continuous
increase in production and its equitable
distribution and pointed out that the
State must play a progressively active
role in the development of Industries.
• This policy states that India is a mixed
economy with overall responsibility of the
government for planned development
of industries and their regulation in the
national interest.
• The main features of the 1948 industry
220
policy are:
» Acceptance of the importance of both
private and public sectors,
» Division of the industrial sector,
» Role of small and cottage industries, and
» Other important features of the industrial
policy.
• It classified industries into 4 categories:
» Strategic Industries (Public Sector): These
industries comes under exclusive State
Monopoly. Ex: arms and ammunition,
atomic energy etc.
» Basic / Key Industries: These industries
run with government control included
coal, iron and steel, aircraft manufacture,
ship building etc.
» Important Industries: Some of the
Important industries controlled by the
private sector. Such important industries
include heavy chemicals, sugar, cotton
textile and woolen industry etc. (But
in still in these industries, the central
government, in consultation with state
government, will have general control on
them).
» Other Industries: All Other Industries
which were not incorporated in the
above three categories are open for the
private sector with many of them having
the provision of compulsory licensing.
Industrial Policy Resolution of
1956
• The Industrial Policy Resolution was the
first comprehensive statement of the
strategy for Industrial development in
India.
• The Industrial Policy Resolution of
1956 gave priority to the role of the
State to assume a principal and direct
responsibility for industrial development.
• The main aim of this policy was:
» To fast-track economic growth and boost
the process of industrialization.
» To reduce disparities in income and
wealth and the removal of regional
disparities through the development of
regions with a low industrial base.
» Promotion of village and small-scale
industries.
• Industries were reclassified into three
categories.
» Schedule 'A'
− It consisted of 17 industries prominent
among them were arms & ammunition,
atomic energy, air transport, railway
etc.
− Development of these sectors was the
exclusive responsibility of the State.
» Schedule 'B'
− It consisted of 12 industries prominent
among them were Machine tools,
chemicals, drug, pharmaceuticals,
antibiotics, fertilizers etc.
− Though industries of this schedule
were supposed to be developed &
owned primarily by the State, private
sector enterprise was also expected
to supplement the efforts of the State.
» Schedule 'C'
− Residual industries were left open to
the private sector enterprise. These
industries were heavily controlled
through licensing provisions.
− This is considered as the most
important industrial policy of India
as it decided not only the industrial
expansion but structured the very
221
nature and scope of the economy till
1991.
Industrial Policy Resolution of
1969
• The aim of this licencing policy was to
address shortcomings in the licencing
policy developed by the Industrial Policy
of 1956.
• Major changes after Industrial Policy
Resolution of 1969:
» The Monopolistic and Restrictive Trade
Practices (MRTP) Act was passed. The
Act envisioned to regulate the trading
and commercial practices of the firms
and check monopoly and concentration
of the economic power.
» The firms having assets of 25 crores or
more were placed under requirement of
taking consent from the Government of
India prior to any expansion, greenfield
project, and takeover of other companies
(as per the MRTP Act). Such companies
were known as the ‘MRTP Companies’.
The upper limit (known as the ‘MRTP
limit’) for such kind of companies was
reviewed upward to ‘50 crore in 1980 and
‘100 crores in 1985.
» To redress the prohibited and restricted
practices of trade, the Government did
set up an MRTP Commission.
Industrial Policy Resolution of
1973
• Indian Policy Statement of 1973 identified
high priority industries with investment
from large industrial houses and foreign
companies were permitted.
• Industrial Policy Resolution of 1973
introduced following major changes:
» A new classificatory word i.e. core
industries was formed. The industries
 of fundamental importance for the
development of industries were placed
in this category like iron and steel,
coal, cement, crude oil, oil refining and
electricity.
» The idea of ‘joint sector’ was developed
which allowed partnership between the
centre, state and the private sector while
setting up some industries.
» Some industries were put under the
Reserved list in which only the small or
medium industries could be set up. Ex:
Coal and lignite, Mineral oils etc.
» To regulate foreign exchange, the Foreign
Exchange Regulation Act (FERA) was
passed in 1973.
» Limited permission for foreign
investments was given to the
Multinational Corporations (MNCs)
and they were allowed to set up their
subsidiaries in the country.
Industrial Policy Resolution of
1977
• Indian Policy Statement was announced
by George Fernandes, the then union
industry minister of the parliament.
• The main focus of the Industrial Policy
statement of 1977 was on effective
promotion of small, cottage and village
industries.
• The highlights of this policy are:
» Small-Scale and Cottage industries:
Small sector was classified into three
categories:
− Cottage & household industries
producing wage goods with vast self-
employment potential.
− Tiny sector with investment in
machinery and equipment up to Rs.
1 lakh.
− Small scale industries with investment
up to Rs.10 lakh and ancillary units
222
with investment in fixed capital up to
Rs. 15 lakh.
» Large Scale Industries
− Basic industries which are crucial for
providing infrastructure as well as for
the development of small and village
industries, like steel, non-ferrous
metals, cement, oil, refineries.
− Capital goods industries for fulfilling
the machinery requirement of basic
industries as well as small scale
industries.
− High technology industries where
production has necessarily to be on a
large scale and which help agricultural
and industrial development such as
fertilizers, petro-chemical industries
etc.
» Public sector undertakings were given
the task of controlling the economy.
By keeping these industries under
government control, it was easy to check
the concentration of economic power in
the hands of a few individuals or groups.
» To achieve equal distribution,
employment-oriented planning was to
replace production-oriented planning.
• The IPR of 1977 failed to make an impact
because though the policy tried to be
different, there was no radical change
from the previous policies.
Industrial Policy Resolution of
1980
• The Industrial Policy of 1980 reiterated
its faith in the ideology of the Industrial
Policy Statement of 1956.
• The Industrial Policy Statement of 1980
placed the thrust on the promotion
of competition in the domestic
market, technological upgrading, and
modernization of industries.
• Some of the socio-economic objectives
 of the policy are:
» Maximum production and achieving
higher productivity
» Higher employment generation
» Correction of regional imbalances
» Promotion of export-oriented industries
• The most important initiatives of the
policy were as given below:
» Foreign investment via the technology
transfer route was allowed again.
» The ‘MRTP Limit’ was revised upward
to `50 crore to promote the setting of
bigger companies.
» Industrial licensing was simplified.
» It extended the provision of automatic
expansion to more industries.
• The 1980 Industrial Policy Statement
opened up new vistas for the private
sector to expand its activities and even
set up industries the sector reserved for
the State in 1956 Resolution.
Industrial Policy Resolution
1985 & 1986
• The industrial policy resolutions
announced in year 1985 and 1986 were of
very much similar kind.
• The main highlights of the policies are:
» Foreign investment was more simplified
with further industrial areas being open
for their entries.
» The ‘MRTP Limit’ was revised upward to
`100 crore,promoting the idea of bigger
companies.
» The provision of industrial licensing was
simplified. Compulsory licensing now
remained for 64 industries only.
» High-level attention on the sunrise
industries such as telecommunication,
computerization, and electronics.
223
» Modernization and the profitability
characteristics of the public sector
undertakings were emphasized.
» The agriculture sector was looked with
a new scientific approach with many
Technology Missions being launched by
the Government.
• These industrial provisions were
envisioned towards liberalizing the
economy without any slogan of ‘economic
reforms’.
• The industrial policies conjoined with the
overall micro-economic policy followed
by the Government was more dependent
on foreign capital.
• When the economy was unable to meet
industrial efficiency, it became difficult
for India to repay external borrowings.
• Finally, at the end of 1980s India was in
the grasp of a severe balance of payment
crisis with a higher rate of inflation (above
13 %) and higher fiscal deficit (above 8
%).
• The deep crisis put the economy in a
financial crunch which made India opt
for a new way of economic management
in the coming times.
New Industrial Policy, 1991
• India faced a severe balance of payment
crisis in June 1991. In 1990 and 1991, there
were several inter-connected events
which were growing in unfavourable
ways for the Indian economy.
» Because of the Gulf War (1990–91), the
higher prices of oil were exhausting
India’s foreign reserves.
» Sharp drop in the private remittances
from the overseas Indian workers,
particularly from the Gulf region in the
wake of the Gulf War.
» Inflation was peaking closely to 17 %.
» Gross fiscal deficit of the central
 government reaching 8.4 % of the GDP.
» By the June 1991, India’s foreign exchange
had declined to just two weeks of import
coverage.
• As a result of the BoP crisis, the
initial phase of reforms focused on
macroeconomic stabilization, with
subsequent phases focusing on industrial
policy, foreign investment policy, trade
and exchange rate policies, financial and
tax reforms, and public sector reforms.
• The new industrial policy, proclaimed
by the Government on July 23, 1991, had
initiated a bigger process of economic
reforms in the country, focusing towards
the structural readjustment naturally
obliged to ‘fulfil’ IMF conditionalities.
• In pursuit of these objectives, government
decided to take a series of initiatives in
respect of the policies relating to the
following areas:
» Industrial licensing
− Under new policy, industrial licensing
was abolished for all industries,
except those specified irrespective of
the level of investment.
− Only 18 industries needed a
compulsory license. Subsequently,
this was further liberalized and only 6
industries such as Alcohol, Electronic
equipment and defence equipment,
Tobacco product, Industrial
explosives, Hazardous chemicals,
Drugs and Pharmaceuticals.
− The objective was to provide
impetus to the attainment of fullest
entrepreneurial and industrial
potential.
» Foreign Investment
− Direct foreign investment was
approved up to 51% foreign equity in
high priority industries. There were 34
industries in this category.
224
− A Special Empowered Board was
also established to negotiate with a
number of large international firms
and agree direct foreign investment
in select areas.
» Foreign Technology Agreement
− Bureaucratic clearance was no longer
required for an Indian entrepreneur
for his commercial technology
relationship with his foreign supplier.
− It was expected that the Indian
industry would not only absorb
foreign technology efficiently,
but competitive pressure would
induce them to invest much more in
indigenous R&D activity.
» Public Sector Undertakings
− The public sector has been central to
the philosophy of development.
− Introduced competition by inviting
private sector participation in the
public sector dominated sector.
− Disinvested government holdings to
bring market discipline to the output
of public enterprises and to get out of
places where government presence is
not expected.
− Due to the policy initiative and
governments decision to get out of
the sectors which could be entrusted
to the private sector, number of
industries reserved for the public
sector was cut down to three which
include defence equipment, Atomic
energy, Railway transport.
» Monopoly and Restrictive Trade
Practices Act
− The objective of the Act was the
prevention of concentration of
economic power in a few hands which
may be detrimental to the objective
of social justice. But the present form
of implementing the Act resulted in
 inhibiting industrial growth.
− The Act was to be restructured so as
to minimize government interference
in investment decisions of the large
companies.
− Restrictions on mergers, acquisitions,
amalgamations, and takeovers were
also sought to be liberalized in the
light of the new wave of liberalization.
Positive of New Industrial Policy,
1991
• The end of licence-permit raj.
• Foreign investment and foreign
technology were supposed to encourage
the investment environment in the country
and boost the competitive environment
by shaking the complacency of Indian
business.
• Removal of the Threshold limits of assets
in respect of MRTP Companies and
dominant undertakings. Giving them free
hand for growth.
• Role of the public sector was redefined,
and attention was paid to increase its
efficiency and productivity.
Criticism of New Industrial Policy,
1991
• New Economic Policy (NEP) was criticized
for promoting 'jobless growth'.
• Neglect of agriculture was another area
of major weakness in the NEP.
• Liberalization of imports might offset
export growth leading to an adverse
impact on BoP position.
• The possible reverse flow of dividends,
royalties, and remittance of profit might
result in the outflow of foreign exchange
creating pressure.
225
National
Manufacturing
Policy 2011
• The Indian government decided to
implement the National Manufacturing
Policy in order to effect quantitative and
qualitative change in the manufacturing
sector. It includes:
» Raise manufacturing sector growth to 12-
14% over the medium term for making it
the engine of growth for the economy.
» It seeks to increase the share of
manufacturing in India's GDP to 25% by
2022.
» Rise the rate of job creation in
manufacturing sector to create 100
million additional jobs by 2022.
» Creation of appropriate skill sets in the
rural migrant and urban poor to make
growth inclusive.
» Enhance the global competitiveness
of Indian manufacturing through
appropriate policy support.
» The policy envisages the establishment of
National Investment and Manufacturing
Zones (NIMZ) armed with world-class
infrastructure that would be autonomous
and self-regulated which would be
developed in partnership with the private
sector.
• The following industry will be given
special attention:
» Employment intensive industries:
Sufficient support will be given to promote
and strengthen employment-intensive
industries to ensure job creation.
» Capital Goods: A special focus will be
given to machine tools; heavy electrical
equipment; heavy transport, earth
moving and mining equipment.
» Industries of strategic importance:
 The launch of programmes to develop
national capabilities to make India a
major force in sectors such as aerospace,
shipping, and others would be justified if
the country had a strategic requirement.
» Small and Medium Enterprises (SME):
The SME sector accounts for around 45
percent of manufacturing production,
40 percent of total exports, and provides
self-employment and job opportunities
across a wide range of geographies.
» Public Sector Enterprises: Public Sector
Undertakings, particularly those in
Defence and Energy sectors, continue
to play a major role in the growth of
manufacturing as well as of the national
economy.
» Industries where India enjoys a
competitive advantage: India's broad
domestic market, combined with its
strong engineering base, has resulted in
indigenous expertise and cost-effective
manufacturing in the automotive,
pharmaceutical, and medical equipment
industries. Instruments which are to be
used to achieve the objectives are as
follow:
» Rationalization and simplification of
business regulations.
» Simple and expeditious exit mechanism
for the closure of sick units while
protecting labour interests.
» Industrial training and skill up-gradation
measures.
» Incentives for SMEs.
» Financial and institutional mechanisms
for technology improvement, including
green technologies.
National Investment
& Manufacturing
Zones (NIMZs)
• National Investment & Manufacturing
226
Zones (NIMZs) are one of the main
components of the 2011 National
Manufacturing Strategy. NIMZs are
broad areas of developed land with the
required eco-system for fostering world-
class manufacturing.
• These helps to meet the increasing
demand for creating world-class urban
centres in India, while will also absorb
surplus labour by providing them with
gainful employment opportunities.
• These NIMZs are managed by Special
Purpose Vehicle (SPVs), which ensure:
» Zone master planning.
» Pre-clearances for the establishment of
industrial units to be established within
the zone.
» Other functions as defined in the various
sections of this policy.
• To allow the NIMZ to function as a self-
governing and autonomous body, it will
be declared by the State Government as
an Industrial Township.
• The Department of Industrial Policy and
Promotion (DIPP) will act as the nodal
agency for the central government in
matters pertaining to the NIMZs.
Land For NIMZ
• Size of land for NIMZ: An NIMZ would
have an area of minimum 5000 hectares
in size.
• Availability of land: The State Government
will be responsible for the selection of land
suitable for the development of the NIMZ
including land acquisition if necessary.
The land may constitute:
» Government-owned land.
» Land under existing industrial areas/
estates/sick and defunct units, including
PSUs, to be purchased by the State
Government.
Ownership
• It is up to the State Government to choose
the model that it believes will work best.
• It may include:
» Keep the ownership with the state
government itself.
» Handover the ownership to a state
government undertaking.
» Have joint ownership with a private
partner.
» Adopt any other appropriate model.
Administration
• A Special Purpose Vehicle, a developer,
the State Government, and the Central
Government would make up the
administrative framework of NIMZ.
• An NIMZ will be notified by the Central
Government, by notification in the
Official Gazette.
• Any SPV must be a legal entity with the
NIMZ as its name. This SPV will act as a
business.
• The SPV's CEO would be a senior
government official from the central or
state level.
The cost of master planning for the
NIMZ would be covered by the central
government.
Number of NIMZ?
• So far, three NIMZs have received
final approval: Prakasam (Andhra
Pradesh), Sangareddy (Telangana), and
Kalinganagar (Odisha), and 13 NIMZs
have received in-principle approval.
• Aside from these, the Delhi Mumbai
Industrial Corridor (DMIC) project has
eight Investment Regions that have been
designated as NIMZs.
227
Difference between SEZ vs
NIMZ?
• NIMZs vary from SEZs in terms of
scale, level of infrastructure planning,
governance mechanisms related to
regulatory procedures, and exit policies.
SEZs are focused on the concept of
industrial growth in partnership with
States and focuses on manufacturing
growth, the advancement of exports and
employment generation.
• NIMZs are based on the principle of
industrial growth in partnership with
States and focuses on manufacturing
growth and employment generation.
Make in India
• The Make in India initiative launched by
the Government in 2014 to encourage
companies to manufacture their
products in India and ensure dedicated
investments into manufacturing.
• It was launched by the Department of
Industrial Policy and Promotion (DIPP),
Ministry of Commerce and Industry.
• Objectives of Scheme:
» Improving the competitiveness of the
private and public sector firms operating
in the country.
» Facilitating integration into the global
value chains.
» Enhance Ease of Doing Business
» Enhance skill development
» Providing employment
• It is an international marketing approach
based on the Singapore model to
enhance the competitiveness of the
manufacturing sector by promoting FDI,
imposing ease of doing business, labour
reform etc.
• The Make in India programme is vital
 for India's economic growth because it
seeks to tap into the country's existing
talent pool, build new job opportunities,
and motivate the secondary and tertiary
sectors.
• The programme also aims to improve
India's Ease of Doing Business ranking
by removing unnecessary laws and
regulations, simplifying bureaucratic
procedures, and making the government
more transparent, sensitive, and
accountable. The focus of the Make in
India programme is on 25 sectors.

These include:

Pharmaceuticals
Automobiles Aviation Chemicals IT & BPM

Defence Electrical Food Textiles and

Construction
Manufacturing Machinery processing Garments

Media and
Ports Leather Wellness Mining
Entertainment

Tourism and Automobile Renewable

Railways Biotechnology
Hospitality Components Energy

Electronics
Space Thermal power Roads Highways
Systems

• Its goals include reducing the number

What did the of points of contact between businesses

government and government agencies, establishing

do to promote
manufacturing?
Ease of doing business
• Government has initiated reforms in the
area such as starting a business, dealing
with construction permits, registration
of property, power supply, paying taxes,
enforcing contracts, and resolving
insolvency.
• The Department of Industrial Policy
and Promotion's eBiz initiative aims to
provide comprehensive Government-
to-Business (G2B) services to businesses
with accountability, pace, and certainty.
single-window programmes, and lowering
enforcement costs. eBiz – India’s first
Government-to-Business (G2B) portal,
has been developed by Infosys in a public
private partnership model.
• Invest India is India’s official agency
dedicated to investment promotion and
facilitation. It is a not-for-profit, single-
window facilitator, set up for prospective
overseas investors and to those aspiring
Indian investors desiring to invest in
foreign locations, and acts as a structured
mechanism to attract investment.
Invest India is essentially an Investment
Promotion Agency in India. Invest India,
set up in 2009, is a non-profit venture
under the Department for Promotion of
Industry and Internal Trade, Ministry of

228
 Commerce and Industry, Government of Fund account portable, hassle-free, and
India. universally accessible.
• Stable and predictable tax regime i.e. » Apprentice Protsahan Yojana: Will
avoiding litigation, retrospective taxation support manufacturing units mainly and
etc. other establishments by reimbursing
• Easing of environmental clearance 50% of the stipend paid to apprentices
norms. during the first two years of their training.
» Revamped Rashtriya Swasthya Bima
150 Yojana: Introducing a Smart Card for the
workers in the unorganized sector seeded
100
with details of two more social security
schemes.
India Rank

50

Factories (Amendment) Bill, 2014

• The Factories (Amendment) Bill, 2014 was
0
2014 2015 2016 2017 2018 2019

Year
I M A G E 13.1: I N D I A E A S E O F D O I N G B U S I N E S S
RANKING
Labour Reforms
Pandit Deendayal Upadhyay
Shramev Jayate Karyakram
• It was launched in October 2014 by the
Government of India.
• The foremost objective of the scheme
is to provide a conducive environment
for industrial development and promote
ease of doing business through the
introduction of several labour reforms.
• The five main schemes launched under
this are:
» A dedicated Shram Suvidha Portal:
The portal allots Labour Identification
Number (LIN) to nearly 6 lakh units and
allow them to file online compliance for
16 out of 44 labour laws.
» An all-new Random Inspection Scheme:
Utilizing technology to eliminate human
discretion in the selection of units for
Inspection and uploading of Inspection
Reports within 72 hours of inspection
mandatory.
» Universal Account Number: Enables 4.17
crore employees to have their Provident
aims to change the 1948 Factories Act.
• The Act seeks to ensure appropriate
safety measures and promote the health
and welfare of factory workers
• It proposes to grant the state government
the authority to allow women to work at
night in a factory or group of factories
that meet certain requirements. The
Bill seeks to impose restrictions on the
employment of pregnant women and
persons with disability in certain works or
processes.
• Norms of hiring and firing were liberalized.
Skill Development
Ministry of Skill Development and
Entrepreneurship (MSDE)
• A separate dedicated ministry for skill
development has been established in
2014 i.e. Ministry of Skill Development
and Entrepreneurship (MSDE).
• The Ministry is in charge of coordinating
all skill development efforts across the
country, bridging the gap between
demand and supply of skilled manpower,
developing a vocational and technical
training system, skill up-gradation, the
development of new skills, and creative

229
 thinking, not only for existing jobs but
also for new jobs.
• Its functional arms, the National Skill
Development Agency (NSDA), the
National Skill Development Corporation
(NSDC), the National Skill Development
Fund (NSDF), and Sector Skill Councils,
assist it in these initiatives (SSCs).
Sector Skill Council (SSC)
• Sector Skill Councils are set up as
autonomous industry-led bodies by
NSDC.
• They create Occupational Standards
and Qualification bodies, develop
competency framework, conduct Train
the Trainer Programs, conduct skill gap
studies, and Assess and Certify trainees
on the curriculum aligned to National
Occupational Standards developed by
them.
• New Skill Development programmes
have been initiated like Pradhan
Mantri Kaushal Vikas Yojana, National
Apprenticeship Promotion Scheme, Deen
Dayal Upadhyaya Grameen Kaushalya
Yojana etc.
Companies Act 2013
• The Companies Act 2013 replaced the
Indian Companies Act, 1956.
• The Companies Act, 2013 seeks to bring
corporate governance and regulation
practices in India at par with the global
best practices.
• Objective:
» It seeks to create a more friendly
environment and improve corporate
governance norms, increase transparency,
enhance the accountability of corporates
and auditors and to protect the interest
of the investor, especially small investors.
230
• Features:
» Corporate Social Responsibility (CSR)
• The companies having annual turnover
of over Rs. 1000 crore or net worth of Rs.
500 crore or more or net profit of Rs. 5
crore or more in any financial year has
to constitute a CSR committee consisting
of at least three directors out of which
one director should be an independent
director.
• Such companies have to spend at least
2% of the average net profit of the
preceding 3 years on CSR activities.
» Directors:
• At least one-third of the directors in all
listed companies should be independent
directors.
• There should be at least one female
director in the prescribed company (not
all companies).
• In all listed companies, at least one
director must be resident director i.e.
stayed in India for at least 182 days in a
year.
• Duties of directors are also prescribed in
Companies Act 2013.
» Auditing and accounting norms
• A National Financial Reporting Authority
should be established to supervise and
regulate the accounting standard of the
companies.
• Mandatory rotation of auditors i.e.
individual auditors could be appointed
for not more than five years and audit
firms could be appointed for not more
than 10 years.
• Auditors cannot provide any other service
to the company.
» Investor Protection
• The class-action suit provision was
introduced for the first time. Under this, a
 shareholder, creditor, or any stakeholder
can sue a company on behalf of
a particular class of shareholder/
stakeholder.
• Exit option to be provided to minority
shareholders during the reorganization
of the company.
» National Company Law Tribunal (NCLT)
• The National Company Law Tribunal
would replace the Board for Industrial
and Financial Reconstruction (BIFR) and
Company Law Board (CLB).
Public Sector
Enterprise/
Undertakings
• The word Public Sector Undertaking,
or Enterprise refers to a Government
Company.
• Government Company is described
under Section 2 (45) of the Companies
Act, 2013 as any company in which not
less than fifty-one percent of the paid-up
share capital is held by the:
» Central Government, or
» State Government or Governments, or
» Partly by the Central Government and
partly by one or more State Governments.
» Includes a company which is a subsidiary
company of such a Government
company.
• The word "public sector undertakings"
applies to government-run companies
that charge fees for their services. Railways,
Posts, and Security Undertakings, for
example, are typically wholly owned and
operated by the government.
• On the other hand, Public sector
enterprises, are companies registered
under the Companies Act, 1956, that are
231
primarily owned by the government and
managed by a Chairman and Managing
Director appointed by the government.
On the boards of public sector companies,
government candidates serve the
government's interests.
• The audit of public sector undertakings
is done by the Comptroller and Auditor
General (CAG) of India while that of
public sector enterprises is done first
by Chartered Accountants and the
supplementary audit is done by the
Comptroller and Auditor General of India.
Evolution of Public Sector
Enterprises
• Indian industry was underdeveloped
when the country gained independence
in 1947, necessitating a major policy drive.
• The Second Five-Year Plan (1956-61)
and the Industrial Policy Resolution
of 1956 established the framework
for India's public sector undertakings/
enterprises, which were expected to play
a significant role in preventing economic
power concentration, reducing regional
disparities, and ensuring that planned
development serves the common good.
• Initially, the public sector was limited
to core and strategic industries such as
irrigation projects (e.g. Damodar Valley
Corporation), fertilizers and chemicals
(e.g. Fertilisers And Chemicals Travancore
Limited), communication networks
(e.g. Indian Telephone Industries), and
heavy industries (e.g. Indian Telephone
Industries) (e.g. Bhilai Steel Plant,
Hindustan Machine Tools, Bharat
Heavy Electricals, Oil and Natural Gas
Commission etc.).
• Subsequently the Government
nationalized several banks (starting with
nationalization of the Imperial Bank of
India which was renamed State Bank
of India in 1955) and foreign companies
(Jessop & Co, Braithwaite & Co, Burn &
 Co.).
• Later, Public Sector companies
started manufacturing consumer
goods (e.g. Modern Foods, National
Textile Corporation etc.) and providing
consultancy, contracting, and
transportation services.
• Reviewing the role of the public sector, the
Industrial Policy Resolution 1991 reduced
the number of industrial undertakings to
just six areas which included strategic
industries like atomic energy, defence,
coal, mineral oils, and railway transport
etc. Efforts were made to divest non-
strategic public sector industries and
to increase private participation in
the equity of profitable public sector
industries.
Objective of PSU
• To create an industrial base with
diversification in different sectors.
• Employment generation and to create an
employee model.
• Accelerate economic growth.
• Reduce regional disparities.
• Export Promotion and import substitution.
• To generate resources for the government.
Cause of Losses of PSU
• Lack of autonomy and accounting.
• Excessive Social overhead cost like
developing infrastructure, amenities to
employers etc.
• Inappropriate location, technology,
product etc.
• Investment decision was based on social
welfare rather than economic welfare.
• Overstaffing.
• Trade Union interference.
• Administrative Price Mechanism: Under
232
this government use to fix the prices of
the product of PSU.
Reforms in PSU
• New Industrial Policy 1991:
» The changes made by the Industrial
Policy 1991 on PSUs were manifold:
− Sectors where the PSUs to be
concentrated,
− Removal of reservation for PSUs in
most sectors,
− PSU restructuring by adopting
market-oriented practices,
− Selling of loss-making PSUs,
− Reduction of government ownership
through disinvestment.
• Voluntary Retirement Scheme (VRS)
» Under this Employee of PSU were
encouraged to seek premature
retirement.
» It is also called the Golden Handshake
Scheme.
• Dismantling of APM
» Price of most of the products of PSU was
deregulated.
• Participation in Share Market
» PSUs were permitted to raise funds from
the public through issue of IPO and get
listed in the stock exchange.
• Navratna Scheme 1997
» In 1977, the government launched the
Navratna scheme to recognize and assist
Central Public Sector Enterprises (CPSEs)
with competitive advantages in their
quest to become global behemoths.
» Government provided significant
autonomy to such PSUs like to invest
 up to Rs. 100 crore or up to 15% of their
net worth in India/abroad, entering into
collaboration, establishing joint ventures
etc.
• Miniratra Scheme 1997:
» The Government introduced the
Miniratna scheme in 1997 in pursuance of
the policy to make the public sector more
efficient and competitive and to grant
enhanced autonomy and delegation of
powers to the profit-making public sector
enterprises.
» Eligibility conditions are:
− Category I: CPSEs should have
made a profit in the last three years
continuously, and the pre-tax profit
should have been Rs. 30 crores or
more in at least one of the three years
and positive net worth.
− Category II: CPSEs should have
made a profit for the last three years
continuously and should have a
positive net worth.
• Maharatna Scheme
» The Government introduced the
Maharatna scheme in December 2009
with the objective to delegate enhanced
powers to the Boards of identified large
sizes Navratna CPSEs to facilitate further
expansion of their operations, both in
domestic as well as global markets.
» Eligibility conditions are:
− Having a Navratna status.
− Listed on the Indian stock exchange,
with a minimum prescribed public
shareholding under SEBI regulation.
− Average annual turnover of more
than Rs.20,000 crore during the last
three years.
− An average annual net worth of more
than Rs.10,000 crore during the last
three years.
233
− An average annual net profit of more
than Rs.2500 crore during the last 3
years.
− Significant global presence or
international operations.
• The Maharatna CPSEs can invest
Rs. 5000 crores or 15% of net worth
whichever is lower in one project without
government permission.
Disinvestment
• Disinvestment refers to government
selling its equity holding in Public
Enterprises to public or private parties,
financial institutions, and mutual funds
etc.
• The disinvestment policy, at initial stage,
had stated a limited sale of equity for
the purpose of raising some resources
to reduce budgetary gaps and providing
market discipline to the performance of
public enterprises.
Objectives of Disinvestment
• Modernization and up-gradation of
public sector enterprises.
• To reorient public investment i.e. to
transfer public investment from non-
strategic to strategic areas.
• Improve the efficiency of an enterprise
and can convert the sick unit into
productive units.
• Increase transparency and accounting to
the general public.
• Releasing huge amounts of scarce public
resources locked up in nonstrategic PSU
for development in areas much higher
on social priority, such as public health,
family welfare, education, social and
essential infrastructure.
Process of Disinvestment
• Government initiated the process
of disinvestment in 1991 under New
Industrial Policy 1991.
• Initially, the disinvestment process only
involved financial institutions.
• In 1992, the Government created a
committee on disinvestment under C.
Rangarajan which recommended that a
disinvestment fund should be constituted,
and the government should go for
strategic disinvestment (management
control is also transferred).
• In 1996, the Disinvestment commission
(a permanent body to advise the
government) was set up.
• In the 1998-99 Budget Address, it
was revealed that the Government's
shareholding in CPSEs would be reduced
to 26% on a case-by-case basis, with the
exception of strategic CPSEs, where the
Government would maintain majority
ownership. Workers' rights were to be
safeguarded at all times. On March 16,
1999, the government categorized PSEs
into Strategic and Non-Strategic areas
for this reason.
Disinvestment in India:
• In 1999, the Department of
Disinvestment was established as a
separate department and later it was
renamed as Ministry of Disinvestment
in 2001. The Department of
Disinvestment was transferred to the
Ministry of Finance in 2004.
• The Department of Disinvestment
has been retitled as Department
of Investment and Public Asset
Management (DIPAM) from 14th
April 2016. It has been made the
nodal department for the strategic
stake sale in the PSUs (Public Sector
Undertakings).
• In 2004, as the Government changed,
there was a change in the viewpoint
234
of Disinvestment Policy. The UPA
Government promised to:
» Devolve complete managerial control
and commercial autonomy to successful,
profit-making companies operating in a
competitive environment they will not be
privatized.
» Navratna companies can raise resources
from the capital market.
» Efforts will be made to renovate and
restructure sick PSEs.
» It favoured the sale of small proportions
of Government equity through IPO/FPO
without changing the character of PSEs.
» It also established the formation of the
‘National Investment Fund’, where the
proceeds from disinvestment of CPSEs
would be channelized. 75% of the
annual income of NIF would be used to
finance selected Social Sector Schemes-
education, health, employment, and the
rest 25% to meet the capital investment
requirements of profitable and revivable
CPSEs.
• On 5th November 2009, the Government
approved the following action plan
for disinvestment in profit-making
government companies:
» Already listed profitable CPSEs (not
meeting the required shareholding of
10%) would be made compliant by
the government's "Bid for Sale," or by
the CPSEs issuing new shares, or a
combination of both.
» Unlisted CPSEs with no cumulative losses
and a net profit in the previous three
years are eligible to be listed.
» The government will maintain at least 51
percent equity and management control
in all cases of disinvestment.
» Every disinvestment cases will be handled
on a case-by-case basis.
• Since 2014, the government has adopted
a disinvestment strategy that involves
 minority stake sales as well as strategic
disinvestment.
• The government has approved the
strategic disinvestment of 33 central
public sector undertakings 'in principle'
so far (CPSEs).
• NITI Aayog, a think tank, has been
tasked with defining such PSUs based on
national security, sovereign functions at
arm's length, market imperfections, and
public interest parameters.
• During 2014-19, the government received
Rs. 2,79,622 crore from public sector
undertakings (PSUs), compared to Rs.
1,07,833 crore in 2004-14.
Some of the major Disinvestment done:
• During 2009-20, some of the
major disinvestment took place in
companies such as NHPC Ltd., Oil
India Ltd., NTPC Ltd., SJVN, NMDC,
SJVN, EIL, CIL, MOIL, etc. with the
help of public offers.
• Finance minister in 2021 said that
Disinvestment of Air India and Pawan
Hans would be completed in 2021-22.
• On 01 February 2021, during the
budget (2021-22) presentation in
the Lok Sabha, the Finance Minister
publicized that two public sector
banks (PSBs) and one general
insurance company are anticipated
to be disinvested this year.
• The government will develop a
National Asset Monetisation Pipeline
and Dashboard, according to the
Finance Minister, with the aim of
monetising government properties.
• Assets of Railway, NHAI, Railways,
Airports Authority of India (AAI),
HPCIL and GAIL will be Monetized.
• The Union Government budgeted Rs. 1.75
lakh cr from stake sale in public sector
companies and financial institutions,
235
including 2 PSU banks and one general
insurance company, in 2021-22 Budget.
The figure is lower than the budgeted
amount of Rs. 2.10 lakh crore for CPSE
disinvestment in 2020-21. However, in
2020-21 the government has raised less
than 3 percent of budgeted revenues
from disinvestment process.
DisinvestmentTarget Acheived
100,000
75,000
50,000
25,000
0
2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
Year
I M A G E 13.2: D I S I N V E S T M E N T T A R G E T AND
ACHEIMENTS
National Investment Fund
• The Cabinet Committee on Economic
Affairs (CCEA) approved the creation
of a National Investment Fund (NIF) in
January 2005.
• The fund's aim was to raise disinvestment
proceeds from central public sector
enterprises and invest them in order to
generate earnings while not depleting
the corpus, with the earnings going to
selected Central social welfare schemes
• It was held outside consolidated fund of
India.
• In 2013, CCEA decided that the entire
disinvestment proceeds will be credited
to the existing ‘Public Account’ under
the head NIF and they would remain
there until withdrawn/invested for the
approved purpose.
• The allocations out of the NIF will be
decided in the annual Government
Budget.
• The broad investment objectives are:
» Investment in social sector programmes
that support education, health care, and
jobs.
» Capital investment in sustainable and and service businesses. It also describes
revivable public sector companies that medium businesses for the first time and
yield sufficient returns in order to extend tries to combine the three levels of these
and diversify their capital base. businesses, namely micro, small, and
medium.
• The Act also offers for a statutory
consultative mechanism at the national
level with a balanced representation of
Micro, Small and all sections of stakeholders, particularly

Medium Enterprises
the three classes of enterprises and with
a wide range of advisory functions.

Development
(MSMED) Act 2006 Definition of Micro, Small and
Medium Enterprises in India
• In 2006, the Micro, Small, and Medium
Enterprises Growth (MSMED) Act was
• Micro, small, and medium enterprises as
per the MSMED Act, 2006 are defined
enacted to resolve policy concerns
based on their investment in plant and
affecting MSMEs, as well as the sector's
machinery (for manufacturing enterprise)
coverage and investment ceiling.
and on equipment for enterprises
• The Act seeks to help these companies providing or rendering services.
expand and compete by establishing
the first-ever legal structure for
• The present ceilings on investment for
enterprises to be classified as micro, small
understanding the idea of "enterprise,"
and medium enterprises are as follows:
which encompasses both manufacturing

Existing and Revised Definition of MSMEs

Existing MSME Classification

Criteria: Investment in plant & Machinery or Equipment
Classification Micro Small Medium
Mfg. Enterprises Investment<Rs. 25 Lac Investment<Rs. 5 cr. Investment<Rs. 10 cr.
Services Enterprise Investment<Rs. 10 Lac Investment<Rs. 2 cr. Investment<Rs. 5 cr.

Revised MSME Classification

Composite Criteria: Investment & Annual Turnover
Classification Micro Small Medium
Manufacturing & Investment<Rs. 1 cr. Investment<Rs. 10 cr. Investment<Rs. 20 cr.
Services and and and
Turnover<Rs. 5 cr. Turnover<Rs. 50 cr. Turnover<Rs. 100 cr.

236
Contribution of MSME Sector
• Over the last five decades, the Micro,
Small and Medium Enterprises (MSME)
sector has emerged as a highly vibrant
and competitive sector of the Indian
economy.
• MSMEs not only play a critical role
in providing significant employment
opportunities at a lower capital cost
than large factories, but also help in the
industrialization of rural and backward
areas, thereby reducing regional
imbalances and assuring food security.
• The Sector consisting of 36 million units,
as of today, provides employment to over
80 million persons.
• The Sector through more than 6,000
products contributes about 8% to GDP.
• MSME contributes 45% to the total
manufacturing output and 40% to the
exports from the country.
Problem in MSME Sector
• Problem in raising funds (limited access
to formal credit and they have to pay
high interest).
• Obsolete Technology.
• Non-Professional management/
entrepreneurship.
• Inadequate infrastructure in rural and
semi-urban areas.
• Dependence on local sources of raw
material.
• Marketing problem: No brands and High
per unit advertisement cost.
• Competition from large scale industry.
• No availability economies of scale.
Measures taken by Government
Financial Support
• Financial support to MSME sector is
237
provided through various mechanism
some of them are as follows:
» Mudra Bank
» Priority Sector Lending (PSL)
» Through various government schemes
like the Credit Guarantee Fund Scheme
for Micro and Small Enterprises, Prime
Minister’s Employment Generation
Programme and Credit Linked Capital
Subsidy Scheme.
Fiscal Support
• Lower rate of 25 % Corporate Tax
extended to companies with an annual
turnover up to Rs. 400 crore from the
earlier cap of up to Rs. 250 crore.
• For the MSME sector, Rs. 350 crore has
been allocated for FY 2019-20 under
the Interest Subvention Scheme, for 2%
interest subvention for all GST registered
MSMEs, on fresh or incremental loans.
• Doubling the exemption threshold under
the goods and services tax (GST) to Rs.
40 lakh annual turnover will reduce the
burden on small and medium enterprises
(SMEs).
• Price and Preference Purchase Scheme:
Under this, preference is granted to
products manufactured by small scale
industry in the government purchase
programme (up to 15% higher price than
other sectors).
Technical and Industrial Support
• Small Industries Development
Corporations (SIDCO) are state-owned
companies or agencies in the states of
India which were established in 1954 for
the promotion of small-scale industries.
It provides technical, managerial,
marketing support etc., to small scale
industries.
• The Government of India founded the
National Small Industries Corporation
 (NSIC) Ltd. in 1955 to encourage,
assist, and foster the growth of small-
scale industries in the country. The
Corporation's key responsibilities are to
promote help and facilitate the growth of
micro and small businesses in the region,
primarily on a commercial basis. It offers
a wide range of support services to
micro and small companies, catering to
their unique needs in areas such as raw
material sourcing, product marketing,
credit rating, technology acquisition,
and the implementation of modern
management practices, among others.
• District Industries Centre (DIC) was
established in 1979 to provide support to
MSME, skill development and technical
issues etc.
Reservation of item for Small Scale
Industry (SSI)
• In 1967, 47 items were reserved for the
small-scale industry. These items were
increased to 900 by 1990.
• The main objective of the reservation
was to eliminate competition from large
scale industry.
• Abid Hussain Committee on Reservation
of Items (1997) recommended to stop
reservation for small scale industry.
• As of today, there are 836 items reserved
for exclusive manufacture in the small-
scale sector.
Capital Formation
or Investment
• It refers to the process of increase in the
physical stock of capital like machinery,
equipment, factory, etc.
• It is the most important determinant of
economic growth because it increases
production, productivity, and the
productive capacity of the future of an
238
economy.
• Our 1st five-year plan was based on the
Harrod-Domar growth model.
• Harrod-Domar growth model states that
economic growth rate can be calculated
as:
Economic Growth Rate =
Investment Rate (IR)
Incremental Capital Output Ratio
Stages of Capital Formation
• Stages of capital formation include the
following stages:
» Saving: Saving is disposable income
minus consumption.
» Finance: Mobilization of saving of
household investment by firms through a
financial institution.
» Investment: Expenditure on capital
goods.
Component of Investment
• Component if Investment includes:
» Fixed Investment: Fixed investment is the
accumulation of physical assets such as
machinery, land, buildings, installations,
vehicles, or technology.
» Inventories or Stocks: It includes raw
material, semi-finished goods, unsold
goods.
» Valuables: It includes commodities like
Gold, Silver etc.
Determinant of Investment
• The determinant of investment are as
follows:
» Interest rates
− Investment is inversely related to
interest rates. If interest rates increase,
 the opportunity cost of investment
rises.
» Expected return on the investment
− Businesses require a return on their
investment in order to cover their
cost. In terms of the entire economy,
the amount of business profits is a
good indication of the potential for
investment.
» Saving
− Household and corporate savings
provide a flow of funds into the
financial sector, which means that
funds will be available for investment.
» Government Policy
− Public policy can have substantial
effects on the Investment.
− Government taxation policy with
respect to corporate profits, capital
gains affect the demands for capital.
Types of Capital Formation
There are two types of capital formation
• Physical Capital formation
» It refers to investments made in the form
of sophisticated tools, machinery etc.
» It directly affects the production process.
• Human Capital formation
» Human capital formation implies
additions to the skills, knowledge of the
individuals.
» It indirectly affects the production
process.
» Its formation can lead toward
improvement in physical capital.
239
Index of Industrial Production
(IIP)
• The Central Statistical Office (CSO),
Ministry of Statistics and Programme
Implementation, compiles and publishes
the all-India Index of Industrial Production
(IIP) monthly.
• It analyses short-term changes in the
amount of production of a basket of
industrial products over a given period in
comparison to a chosen base period.
• The Central Statistics Office (CSO)
revised the base year of the all-India
Index of Industrial Production (IIP) from
2004-05 to 2011-12 on 12 May 2017.
• Total number of item groups has been
enlarged from 399 under 2004-05 series
to 407 under the 2011-12 series. Each
item group may encompass several sub-
industries.
• Revisions in the IIP are required to
maintain representativeness of the items
and producing entities and also address
issues relating to the continuous flow of
production data.
• The revised IIP (2011-12) not only reflects
the changes in the industrial sector but
also aligns it with the base year of other
macroeconomic indicators like the Gross
Domestic Product (GDP) and Wholesale
Price Index (WPI).
• Total number of item groups has been
enlarged from 399 under 2004-05 series
to 407 under the 2011-12 series. Each
item group may encompass several sub-
industries.
• Electricity, crude oil, cement, steel,
refinery products, coal, natural gas, and
fertilizers are the eight important core
industries that include around 40% of
the weight of items included in the Index
of Industrial Production
• Industrial production for the purpose of
IIP is separated into three sectors:
Sector Number of Item Groups
Mining 1 14.373%
Manufacturing 405
Electricity 1 7.994%
Total 407
• The IIP is used for policy purposes by
public bodies, including government
agencies/departments such as the
Ministry of Finance and the Reserve Bank
of India.
Index of Eight Core
Industries
• The Monthly Index of Eight Core
Industries (ICI) is a production volume
index that aims to provide an early
indicator of production efficiency of
"core" industries before the Central
Statistics Office publishes the Index of
Industrial Production (IIP).
• These industries are likely to impact
general economic activities as well as
industrial activities.
• These eight types of industries account
for nearly around 40 percent in the Index
of Industrial Production (IIP).
• Components covered in these eight
industries for the purpose of compilation
of index are as follows
» Coal: Coal Production excluding Coking
coal.
240
Weight (%)
77.633%
100%
» Crude Oil: Total Crude Oil Production.
» Natural Gas: Total Natural Gas
Production.
» Refinery Products: Total Refinery
Production (in terms of Crude
Throughput).
» Fertilizer: Urea, Ammonium Sulphate
(A/S), Calcium Ammonium Nitrate (CAN),
Ammonium chloride (A/C), Diammonium
Phosphate (DAP), Complex Grade
Fertilizer and Single superphosphate
(SSP).
» Steel: Production of Alloy and Non-Alloy
Steel only.
» Cement: Production of Large Plants and
Mini Plants.
» Electricity: Actual Electricity Generation
of Thermal, Nuclear, Hydro, imports from
Bhutan.
• The Index is gathered and released
by the Office of the Economic Adviser
(OEA), Department of Industrial Policy &
Promotion (DIPP), Ministry of Commerce
& Industry, Government of India.
• The all-India Index of Industrial
Production (IIP) has had its base year
changed from 2004-05 to 2011-12 by
the Central Statistics Office (CSO),
Ministry of Statistics and Programme
Implementation.
Industry Weight
Coal 10.33
Crude oil 8.98
Natural Gas 6.88
Refinery Products 28.04
Fertilizers 2.63
Cement 5.37
Electricity 19.87
Steel 17.92
Annual Survey of
Industries (ASI)
• The Annual Survey of Industries (ASI)
is India's primary source of industrial
statistics, providing data on key aspects
of the country's registered manufacturing
sector.
• ASI is widely regarded as the most
detailed and trustworthy source of
structured manufacturing sector data,
offering disaggregated industry-specific
information on production, investment,
jobs, and costs. It does not refer to
unorganized, unregistered, or informal
companies.
• ASI is the main survey conducted by the
Central Statistics Office (CSO) Industrial
Statistics (IS) wing. It ensures timely
dissemination of statistical information
to assess and evaluate the dynamics in
composition, growth, and structure of the
organized manufacturing sector.
• The ASI extends to the entire country.
• It covers all factories registered under
Sections 2 of the Factories Act, 1948.
241
Source
Office of the Coal Controller, Kolkata
Ministry of Petroleum and Natural Gas
Ministry of Petroleum and Natural Gas
Ministry of Petroleum and Natural Gas
Ministry of Chemicals and Fertilizers
Ministry of Commerce and Industry
Central Electricity Authority.
Joint Plant Committee, Kolkata
ASI vs IIP
• Annual Survey of Industries (ASI) on yearly
basis and Index of Industrial Production
(IIP) on a monthly basis.
• The ASI has been conducted under the
Collection of Statistics Act since 1959
whereas IIP is compiled on the basis
of data sourced from 14 ministries/
administrative departments.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) Why is the Government disinvesting
its equity in the Central Public
Sector Enterprises (CPSEs)? 2011
1. The Government intends to use the
revenue earned from the disinvestment
mainly to pay back the external debt.
2. The Government no longer intends to
retain the management control of the
CPSEs.
Which of the statements given above is/
are correct?
(a) 1 only
 (b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (d)
• Explanation: Following the 1991
economic liberalization and structural
reforms, disinvestment of a percentage
of the government's shares in public
enterprises became a policy choice.
Q.2) What is/are the recent policy
initiative(s) of the Government of India to
promote the growth of the manufacturing
sector? 2012
1. Setting up of National Investment and
Manufacturing Zones
2. Providing the benefit of ‘single window
clearance’
3. Establishing the Technology Acquisition
and Development Fund
Select the correct answer using the codes
given below:
(a) 1 Only
(b) 2 & 3 Only
(c) 1 & 3 Only
(d) 1, 2 & 3
Ans. (d)
• Explanation: In order to bring about
a quantitative and qualitative change
and to give the necessary impetus to the
manufacturing sector, the Department
has notified the National Manufacturing
Policy (NMP) with the objective of
enhancing the share of manufacturing
in GDP to 25% and creating 100 million
jobs over a decade or so.
• The policy is based on the principle of
industrial growth in partnership with the
States.
• Government is focusing on enhancing
India's rank in Ease of Doing Business,
by implementing single window
clearances, use of ICT and creating basic
242
infrastructure.
• The Central Government will provide
an enabling policy framework,
provide incentives for infrastructure
development through appropriate
financing instruments, and encourage
state governments to use the policy's
instruments.
• In coordination with concerned Central
Government agencies as well as the
States, the Department has begun
implementing the strategy.
Q.3) If the interest rate is decreased in an
economy, it will: 2014
(a) decrease the consumption
expenditure in the economy
(b) increase the tax collection of the
Government
(c) increase the investment expenditure
in the economy
(d) increase the total savings in the
economy
Ans. (c)
• Explanation: Interest rates influence the
public's appetite for goods and services,
and thereby aggregate investment
expenditure. Lower interest rates
stimulate more investment spending,
which gives the economy a boost in
periods of weak economic growth.
• Lower interest rates minimize the cost
of borrowing, enabling companies
and households to spend more. Lower
interest rates often enable banks to lend
to businesses and households, allowing
them to spend more.
Q.4) In the Index of Eight Core Industries,
which one of the following is given
the highest weight? 2015
(a) Coal Production
(b) Electricity generation
(c) Fertilizer Production
 (d) Steel Production
Ans. (b)
• Explanation: The Eight Core Industries
comprise 40.27 per cent of the weight of
items included in the Index of Industrial
Production (IIP). Coal, Crude, Oil Natural,
Gas Refinery Products, Fertilizers, Steel,
Cement, Electricity.
Q.5) The substitution of steel for wooden
ploughs in agricultural production is
an example of 2015
(a) labour-augmenting technological
progress
(b) capital-augmenting technological
progress
(c) capital-reducing technological
progress
(d) None of the above
Ans. (b)
• Explanation: “Capital” in an economic
context means machinery or capital
goods which can be employed to produce
other goods.
• Substitution of steel can be considered
as the substitution of a lesser machine by
a better machine.
• This encourages steel production. Hence,
it is capital-augmenting technological
progress.
Q.6) India’s ranking in the ‘Ease of Doing
Business Index’ is sometimes seen in the
news. Which of the following has declared
that ranking? 2016
(a) Organization for Economic
Cooperation and Development (OECD)
(b) World Economic Forum
(c) World Bank
(d) World Trade Organization (WTO)
Ans. (c)
• Explanation: The ease of doing business
243
index is an index created by Simeon
Djankov at the World Bank Group. The
academic research for the Report was
done jointly with professors Oliver Hart
and Andrei Shleifer.
• Higher rankings (a low numerical
value) indicate better, usually simpler,
regulations for businesses and stronger
protection of property rights.
Q.7) Recently, India’s first ‘National
Investment and Manufacturing Zone’
was proposed to be set up in 2016
(a) Andhra Pradesh
(b) Gujarat
(c) Maharashtra
(d) Uttar Pradesh
Ans. (a)
• Explanation: Andhra Pradesh is set to
house India’s first national investment
and manufacturing zone after the state
assured the Centre of availability of 2500
acres (10 sq km) of land in one place in
Prakasam district.
• The imminent final approval for the NIMZ,
which is expected to give a fillip to Prime
Minister’s Make in India campaign, comes
four years after the concept was mooted
to boost manufacturing in the country
and two years after the Department of
Industrial Policy and Promotion gave an
in-principle nod to Andhra Pradesh in
this regard.
Q.8) Which of the following have
occurred in India after its liberalization of
economic policies in 1991? 2017
1. The share of agriculture in GDP
increased enormously.
2. The share of India’s exports in world
trade increased.
3. FDI inflows increased.
4. India’s foreign exchange reserves
increased enormously.
Select the correct answer using the codes of acquiring and raising the number of
given below: persons who have the skills, education,
(a) 1 and 4 only and experience that are essential for the
country's economic and political growth.”
(b) 2, 3 and 4 only It is thus related to investment in man
(c) 2 and 3 only and his development as a creative and
(d) 1, 2, 3 and 4 productive resource.

Ans. (b) • As a result, human capital formation

• Explanation: The share of agriculture in
GDP has decreased. So the 1st statement
is wrong.
• The share of India’s exports in world trade
increased.
• FDI inflows increased. Ex: Foreign direct
investment in India increased from US
$ 129 millions in 1991-92 to US $ 40,885
million in March, 2005.
refers to investments in schooling,
health care, and the training of staff in
specialized skills.
• While the accumulation of physical
capital is significant in the phase of a
country's economic development, it is
becoming increasingly clear that the
growth of tangible capital stock is heavily
dependent on human capital creation,
which must be given due consideration.

• India’s foreign exchange reserves

increased enormously. Q.10) In spite of being a high saving
economy, capital formation may not result
in a significant increase in output due
Q.9) Consider the following statements: to: 2018
Human capital formation as a
concept is better explained in terms (a) weak administrative machinery
of a process, which enables: 2018 (b) illiteracy
1. individuals of a country to accumulate (c) high population density
more capital. (d) high capital-output ratio
2. increasing the knowledge, skill levels Ans. (d)
and capacities of the people of the
country. • Explanation: Capital output ratio is the
amount of capital needed to produce one
3. accumulation of tangible wealth.
unit of output. For example, suppose that
4. accumulation of intangible wealth. investment in an economy, investment is
Which of the statements given above is/ 32% (of GDP), and the economic growth
are correct? corresponding to this level of investment
is 8%.
(a) 1 and 2
(b) 2 and 4 only
• The growth of a nation is impossible
without sufficient resources, either in the
(c) 2 only form of physical capital or in the form of
(d) 1, 3 and 4 human capital.
Ans. (b) • The quicker the speed of economic
development, the higher the rate of
• Explanation: The word "human capital capital accumulation. Capital formation
production" refers to the development involves both saving and investment.
of abilities and skills within a country's Savings, on the other hand, are not the
population. Human capital creation, same as hoarding.
according to Harbison, is “the process

244
• Savings must be mobilized in banks and
financial institutions before they can be
used for investment. And, by taking out
loans from these banks and financial
institutions, merchants, entrepreneurs,
and farmers invest these community
savings in capital goods. This is the
method of capital development.
• Increase in the amount of real savings,
Mobilization of savings through financial
and credit institutions, and Investment
of savings are the three phases in the
capital creation process. Economic
growth would be unlikely if a nation has
high savings but low technology and
productivity.
Q.11) In the context of any country, which
one of the following would be considered
245
as part of its social capitals? 2019
(a) The proportion of literates in the
population
(b) The stock of its buildings, other
infrastructure, and machines
(c) The size of population in the working
age group
(d) The level of mutual trust and
harmony in the society
Ans. (d)
Explanation: Social capital broadly refers
to those factors of effectively functioning
social groups that include such things as
interpersonal relationships, a shared sense
of identity, a shared understanding, shared
norms, shared values, trust, cooperation,
and reciprocity.
 CHAPTER - 14
FINANCIAL INCLUSION
Financial Inclusion
• The objective of financial inclusion is
mainly to provide finance on easy terms
to the vulnerable and weaker sections
of the society to facilitate investment
and economic growth in the country.
Financial inclusion (FI) enables improved
and better social development, in an
equitable manner across the country.
• It enables empowerment of the under-
privileged and poor, including women,
with the aim of enabling them to make
better financial choices by being self-
sufficient and well-informed.
• The attempt to expand access to the
formal financial sector of which financial
inclusion is a part is a continuous process.
Financial Inclusion:
• It is described as the delivery of various
banking services at an affordable
cost, particularly to the vast sections
of disadvantaged and low-income
group.
• It is the process of ensuring affordable
access to different financial services
and a timely and sufficient amount of
credit to disadvantaged populations
such as poorer sections and low-
income groups.
• Facilities related to Credit, savings,
insurance, and payments and remittance,
are among the financial services listed
by the Rangarajan Committee; financial
inclusion refers to universal access to a
wide variety of financial services at a fair
cost, according to the committee.
246
Various aspects of Financial
Inclusion
• The goal of financial inclusion is making
sure that everyone has access to a
variety of relevant financial services and
that they are able to understand and use
them.
• The Government of India, the Reserve
Bank of India, and the National Bank
for Agriculture and Rural Development
(NABARD) have all taken steps to achieve
extensive financial inclusion.
• Some of the important initiatives includes
SHG-Bank Linkage Programme, Kisan
Credit Cards (KCC), the opening of No-
Frills Accounts, mobile banking, Pradhan
Mantri Jan Dhan Yojna (PMJDY) etc.
Significance of Financial
Inclusion
• Financial inclusion facilitates good
financial decision making through
financial literacy and skilled advice, as
well as access to financial services for
all, particularly vulnerable groups such
as women, minorities, refugees, and the
elderly micro-entrepreneurs and low-
income groups at an affordable cost
so as to enable them to Manage their
finances on everyday basis confidently,
securely, and effectively.
• Plan for the future to defend themselves
against short-term fluctuations in
income and spending, as well as to build
capital and benefit from financial sector
developments.
• Dealing successfully with financial
distress reduces their vulnerability to the
unexpected.
• Financial inclusion and various financial
services for poor and low-income citizens,
and micro and small enterprises are all
essential and integral components of the
financial sector, according to the United
Nations Capital Development Fund
(UNCDF), which invests in LDCs. Each
has its own competitive advantages
and presents the market with a business
opportunity.
Financial
Intermediaries
• A financial intermediary is an institution
that serves as a middleman among two
parties in a financial transaction, like a
commercial bank, investment banks,
mutual funds and pension funds.
• They mobilize the saving of households
for investment in firms. Hence, they
promote capital formation.
• Types of financial intermediaries are as
follows:
» Banks: It includes commercial banks,
cooperative banks, regional rural banks,
local area banks.
» Development financial institution (DFI):
It includes institutions like SIDBI, NABARD,
NHB etc.
» Non-Banking Financial Institution
(NBFI)/Non-Banking Financial
Companies (NBFC): It includes insurance
companies, mutual benefit company, etc.
Banks
• We have already discussed banks and
their evolution in detail in module no 6.
• So in this topic, we will discuss other types
of banks.
247
Cooperative Banks
• A cooperative bank is a financial
institution that is owned and operated
by its shareholders, who are also the
bank's clients. It offers a wide variety of
standard banking and financial services.
The States Cooperative Societies Act
governs co-operative banks in India.
They are also controlled by the Reserve
Bank of India (RBI) under two laws:
» Banking Regulations Act, 1949,
» Banking Laws (Co-operative Societies)
Act, 1955.
− The problem of rural credit was the
impetus for India's co-operative
movement, which began with the
passage of the Co-operative Societies
Act in 1904.
− The aim of this law was to create
cooperative credit societies to
encourage saving, self-help and
cooperation among farmers, artisans
etc.
Features of Cooperative Banks
• All the co-operative banks share common
features:
» Customer Owned Entities: Co-operative
bank members are both customer and
owner of the bank.
» Democratic Member Control:
Cooperative banks are owned and
operated by their owners, who elect
the board of directors democratically.
According to the cooperative concept of
"one person, one vote," members typically
have equal voting rights.
» Profit Allocation: A large portion of a
company's annual profit, benefits, or
surplus is normally set aside as reserves. In
certain cases, a portion of this benefit will
be allocated to co-operative members,
subject to legal and legislative limits.
Structure of co-operative
banks in India
Cooperative Bank in India
Urban Rural
Short term Structure
Three tier structure
I M A G E 14.1: S T R U C T U R E O F C O - O P E R AT I V E
• Rural Co-operative Banks (RCBs)
» Short-Term Co-operative Bank Structure
− A State Co-operative Bank works at
the top level (i.e. works at the state
level).
− Central Co-operative Bank works at
the Intermediate Level (i.e., District
Co-operative Banks ltd. works at
district level).
− Primary co-operative credit societies
at the base level (At village level):
Primary Agricultural Credit Societies
(PACS) are the backbone of the co-
operative credit system in India,
Co-operative banks in India finance rural Co-operative banks in India finance
areas urban areas
• Farming
• Cattle
• Milk
• Hatchery
• Personal finance
Land Development Bank
• These are cooperative banks which
provide medium and long term credit to
the agricultural sector.
• The Land development banks are
structured in 3 levels namely.
248
accounting for the majority of co-
operative institutions.
» Long-Term Co-operative Bank Structure
− At the highest level, there are State
Cooperative Agriculture and Rural
Long term Structure
Development Banks (SCARDBs).
Two tier structure
− At the district or block level, Primary
BANKS
Co-operative Agriculture and Rural
Development Banks (PCARDBs).
• Urban Co-operative Banks (UCBs) are
either scheduled or non-scheduled.
Scheduled and non-scheduled UCBs are
again of two kinds- multi-state and those
operating in a single state.
Role of Co-operative Banks in
India
• The co-operative banks play an
important role in India both in rural
and urban financing. The table below
illustrates their significance.
• Self-employment
• Industries
• Small scale units
• Home finance
• Consumer finance
• Personal finance
» State,
» Central,
» Primary level and they meet the long-
term credit necessities of the farmers for
developmental issues.
• The primary land development banks in
 the state's districts and tehsil areas are
overseen by the state land development
banks, which are all registered under the
Co-operative Societies Act.
• LDBs get their working capital from
share capital, loans, and debentures,
as well as borrowings from State Bank
of India, commercial banks, and State
Cooperative Banks. NABARD oversees
land development banks.
• These institutions do not take deposits
from the general public.
Advantages of Cooperative Banking
• Cooperative Banking provides an
effective alternative to the traditional
credit system.
• Cooperative Banking encourages saving
and investment.
• It provides cheap and easy credit to
people in rural areas.
• Cooperative societies have helped in
the introduction of better agricultural
methods like improved seeds, chemical
fertilizers, modern implements, etc.
Disadvantages of Cooperative
Banking
• Primary credit societies' organisational
and financial constraints severely restrict
their ability to offer sufficient credit to
the rural population.
• Cooperative Banks are losing their
luster due to expansion of Scheduled
Commercial Bank and adoption of
technology.
• Political Interference to raise their vote
bank and, in most cases, have their
members elected to the board of directors
to achieve unfair advantages.
• Regional Disparities- the cooperatives
in northeast states and in states like
West Bengal, Bihar, Odisha are not as
developed as the ones in Maharashtra
and Gujarat.

Difference between Commercial bank and Cooperative bank

Parameter Commercial Banks Cooperative Banks

Under the co-operative

Registration Under Companies Act 1956 societies act of state
government

Financial Inclusion, provide

Objective Profit Making credit at concessional rate
rural sector, weaker section etc.

Provide value-added Provide only basic banking

Services
service service

Government, NABARD/RBI, and

Source of fund Public deposits
very less public deposit.

State Government, RBI,

Regulator RBI
NABARD

249
Structure Unified Structure
Short, medium and long
Loan
term
Priority Sector Lending Applies
Regional Rural Banks (RRB)
• RRBs (Regional Rural Banks) are financial
institutions that provide credit to farmers
and other rural businesses.
• Regional Rural Banks were founded in
1976 as a result of the recommendations
of the Narasimham Working Group (1975)
and the Regional Rural Banks Act.
• On October 2, 1975, the Prathama
Grameen Bank became the first Regional
Rural Bank.
• In India, there are currently 56 RRBs.
• RRBs' key goals are to provide credit and
other services to agricultural labourers,
artisans, small and marginal farmers,and
small entrepreneurs in rural areas, with
the aim of closing the credit gap in rural
areas, reducing regional imbalances, and
increasing rural jobs generation.
• Priority sector lending has been extended
to RRBs in the same way as it has to
commercial banks.
• RRBs have a 50:35:15 shareholding
pattern among the three sponsoring
entities: central government, sponsoring
bank, and state government, respectively.
• In 2010, a committee chaired by K.C.
Chakrabarty reviewed the financial
status of all RRBs and recommended
that 40 of the 82 RRBs be recapitalized.
• The remaining RRBs, according to the
Committee, are capable of achieving the
required amount of CRAR on their own.
• Accepting the committee's suggestions,
the central government and other
shareholders began pouring funds
250
Three-tier structure
Short term
Not Applies
into the RRBs to recapitalize them. The
amalgamation process proceeded in the
same way.
RRB Amendment Act, 2015
• The Regional Rural Banks (Amendment)
Act of 2015 took effect on 4th February,
2016.
• Authorized capital:
» The Act raises the amount of authorized
capital to Rs. 2,000 crore and states that
it cannot be reduced below Rs. 1 crore.
• Shareholding:
» The Act allows RRBs to collect capital
from sources other than the federal and
state governments, as well as sponsor
banks, as long as the central government
and the sponsor bank have a joint
shareholding of at least 51 percent.
» Furthermore, if the state government's
shareholding in the RRB falls below 15%,
the central government must consult with
the state government in question.
• Tenure:
» The Act stipulates the term of office of a
director (excluding the Chairman) to be
three years.
• Board of Directors:
» The Act raises the occupancy of directors
to three years from the present two years.
The Bill also statuses that no director can
hold office for a total period of exceeding
six years.
• Government Limit:
» According to the Act, the Central
government can increase or decrease
the shareholding limit of the central
government, State government,
or sponsoring bank in the RRB by
notification, after consulting with the
state government and sponsoring bank.
Local Area Banks (LABs)
• They are small private banks that were
created as low-cost structures to provide
effective and competitive financial
intermediation services in a restricted
geographic area, mainly in rural and
semi-urban areas, with three contiguous
districts.
• LABs were developed to allow local
institutions to mobilise rural savings
while also making them available for
investments in the local region.
• LABs were established in August 1996,
following an announcement made by
the then-Finance Minister in the Union
Budget.
• A minimum capital of Rs. 5 crores was
needed for LABs.
• The promoters of the bank may include
private individuals, trusts, corporate
entities, and societies with a minimum
capital contribution of Rs. 2 crores.
• The area of operation of LAB is restricted
to a maximum of three geographically
contiguous districts and are allowed to
open new branches only in its area of
operation.
• Since LABs are being established
in district towns, their activities are
focused on the local customers with
lending largely to agriculture and allied
activities, agro-industrial activities,
small scale industries,activities related
to trade and the non-farm sector. LABs
are also required to observe the priority
sector lending goals set at 40% of net
251
bank credit (NBC) as applicable to other
domestic banks.
• In 2014, RBI has allowed LABs to be
converted into small finance banks
subject to them meeting the prescribed
eligibility standards.
Development
Financial Institution
(DFI)
• These are a special type of financial
institution that provides finance and
technical assistance to various sectors
of the economy to promote economic
development.
• These are not permitted to accept
deposits from the public.
• They raise funds from RBI, government,
and through the issue of their bonds to
the general public.
• They provide finance in the following
forms:
» Provision of medium and long term loans.
» Refinance i.e. process by which one loan
is replaced by another loan, in most cases
with more favorable terms.
» Guarantee against the loan (this is also
called credit enhancement).
» Subscription, for example, shares and
debenture of the company.
» Underwriting: Under this, a Financial
institution guarantees to purchase a
certain percentage of share of an initial
public offer (IPO) of a company in case it
remained under-subscribed by the public.
Underwriting commission is charged for
such guarantee.
• They also provide technical assistance to
preparation of project Reports, evaluation
of investment projects, provision of
technical advice, management of
 services and marketing information.
• Different types of development financial
institution are:
» For industry: IFCI, ICICI, IDBI, SIDBI etc.
» For foreign trade: EXIM
» For agriculture: NABARD
» For Housing: National Housing Bank
Industrial Credit and
Investment Corporation of
India Limited (ICICI)
• ICICI was founded in 1955 on the
initiative of the World Bank, the Indian
government, and representatives from
the Indian business community.
• The main goal was to establish a
development financial institution that
would provide medium- and long-term
project financing to Indian companies.
• ICICI transformed its business in the 1990s
from a development financial institution
that only provided project finance to
a diversified financial services group
that provided a wide range of products
and services both directly and through
subsidiaries.
• ICICI Bank was established in 1994 as a
wholly-owned subsidiary of ICICI Limited,
an Indian financial institution.
• In 2002, ICICI Ltd was merged with ICICI
Bank Ltd. This ‘reverse merger’ converted
it into the first universal bank of India
(financial institution undertakes various
types of financial business).
Industrial Development Bank
of India Limited (IDBI)
• The Industrial Development Bank of India
(IDBI) got established as a Development
Financial Institution (DFI) on 1st July,
1964, under the Industrial Development
252
Bank of India Act, 1964. It was granted
autonomy in 1976.
• It is a top institution in the field of
industrial finance.
• In 2003, the IDBI was converted into a
universal bank.
• On 21st January, 2019, LIC of India
completed the acquisition of a 51 percent
controlling stake in IDBI Bank, making it
the bank's majority shareholder.
Small Industries Development
Bank of India (SIDBI)
• Small Industries Development Bank of
India (SIDBI) was set up on 2nd April 1990
under the Small Industries Development
Bank of India Act, 1989, it was granted
autonomy in 1998.
• It performs as the Principal Financial
Institution for Development, Promotion,
Financing of the Micro, Small and
Medium Enterprise (MSME) sector. In
addition to this SIDBI also coordinates
various functions of institutions engaged
in similar activities.
• It is headquartered in Lucknow and
operates under the Department of
Financial Services, Government of India.
• It runs a refinance programme known as
Institutional Finance in order to increase
and sustain money supply to the MSE
market.
• SIDBI offers Term Loans to Banks,
Small Finance Banks, and Non-Banking
Financial Companies through this
scheme.
• SIDBI loans directly to MSMEs in addition
to refinancing activities.
• With 16.73 percent of the shares, State
Bank of India is the largest individual
shareholder in SIDBI, followed by the
Government of India and the Life
Insurance Corporation of India.
Export-Import Bank of India
(EXIM)
• Export-Import Bank of India is a financial
institute in India, established in 1982
under Export-Import Bank of India Act
1981.
• It aims for financing, facilitating and
promoting foreign trade of India.
• It is a wholly owned Government of India
entity.
• EXIM Bank extends Lines of Credit
(LOCs) to overseas financial institutions,
regional development banks, sovereign
governments and other entities overseas,
to enable buyers in those countries to
import developmental and infrastructure
projects, equipment, goods and services
from India, on deferred credit terms.
• Export Development Fund (EDF)
facility, a special fund, was established
by GoI under the Exim Bank Act and
administered by Exim Bank, to sanction
loans in the interest of international trade
towards meeting strategic objectives.
• Exim Bank-issued India’s first USD
denominated Green bonds.
National Bank for Agriculture
and Rural Development
(NABARD)
• The agricultural credit functions of RBI
and the refinance functions of the then
Agricultural Refinance and Development
Corporation were transferred to NABARD
on July 12, 1982. This is how NABARD
formed.
• It was constituted on the recommendation
of Committee to Review the Arrangements
For Institutional Credit for Agriculture
and Rural Development (CRAFICARD)
under the Chairmanship of B. Sivaraman.
• It was set up with a capital of Rs. 100
crore and had a paid-up capital of Rs.
253
12,580 crore as of 31st March, 2019.
• Due to this change in the share capital
composition between the Government
of India and the Reserve Bank of India,
NABARD is now entirely owned by the
Government of India. NABARD, as a
Development Bank, is mandated to
provide and regulate credit and other
facilities in rural areas for the promotion
and growth of agriculture, small scale
manufacturing, handicrafts and other
types of rural crafts, cottage and village
industries, and other allied economic
activities, with the aim of fostering
integrated rural development and
ensuring rural prosperity.
National Housing Bank (NHB)
• National Housing Bank (NHB), is an apex
financial institution for housing which
was set up on 9th July, 1988 under the
National Housing Bank Act, 1987.
• NHB was established with the aim
of serving as a primary agency for
promoting housing finance institutions at
both the local and regional levels, as well
as providing financial and other support.
Its headquarters are in New Delhi.
• NHB has been established
» For making housing credit further
affordable.
» To regulate the actions of housing finance
companies.
» To promote a sound, healthy, viable and
cost-effective housing finance system to
cater to all segments of the population.
Non-Banking
Financial Institution
(NBFC)
• It is an institution that is registered under
 the Companies Act, 1956 and is involved
in the business of loans and advances,
the acquisition of stocks/shares/
securities/bonds/debentures delivered
by the government or a local authority,
or other marketable securities of a similar
nature, leasing, hire-purchase, insurance,
and chit business. But it does not consist
of any institution whose main business
is that of agriculture activity, industrial
activity, sale or purchase any goods
(other than securities) or providing any
services and sale/purchase/construction
of the immovable property.
• NBFC include a heterogeneous group
of financial institutions: Insurance
companies, microfinance institutions
(MFI), Hedge funds, venture capital funds,
Collective investment scheme, Nidhi/Chit
funds etc.
• Features of NBFCs:
» NBFC 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 of Deposit
Insurance and Credit Guarantee
Corporation is not available to depositors
of NBFCs.
Insurance Sector
Insurance Companies
• These are financial institutions which
raise funds from the public through the
sales of insurance policies.
• Insurance companies corpus is invested
in security markets by asset management
companies.
• There are two types of insurance firms:
» Life insurance: Life insurance covers
provided financial compensation in case
of death or disability.
» General Insurance: General insurance
254
offers you Insurance or financial
compensation for everything else in life
Life Insurance Corporation of India
(LIC)
• On June 19, 1956, the Life Insurance
Corporation Act was passed, and the LIC
was established on September 1, 1956.
• The state-owned Life Insurance
Corporation of India was formed by the
merger of over 245 insurance companies
and provident societies.
• The goal of the Life Insurance Corporation
of India (LIC) was to spread life insurance
much more widely, especially in rural
areas, with the goal of reaching all
insurable persons in the country and
giving them with adequate financial
cover at a reasonable cost.
• Since its inception, the Life Insurance
Corporation of India has held a monopoly
in the Indian life insurance market.
General Insurance Corporation
(GIC)
• General Insurance Corporation (GIC) was
established in 1973 by nationalizing the
existing private sector general insurance
company.
• It was created under the provision
of Companies Act, 1956 as a private
company limited by shares.
• GIC was formed with the aim of
controlling, superintending, controlling,
and carrying on the business of general
insurance.
• It had four subsidiaries:
» National Insurance Company Limited.
» The New India Assurance Company
Limited.
» The Oriental Insurance Company Limited.
» United India Insurance Company Limited.
• In March 2002 the GIC was withdrawn
from holding company status of the
four public sector general insurance
companies. Now these four companies
are directly owned by the Government of
India
Insurance Reforms
• The Government of India formed a
committee in 1993, chaired by R. N.
Malhotra, former Governor of the Reserve
Bank of India (RBI), to provide suggestions
for reforms in the insurance sector.
• The aim was to add to the changes
already underway in the financial sector.
• Some of the major recommendations of
the committee are as follow:
» Insurance companies to be given greater
freedom to operate.
» Private companies with at least paid-up
capital of One Billion to be allowed to
enter the insurance sector.
» No company must be allowed to deal
with both Life and General Insurance as
a single entity.
» Foreign companies may well be permitted
to enter the insurance sector but only in
collaboration with Indian companies.
» Industry must be opened up to the
competition in order to improve customer
services and increase the coverage of the
insurance industry.
» It also proposed the setting up of an
independent regulatory authority- the
IRDA, to deliver greater autonomy to
insurance companies to improve their
performance and enable them to
function independently.
The Insurance Regulatory
Development Authority (IRDA)
• The IRDA, as an autonomous body, which
255
was constituted on April 19, 1999, by the
Government of India.
• The Insurance Regulatory and
Development Authority (IRDA) Act, 1999
vested the IRDA with the responsibility of
regulating and developing the business
of insurance and reinsurance in India.
• Important functions of IRDA are:
» To control, ensure, and encourage the
orderly development of the insurance
industry.
» To impose regulations on insurance
companies' accumulation of funds.
» To resolve disagreements between
insurers and intermediaries. To frame
regulations on the protection of
policyholders' interests.
• The IRDA has set up the grievance
redressal cell to take up the complaints
of the policyholder.
Micro Insurance
• IRDA regulates micro-insurance
policies, which are a special category of
insurance policies designed to encourage
insurance coverage among economically
disadvantaged sections of society.
• The IRDA Micro-insurance Regulations,
2005 describe and permit micro-
insurance. Micro-insurance is described
as a general insurance policy (which
may cover health, belongings, house,
tools, personal injury contracts, pets, and
so on) or a life insurance policy with a
fixed amount of Rs. 50,000 or less. They
can be completed either in groups or
individually.
• Micro- insurance business is completed
by means of the following intermediaries
in India:
» Non-Government Organizations
» Self-Help Groups
» Micro-Finance Institutions
• In the Union Budget 2015-16, government-
sponsored micro insurance was launched
for the disadvantaged units of society.
» The Pradhan Mantri Suraksha Bima
Yojna (PMSBY) covers an accidental
death risk of Rs. 2 lakh for only Rs. 12
per year (i.e. Rs. 1 per month). It would
protect all people between the ages of 18
and 70 who have a savings account for
accidental injury or death.
» For the age group of 18-50, the Pradhan
Mantri Jeevan Jyoti Bima Yojana
(PMJJBY) will cover both natural and
accidental death risks of Rs. 2 lakh for a
premium of Rs. 330 per year (less than
Rs. 1/day). i.e., it would protect all people
between the ages of 18 and 50 who
have a savings account for death from
any cause. This scheme is available via
the Life Insurance Corporation of India
(LIC of India) or other life insurance firms
willing to sell life insurance on similar
terms.
Micro Finance
• Microfinance, also known as micro-
credit, is a form of banking service
that provides financial services to low-
income individuals or unemployed or
groups who would otherwise be unable
to obtain them. It is small-scale financial
intermediation, inclusive of savings,
credit, insurance, business services and
technical support provided to the needy
borrower.
• Microfinance is vital because it provides
resources and access to capital to the
financially underserved, such as those
who are unable to obtain checking
accounts, lines of credit, or loans from
traditional banks. Without microfinance,
these groups would have to rely on
moneylenders.
256
Micro Finance and Indian
Economy
• There are four important Microfinance
models predominant in India.
• Microfinance has become a movement
in India. At the same time it has become
an exceptional instrument of capability
enhancement and empowerment.
» Firstly, it has added millions of individuals
to the banking sectors by developing the
habit of thrift and saving.
» Secondly, it aids in poverty alleviation.
» Thirdly, it encourages group and
individual activities which delivers
livelihood on a regular basis.
» Fourthly, with the help of Micro Finance,
financial inclusion is possible with the
common effort of Bank, Micro-Finance
Institutions and NGO’s etc.
» Fifthly, it empowers women in all three
important domain i.e. economically,
socially, and Politically.
Need for Microfinance
• Microfinance seeks to help economically
disadvantaged households to achieve
higher levels of wealth formation and
income protection at the household and
community level.
• Poor women can become economic
agents of change by having access to
financial services and then receiving
financial resources.
• Women become economically self-
sufficient, contribute directly to their
families' well-being, take a more active
position in decision-making, and are
better prepared to confront systemic
gender inequality.
Parameter Micro Finance
Size of Loan Small size of credit
Duration of loan Short duration
Emphasis on Saving as well
Saving
as loan
Nature of organization Social organization form
Micro Finance
Institution (MFI)
• The informal institutions that undertake
microfinance activities are referred to as
Microfinance Institutions (MFIs).
• Micro Finance Institution means any
entity (irrespective of its organizational
form), which provides microfinance
services in the form and way as may be
prescribed but does not include:
(i) a banking company.
(ii) a co-operative society.
• In the 1990s, the savings, grants and soft
loans were the main sources of funds,
whereas in the late 2000‘s commercial
loans and equity are the main source of
funding to the sector.
• The exhibit again depicts that the
MFIs have been transformed from a
developmental tool to viable business
and finally as an attractive asset class.
Micro Units Development
Refinance Agency (MUDRA)
Bank
• The Micro Units Development Refinance
Agency (MUDRA) Bank is a microfinance
refinancing institution.
257
Bank
Large size of credit
Medium/large duration
Focus on loan only
Commercial organization form
• MUDRA Bank will refinance Micro-
Finance Institutions through a Pradhan
Mantri Mudra Yojana, with a corpus of
Rs. 20,000 crore made available from
the shortfalls of Priority Sector Lending.
There is also a credit guarantee corpus
of Rs.3,000 crore for guaranteeing loans
given to micro-enterprises in the Union
Budget 2015-16.
• It was launched on 8 April 2015 and was
converted as a wholly-owned subsidiary
of SIDBI and renamed as MUDRA (SIDBI)
Bank.
• The MUDRA Bank is primarily responsible
for –
» Developing policy guidelines for the
micro/small enterprise financing industry,
as well as registering and regulating MFI
organizations.
» MFI organizations are accredited and
rated.
» Establishing responsible lending policies
to avoid indebtedness and to ensure
proper client security principles and
recovery methods.
» Creating a standardized set of covenants
for last-mile lending to micro and small
businesses.
» Promoting appropriate technological
strategies for the final mile.
» Creating and implementing a Credit
 Guarantee System to provide loan
guarantees to micro-enterprises.
Creating a good architecture of Last Mile
Credit Delivery to micro businesses under
the scheme of Pradhan Mantri Mudra
Yojana.
• MUDRA Bank operates through regional
level financing institutions who in turn
connects with last-mile lenders like Micro
Finance Institutions (MFIs), Small Banks,
Primary Credit Cooperative Societies, Self
Help Groups (SHGs), NBFC (other than
MFI) and such other lending institutions.
• In lending, MUDRA gives priority to
enterprises set up by the under-privileged
sections of the society particularly those
from the scheduled caste/tribe (SC/ST)
groups, first-generation entrepreneurs
and existing small businesses.
Pradhan Mantri
MUDRA Yojana
(PMMY)
• The Union Government launched the
Pradhan Mantri MUDRA Yojana (PMMY)
on April 8, 2015, to provide loans up to
Rs. 10 lakhs to non-farm small/micro-
enterprises and non-corporate.
• All banks, including Public Sector Banks,
Private Sector Banks, Regional Rural
Banks (RRBs), State Co-operative Banks,
Urban Co-operative Banks, Foreign
Banks, and Non Banking Finance
Companies (NBFCs)/Micro Finance
Institutions (MFIs), are required to lend
to non-farm sector income-generating
activities with a value of less than Rs.10
lakh under the PMMY.
• These loans are categorized as MUDRA
loans under PMMY.
• The government has established a new
institution called MUDRA (Micro Units
Growth & Refinance Agency Ltd.) to
258
carry out the Scheme's development and
refinancing activities, as well as serve as
a regulator for the microfinance sector in
general.
• PMMY's mission is to provide grants to
small businesses that are not corporations.
Loan offerings under PMMY
» Shishu: covering loans up to Rs. 50,000/-
given with no collateral, at 1% rate of
interest/month repayable over a period
of 5 years.
» Kishor: cover loans above Rs.50,000/-
and up to Rs. 5 lakh.
» Tarun: cover loans beyond Rs. 5 lakh to
Rs. 10 lakh.
• Approach of PMMY
» Enterprises in the smallest segment must
receive at least 60% of the funding.
MUDRA Bank's partner intermediaries
must strive to adhere to the following
general framework:
− First-time entrepreneurs, young
entrepreneurs (those under 30 years
old), and women entrepreneurs will
be welcomed, with special schemes
being planned for them.
− Cash flow-based lending would
be prioritized over security-based
lending. Collateral securities, among
other things, must be avoided.
− Repayment commitments shall be
flexible and framed in light of the
entrepreneur's company cash flows.
Collective
Investment Scheme
(CIS)
• A Collective Investment Scheme (CIS) is
an investment scheme in which many
people pool their money to invest in a
 specific asset(s) and share the profits
based on an arrangement reached
before the money was pooled.
• SEBI regulates CISs under the SEBI
(Collective Investment Scheme)
Regulations, 1999.
• A licensed Collective Investment
Management Company is allowed to
raise funds from the general public for a
specific Scheme and then sell “units” to
the public (which are essentially shares
of that Scheme provided in proportion to
the contribution made by the investor).
These units are required by means of law
to be listed on a stock exchange platform.
Nidhi (Mutual
Benefit Society)
• Nidhi refers to any mutual benefit society
that has been designated as a Nidhi
Company by the Central Government.
They are mutual benefit societies since
their transactions are limited to members
only, and membership is limited to
individuals.
• The members' contributions are the
primary source of funds. The loans are
usually secured and are provided to
members at reasonably low rates for
purposes such as house building or
repairs.
• When compared to the organized
banking sector, the deposits mobilized by
Nidhis are small, and they were formed
primarily to encourage members to
practice thrift and save.
• The companies doing Nidhi business, viz.
borrowing from members and lending
to members only, are known under
different names like Nidhi, Benefit Funds,
Permanent Fund, Mutual Benefit Funds
and Mutual Benefit Company.
• Nidhi's are companies controlled by the
Ministry of Corporate Affairs (MCA) and
259
registered under section 620A of the
Companies Act, 1956 (Section 406 of the
new Companies Bill 2012, as approved by
Lok Sabha).
• Nidhis are also classified as Non-Banking
Financial Companies (NBFCs). Since
Nidhis are classified as NBFCs, RBI has
the authority to issue directives to them
about their deposit acceptance activities.
• Under the new provisions, Nidhi
companies are mandatory to apply to
the Union government for updating of
their status or declaration as ''Nidhi
Company'' in ''Form NDH-4''.
Chit Funds/Chitty/
Kuri
• It is a kind of saving scheme where
a specified number of subscribers
contribute payments in installment over
a defined period.
• The periodic collection is provided to a
member of the chit funds who is chosen
based on a previously agreed-upon
criterion.
• The beneficiary is normally chosen by
a bidding process, a lot drawing, or, in
some cases, an auction or a tender.
• In any case, each chit fund member is
guaranteed a turn before the second
round begins, and any member becomes
eligible for periodic selection once more.
• Chit funds are basically savings accounts.
They come in a different variety of forms
and sizes, and there is no one-size-fits-all
approach. Chit fund business is controlled
under the Central Act of Chit Funds Act,
1982 and the Rules framed under this Act
by the several State Governments for this
purpose.
• Since the Central Government has not
developed any operating rules for them,
state governments must register and
regulate chit funds according to their
 own rules.
• Chit funds are functionally included in
the RBI's classification of non-banking
financial companies as miscellaneous
non-banking companies (MNBC). The
RBI, on the other hand, has not developed
a separate regulatory structure for them.
• The Chit Funds (Amendment) Bill, 2019:
• It seeks to amend the Chit Funds Act,
1982.
• Features:
» Names: The Bill inserts additional names
for chit fund such as ‘fraternity fund’ and
‘rotating savings and credit institution’.
(chit, chit fund, and kuri are the existing
name in ate act).
» Participation of subscribers: As per the
act, a chit can be drawn in the presence
of at least two subscribers. The Bill seeks
to allow these subscribers to join via
video-conferencing.
» Foreman’s commission: Under the Act,
the ‘foreman’ is responsible for managing
the chit fund. The Bill seeks to increase
the commission from 5% to 7% of the
chit amount.
» Aggregate amount of chits: The Bill
increases limits of amount of chit funds.
From one lakh to three lakh rupees for
chits conducted by individuals, and for
every individual in a firm or association
with less than four partners. And from six
lakh to18 lakh rupees, for firms with four
or more partners.
» Application of the Act: The bill allows the
state governments to specify the base
amount over which the provisions of the
act will apply.
Payment Banks
• Payment Banks is a new set of banks
licensed by the Reserve Bank of India, with
the aim to promote financial inclusion by
260
enabling them to provide
» Various Payments/remittance services to
low-income households, migrant labour
workforce, small businesses, other types
of unorganized sector entities, and other
users through high volume-low value
deposits and payments/remittance
services using a secured technology-
based platform.
» Payment Banks are differentiated or
restricted banks. The Payment Bank
cannot set up subsidiaries to undertake
non-banking financial services activities
(hire purchase, leasing etc.) nor can it
undertake lending business.
• Since liquidity is the most important
requirement for such banks, they will be
bound by the Reserve Bank of India's
reserve requirement regulations (CRR,
SLR etc.).
• For operational and liquidity
management purposes, payment banks
would be expected to invest at least 75%
of their "demand deposit balances" in
Statutory Liquidity Ratio (SLR) qualifying
Government securities/treasury bills
with maturities up to one year and keep
no more than 25% in current and time/
fixed deposits with other scheduled
commercial banks.
• Payment banks must have a minimum
paid-up equity capital of Rs. 100 crore,
with the promoter contributing a
minimum of 40% of the paid-up equity
capital for the first five years of operation.
• The Payments Bank will be formed as
a public limited company under the
Companies Act of 2013 and will be
licensed under Section 22 of the Banking
Regulation Act of 1949.
• The proposal for the establishment of
payments banks stemmed from the Report
of the Committee on Comprehensive
Financial Services for Small Businesses
and Low-Income Households (Chairman:
Nachiket Mor) submitted in January 2014.
Small Finance Bank
(SFB)
• It is a private financial institution intended
to further the objective of financial
inclusion by primarily undertaking basic
banking activities of acceptance of
deposits and lending to un-served and
underserved sections.
• The concept of SFB was also one of
the suggestions in the 2009 Report, A
Hundred Small Steps, of the Committee
on Financial Sector Reforms headed by
Raghu Ram Rajan.
• Resident professionals/individuals with
10 years of experience in banking and
finance and companies and societies
controlled and owned by residents
will be eligible to set up small finance
banks. Existing Micro Finance Institutions
(MFIs), Non-Banking Finance Companies
(NBFCs), and Local Area Banks (LABs)
that are retained and controlled by
residents can also choose for conversion
into small finance banks.
• The minimum capital for SFBs has been
set at Rs. 100 crore, with a 40 percent
initial investment from the promoters,
which must be reduced to 26 percent
over a 12-year term. Foreign Investment is
permitted as in the case of other private
sector commercial banks. After the SFBs
reaches the net worth of Rs.500 crore,
listing of its shares on a stock exchange
will be compulsory within 3 years of
reaching that net worth.
• SFBs are full-fledged banks in contrast
to payments banks formed around the
same time.
• Therefore, they are subject to all prudential
regulations and norms and regulations of
RBI as applicable to existing commercial
banks such as maintenance of Statutory
Liquidity Ratio (SLR) and Cash Reserve
Ratio (CRR)
• They must extend 75% of their Adjusted
261
Net Bank Credit (ANBC) to sectors
eligible for Reserve Bank classification as
priority sector lending (PSL), with at least
50% of their loan portfolio consisting of
advances and loans of up to Rs. 25 lakh.
National Strategy
for Financial
Inclusion (2019-24)
• This is an initiative of the Reserve Bank
of India (RBI) which seeks to promote
financial inclusion across all Tier 2 to Tier 6
urban centres in India. Financial inclusion
not only promotes economic growth but
also helps in poverty alleviation.
• This policy was launched in 2019 and
it seeks to drive economic growth
through various financial services and
also reduce the dependence on cash in
India (presently the Cash to GDP Ratio is
expected to hit 14-15%).
• Amongst others:
» it seeks to enforce behavioural changes
and educate the consumers on various
financial services,
» making consumers understand their
rights and responsibilities,
» making insurance available to all the
beneficiaries of the Jan Dhan Yojana
scheme,
» increasing number of banking outlets
which will ensure that individuals have
access to banking services in a radius
of every 5 kms or a location which has
about 500 households in the hilly areas
by March 2020 and
» ensuring all adults have access to
financial services through mobile phones
by 2024.
• Various NBFC’s, Central and State
Government, NGOs amongst others
have been made as stakeholders for the
 success of this scheme.
• The strategy also hopes to make the
Public Credit Registry, fully operational
by 2022 (it was set up on the basis of
the YM Deosthalee committee report of
the RBI and it contains all information
related to credit mechanisms, consumer
behaviour and the credit scores).
Recommendations
of the Second
Administrative
Reforms
Commission on
Financial Inclusion
• The Second Administrative Reforms
Commission was set up in 2005 and was
headed by M Veerappa Moily.
• Amongst its various recommendations, its
recommendations on financial inclusion
paved the way for better governance in
the nation.
• The following are its recommendations
with respect to financial inclusion:
» A differentiation had to be made and
the special needs of the poor had to be
catered to. This would involve innovative
financial strategies which are tailor
made for the benefit of the poor and
developing new products related to
banking, insurance savings and loans,
» It critiqued banks and other public
sector banks for having narrow policies
that hampered the functioning of the
Self-Help Groups (SHG’s) in terms of its
utilization of various loans. It limited the
utilization of loans,
» It recommended the extension of the
Regional Rural Banks to areas that
hitherto remained as non-banking areas.
262
It stated that this will speed up the process
of financial inclusion in the country,
» For the first time in governance, it
discussed the possibility of high telecom
density and latest communication
technology based on the internet being
used to increase the rate of financial
inclusion in the country.
» It also recognized the role of Micro-
Financial institutions in the process of
financial inclusion.
Poverty
• It is a social as well as a multidimensional
phenomenon. As stated by the World
Bank, “poverty is pronounced deprivation
in wellbeing.”
• Amartya Sen in his capability approach
perhaps provided the broadest meaning
to well-being. According to him, well-
being originates from a capability to
function in society.
• Poverty occurs when people lack key
capabilities because of insufficient
income or inadequate education, or poor
health or a sense of powerlessness, or
the absence of rights such as freedom
of speech or insecurity, or low self-
confidence.
• The Human Development Report (2010)
introduced the Multidimensional Poverty
Index (MPI) which is grounded in the
capability approach and an innovative
effort to complement the income-based
poverty indices.
• It comprises an array of dimensions
from participatory exercises among
poor communities and an emerging
international consensus. The MPI shows
the share of the population that is multi-
dimensionally poor adjusted by the
intensity of deprivation with respect to
health, education and living standards.
• The poverty line in India is income-based.
• In 1978, the poverty line was initially fixed
in terms of income/food requirements. It
was specified that the calorie standard
for a typical individual in rural zones was
2400 calorie and was 2100 calorie in
urban areas.
Poverty:
• Poverty is one of the major important
and pressing problems facing
Indian Economy today. It is a socio-
economic issue that goes beyond the
boundaries of the economic arena
and covers other types of aspects like
the inability to participate in social
and political life. Poverty, however,
is multidimensional in nature. Apart
from the income approach to poverty,
there are other ways to conceptualize
poverty, i.e., deprivation in other
areas such as literacy, schooling,
life expectancy, child mortality,
malnutrition, safe water and sanitation
Relative vs. Absolute Poverty
• Absolute poverty is when household
income is below a certain level, which
makes it impossible for the person
or family to meet basic needs of life
including food, shelter, safe drinking
water, education, healthcare, etc.
• Relative Poverty: It is defined from
the social perspective that is living
standard compared to the economic
standards of population living in
surroundings. Hence, it is a measure
of income inequality.
Poverty Line, Poverty Line
Basket and Poverty Ratio
• The traditional method of determining
poverty is to establish a minimum
expenditure (or income) needed to buy a
basket of goods and services necessary
to meet basic human needs, which is
referred to as the poverty line.
263
• The poverty line basket, or PLB, is a set
of products and services needed to meet
basic human needs.
• The poverty ratio, also known as the
headcount ratio, is the percentage of the
population living in poverty (HCR).
• Poverty estimation in India is now
carried out by NITI Aayog’s task force
through the calculation of poverty line
on the basis of the data collected by the
National Sample Survey Office (NSSO)
under MOSPI (the Ministry of Statistics
and Programme Implementation).
Note: Recently, the Ministry of Statistics
and Programme implementation
(MoSPI) passed an order to merge the
Central Statistics Office (CSO) and
National Sample Survey Office (NSSO)
into the National Statistical Office
(NSO).
• From 1999-2000 onwards, the NSSO
switched to an MRP (Mixed Reference
Period) method which measures
consumption of five low-frequency items
(education, clothing, footwear, durables
and institutional health expenditure) over
the previous year, and all other items over
the previous 30 days.
• Fishers Price Index is used on all India
poverty line baskets to generate the state
specific rural and urban poverty lines.
History of poverty estimation
in India
• The process and methodology of
estimating poverty and the identification
of BPL households have been a matter of
argument.
• Dadabhai Naoroji's book, "Poverty and
the Un-British Rule in India," contains one
of the earliest estimates of poverty. Based
on 1867-68 rates, he devised a poverty
line ranging from Rs. 16 to Rs. 35 per
capita per year. He suggested a poverty
line focused on the cost of a subsistence
 diet of "rice or flour, dhal, mutton, onions,
ghee, vegetable oil, and salt."
Alagh Committee (1979)
• In 1979, a task force set up by the
Planning Commission for the purpose of
Area Calorie
Rural 2400
Urban 2100
Lakdawala Committee (1993)
• In 1993, an expert group chaired by DT
Lakdawala was established to study
poverty estimation methods and made
the following recommendations:
» Consumption expenditure should
be calculated based upon calorie
consumption as earlier.
» State-specific poverty lines should
be constructed, and these should be
updated using Consumer Price Index
of Agricultural Labour (CPI-AL) in rural
regions and the Consumer Price Index
of Industrial Workers (CPI-IW) in urban
regions.
» Discontinuation of ‘scaling’ of poverty
approximations based on National
Accounts Statistics.
This means that the consumption habits of
the poor are reflected in the CPI-IW and
CPI-AL baskets of goods and services.
Tendulkar Committee (2009)
• The Planning Commission formed
another expert group to study poverty
264
estimating poverty, headed by YK Alagh,
established a poverty line for rural and
urban areas based on nutritional needs.
The nutritional criteria and associated
consumption expenditures are based
on the task force's recommended price
levels for 1973-74.
Minimum consumption expenditure (Rs
per capita/month)
49.1
56.7
estimation techniques in 2005, chaired
by Suresh Tendulkar, to resolve the
deficiencies of the previous methods.
• It recommended four major changes
» A shift away from calorie consumption-
based poverty estimate;
» A uniform Poverty Line Basket (PLB) in
rural and urban India, a reform in the
price adjustment procedure to address
spatial and temporal problems with price
adjustment, and the inclusion of private
health and education expenditure when
calculating poverty.
» The Committee suggested using Mixed
Reference Period (MRP) based estimates,
rather than Uniform Reference Period
(URP) based estimates that were utilized
in earlier procedures for estimating
poverty.
• It calculated consumption of the
following products: pulses, milk, edible
oil, non-vegetarian items, vegetables,
cereal, dry fruits, fresh fruits, sugar,
spices, and salt, other food, intoxicants,
fuel, clothes, footwear, education,
entertainment, medical (non-institutional
and institutional), personal & toilet goods,
other goods, other services, and durables.
• The Tendulkar Committee computed new
poverty lines for urban and rural areas of
each state.
• It concluded that all India poverty line
was Rs. 446.68 per capita per month in
rural regions and Rs. 578.80 per capita
per month in urban regions in 2004-05.
• The Committee also proposed a new
method of updating poverty lines, which
uses the consumption basket of people
near to the poverty line to account for
shifts in prices and consumption trends,
Year
2004-05
2009-10
2011-12
Rangarajan Committee
• In the year 2012, the Planning Commission
established a new expert board on poverty
estimation, chaired by C Rangarajan with
the following key objectives:
» To deliver an alternate technique to
estimate poverty levels, and
» To analyses whether poverty lines should
be fixed solely in terms of a consumption
basket or if other criteria are also relevant.
30
30.9
25.4 26.4
20
13.7
10
0
Rural Urban
Tendulkar Rangrajan
I M A G E 14.2: P OV E R T Y L I N E
265
rather than indices derived from the CPI-
AL for rural areas and CPI-IW for urban
areas, as was done previously.
• The main criticism of the poverty line
computed by Tendulkar Committee is
that, since it is so short, it risks excluding
many deserving people from government
assistance.
• National poverty lines (in Rs. per capita
per month) for the years 2004-05, 2009-
10 and 2011-12
Rural Urban
446.7 578.8
672.8 859.6
816.0 1000.0
• The Rangarajan committee increased
the regular per capita expenditure for
the rural poor to Rs. 32 from Rs. 27 and
for the urban poor to Rs. 47 from Rs. 33,
bringing the poverty line for rural India to
Rs. 972 and for urban India to Rs. 1,407,
respectively.
• Instead of Mixed Reference Period
(MRP) it recommended Modified Mixed
Reference Period (MMRP).
• Poverty Threshold defined as persons
spending below ₹47 a day in cities and
₹32 in villages be considered poor. Based
29.5 on this methodology, the Rangarajan
committee estimated that the number of
21.9
poor was 19% higher in rural areas and
41% more in urban areas than what was
estimated using the Tendulkar committee
formula.
Overall
• The Rangarajan Committee
recommendations are yet to be decided,
but the Tendulkar poverty line remains
 the official poverty line and is used to
calculate official poverty figures in 1993-
94, 2004-05, and 2011-12.

Parameter Tendulkar Committee C. Rangarajan Committee

Rural poverty line per

month, 4080 4860
family of five-person

BPL (below poverty line in

27 37
crore)

Only Calorific value of

Calorie Expenditure Calorie protein fat
expenditure

Calorie in rural areas 2400 2155

Calories in urban areas 2100 2090

Set up in 2005 2012

Per capita monthly Monthly expenditure of

Poverty estimation method
expenditure family

Eliminating Poverty • Employment-intensive growth in

• 80% of the Indian poor are in rural regions.
Their livelihood directly or indirectly rests
on the performance of agriculture.
• But agriculture characteristically grows
slowly
manufacturing and services that grow
faster create jobs to which underemployed
farmers can migrate.
• Effective Implementation of all the things
for the success of Make in India

» Limited livelihood opportunities at the » Infrastructure (especially power, roads

local level.
» Subsistence incomes for small and
marginal farmers.
• Modernize agriculture & accelerate
agricultural growth
• Generate job opportunities in industry
& services for farmers wishing to exit
agriculture
and ports).
» Ease of Doing Business (including trade
facilitation).
» Credit access for MSMEs
» More flexible labour laws
» Reform of the Land Acquisition Law
» A Modern Bankruptcy Law
» Skill Development

266
 I M A G E 14.3: W AY S OF S U S TA I N E D R A P I D G R OW T H

• Making Social Programs more effective • The NSSO defines following three broad
like Midday Meal Scheme, the National Status
Food Security Act 2013, MGNREGA etc. i) Working (engaged in economic
• Jan Dhan Yojana, Aadhaar, Mobile (JAM) activity) i.e. ‘Employed’
trinity could play a vital role in widening ii) Seeking or available for the work i.e.
the reach of government to the vulnerable ‘Unemployed’
sections.
iii) Neither seeking nor available for the
work.

Unemployment • Individuals with broad activity statuses of

I or ii) are classified as being in the labour
• Unemployment is described as "a force, whereas those with activity status iii)
situation in which an individual is are classified as being outside the labour
physically and mentally capable of force. Thus labour force constitutes both
working at the current wage rate but is employed and unemployed.
unable to find jobs." • In other words, the Labor force (also
• Since its establishment in 1950, the called the workforce) is the entire
National Sample Survey Organization number of people employed or seeking
(NSSO) has been measuring jobs and employment in a nation or region
unemployment in India. • The unemployment rate is the % of the
labour force that is without work.
8
Unemployment Rate

Unemployed rate = Unemployed Workers * 100

Total Labour Force
4

• Types and forms of unemployment are as

0
follows:
Jan-18

Jul-18

Oct-18

Jan-19

Jul-19

Oct-19

Dec-19
Apr-18

Apr-19

I M A G E 14.4: U N E M P L OY M E N T R AT E IN INDIA
Structural Unemployment
• Structural unemployment is the situation

267
 in which a country is unable to provide
a job to all job seekers because the
resources available in the country are
limited.
• It can happen because investment has
failed to keep pace with growth in the
labour force.
• The solution is a major investment in new
industries, training of workers, or large
scale migration from depressed regions.
• India’s unemployment is basically
structural in nature. It is related with the
inadequacy of productive capacity to
create enough jobs for all those who are
able and willing to work.
Disguised Unemployment
• It is a condition where more people are
working than is necessary. And if some
are removed, output is unaffected.
• People are apparently engaged in
agricultural activities in Indian villages,
for example, where the majority of the
unemployment is in this type.
Underemployment
• It is a condition in which people who are
working but contribute less to production
than they are capable of.
• For example, a diploma holder in
engineering who, due to a lack of suitable
employment, begins selling shoes may
be considered underemployed.
Open Unemployment
• Under this category, all those who have
no work to do fall in this.
• They are able to work and also willing to
work, but there is no work for them.
• This unemployment is in the nature of
involuntary idleness.
268
• Such unemployment can be seen and
counted in terms of the number of
such persons. Hence, it is called open
unemployment.
Cyclical Unemployment
• It is a result of the business cycle, where
unemployment rises during recessions
and declines with economic growth.
• Associated with the downswing and
depression phases of the business cycle,
it is to be found in capitalist or market-
oriented developed economies.
• Falling income lowers the demand for
goods and services. As a result, the
economy produces less than it is capable
of, aggravating further the employment-
income situation.
Frictional Unemployment
• Frictional unemployment happens due to
improper adjustment between the supply
of labour and demand for labour.
• This type of unemployment characterizes
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.
• Individuals by choice go unemployed as
they expect better job prospects than
what are available to them and which
they consider below their qualification
and less remunerative.
• In such situation, it is necessary that
workers move from industry to industry.
In between the time of leaving and
joining, the time for which the workers
get no work is a period of unemployment,
known as frictional unemployment.
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.
Demographic Unemployment
• Demographic unemployment occurs
when the number of new workers entering
the labour force through the natural
increase or inward migration exceeds the
number leaving the workforce.
• Demographic unemployment is, to
a great extent, similar to structural
unemployment and is very common in
India. It is so because the rate of growth
of population in India is much higher
than that of employment opportunities.
Technological Unemployment
• Technological unemployment is the
unemployment caused by technical
progress; the skills of particular types of
worker are made redundant due to the
changes in the methods of production,
usually by substituting machines for
manual services.
Causes of Unemployment in India
• Important causes of unemployment in
India may be summarized as follows:
» Jobless Growth
− Economic growth is usually expected
to generate employment.
− However, in India, most of the
economic growth has been jobless.
269
− Economic growth could not create
many jobs in India.
» Increase in Labour Force
− Over the years, the 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 large expansion in the labour
force.
» Inappropriate Technology
− In India, while capital is a scarce
factor, labour is available in abundant
quantity.
− Under these circumstances, the
country should have labor-intensive
techniques of production not only in
industries but also in agriculture.
− In western countries, where capital is
in abundant supply, use of automatic
machines is both rational and
justified, while in India, on account of
the abundance of labour, this policy
results in large unemployment.
» Inappropriate Education System
− The education system in India is
defective and it does not aim at the
development of human resources.
− The curriculum and syllabus taught in
schools and colleges, is not as per the
current requirements of the industries.
Consequences of Unemployment In
India
• Unemployment is the root of a number of
social and economic problems. Some of
the vital problems are as under:
» Poverty
− Poverty is the immediate consequence
 of unemployment because when
a person is unemployed, he earns
nothing and becomes poor.
» Income Inequalities
− Unemployment causes income
inequalities also.
− Indian economy is beset with gross
economic inequalities. There are
inequalities in income, consumption
etc.
» Under–Utilization of Resources
− An important economic consequence
of unemployment is that a lot of
resources available in the country
remain under-utilized.
− India has vast natural resources,
but we are unable in utilizing these
resources to the desired Extent.
» Social Problems
− Unemployment is the cause 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 forces them to do what
they do not like to do and should not
do. It causes crimes of theft, dacoity,
robbery etc.
Remedial Measures
• The measures that can help us in
eradicating or minimizing Unemployment:
» Expanding Volume of Work
270
− Solution to the problem of
unemployment lies in enlarging the
opportunities for work. This needs to
be completed 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.
− The ultimate avenue of more
employment has to be found in the
industrial sector, as also in the service
sector.
» 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.
− Secondly, capital formation directly
generates employment in the capital
goods sector. This also provides
capital goods for the production of
consumer goods and services.
» Appropriate Mix of Production
Techniques
• It is also necessary to choose such
a combination of capital-intensive
and labor-intensive technologies of
production may generate maximum
employment.
• Labour-intensive activities such as
cottage/household activities and also
many agricultural operations, provide
employment but capital-intensive
technologies, are, by and large, more
employment-creating, labour when
employed in capital intensive industries,
give rise not only to capital goods but
also generate employment in industries
 which provide inputs to them.
• Hence, the right mix of technologies which
may provide maximum employment at a
higher wage rate and provide a surplus
for further investment.
» Special Employment Programmes
− Till the economy matures to a level
where everyone finds the job as
described above, it is necessary, as an
interim measure, to undertake special
employment programmes for those
who do not get benefit from this type
of growth in the short run.
− The need for supplement programmes
is all the more important for poor
people, residing mostly in rural areas
and small towns.
− Specific employment programmes
to suit specific group of people and
specific areas.
Inequality
• Inequality refers to the difference in
income/expenditure levels of various
sections of the society.
• The United Nations describes inequality
as “the state of not being equal, especially
in status, rights and opportunities”.
• Inequality can be broadly classified in to:
» Economic Inequality
− Most predominant forms of economic
inequality measured are those
of income inequality and wealth
inequality.
− Income inequality is the inequality
in and disparity in the incomes
commanded by the top percentile of
the population in comparison to the
bottom percentiles.
271
− Wealth inequality measures inequality
by calculating disparities in wealth
instead of income.
» Social Inequality
− Social disparity arises when a society's
wealth is distributed unequally.
− In India, one of the most distinctive
types of social inequity occurs
within the domains of gender and
caste, where people from the most
disadvantaged parts of these social
groups are specifically impacted in
terms of their opportunities, access
to basic necessities, and overall
potential. Both these categories are
deeply intertwined and inequality
in one often affects the inequality in
another.
Measure of Inequality
Lorenz Curve
• The Lorenz curve is basically a graphical
representation of income inequality or
wealth inequality developed by American
economist Max Lorenz in 1905.
• It is generally used to depict income
distribution, where it indicates what
percentage (y percent) of total income
the bottom x percent of households
have. The x-axis shows the percentage
of families, while the y-axis shows the
percentage of income.
• If the x-value is 45 and the y-value is 14.2,
the bottom 45 percent of the population
owns 14.2 percent of the overall income
or capital.
• A straight line at an angle of 45 from
the start on the graph indicates perfect
equality. The curve below this line shows
inequality. The greater the inequality, the
greater will be the degree of curvature.
 Remedial measure by

100%
government to reduce
A inequality

Cumulative share of income earned

• Land reform.

)
e
re
eg
• Poverty alleviation and employment
D
5
(4
generation programmes.
y
lit
ua

• Other development programmes like

Eq
of

ve rural development programme, skill

ne

ur
C
Li

development, education, health and

n
re
Lo

B social security programme etc.

• Nationalization of banks and financial
institutions.
100%
Cumulative shareof people from lowest to highest incomes • Promoting financial inclusion.
I M A G E 14.5: L O R E N Z C U R V E
• Promotion of MSME.
• Progressive taxation and progressive
Gini Coefficient government expenditure.
• Gini Coefficient is an arithmetic measure
of inequality based on Lorenz curve.
• Corrado Gini, an Italian statistician, UPSC CSE PRELIMS
founded it in 1912.
• A Gini coefficient of zero denotes true
Previous Years
equality, with all values being equal (for
example, where everyone has the same
Questions
income). Q.1) Microfinance is the provision of
financial services to people of low-
income groups. This includes both the
consumers and the self-employed.
Cause of Inequality The service/services rendered under
• Difference in ownership of land and micro-finance is/are: 2011
wealth. 1. Credit facilities
• Institution of private property and 2. Savings facilities
inheritance loss.
3. Insurance facilities
• Scarcity of capital.
4. Fund Transfer facilities
• Inadequate infrastructure particularly Select the correct answer using the codes
social infrastructure like school etc.
given below the lists:
• Leakage in government developmental (a) 1 only
expenditure.
(b) 1 and 4 only
• Difference in access to education and
training. (c) 2 and 3 only
• Inheritance difference in ability of (d) 1, 2, 3 and 4
individuals. Ans. (d)
• Difference in access to credit facilities. • Explanation: Microfinance is a source

272
 of financial services for small businesses
and entrepreneurs lack access to banking
and associated services.
• The two key mechanisms for the delivery
of financial services to such clients are:
» Relationship-based banking for small
businesses and individual entrepreneurs;
and
» Group-based models, where several
entrepreneurs come together to apply
for loans and other services as a group.
• For some, microfinance is a movement
whose object is “a world in which as
many poor and near-poor households
as possible have permanent access to
variety of high-quality financial services,
comprising not just credit but also
insurance, savings, and fund transfers.”
Q.2) Which of the following can aid in
furthering the Government’s objective
of inclusive growth? 2011
1. Promoting Self-Help Groups
2. Promoting Micro, Small and Medium
Enterprises
3. Implementing the Right to Education
Act
Select the correct answer using the codes
given below:
(a) 1 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2 and 3
Ans. (d)
• Explanation: The agenda for inclusive
growth was envisioned in the Eleventh
Plan document, which aimed to achieve
not only faster growth but also a growth
process that ensured a broad-based
improvement in the quality of life of
people, particularly the poor, SCs/STs,
other backward castes (OBCs), minorities,
and women, as well as equal opportunity
273
for all. The idea of inclusive growth
envisions bringing these marginalized
parts of society into the mainstream of
society so that they can profit from faster
economic growth.
• Inclusive growth means economic growth
that creates employment opportunities
and helps in reducing poverty.
• It entails vulnerable people getting access
to basic health and education facilities.
It entails ensuring equal opportunity
for all, as well as inspiring people
through education and skill growth. It
also encompasses an environmentally
sustainable growth mechanism that
strives for good governance and aids in
the development of a gender responsive
society.
• Increased job opportunities are critical
because they are a vital condition for
raising people's living standards.
• The Mahatma Gandhi National Rural
Employment Guarantee Act (MGNREGA),
one of India's largest social safety nets,
has improved people's living standards
and reduced migration to a large extent.
• Apart from that, the government
has launched a number of flagship
programmes, such as the Sarva Siksha
Abhiyan (SSA), the National Rural Health
Mission (NRHM), and Bharat Nirman,
to improve education, health, and
infrastructure, thereby making growth
more inclusive.
Q.3) In India, which of the following have the
highest share in the disbursement of credit
to agriculture and allied activities?2011
(a) Commercial Banks
(b) Cooperative Banks
(c) Regional Rural Banks
(d) Microfinance Institutions
Ans. (a)
• Explanation: Commercial Banks have
the highest share in the distribution of
 credit to agriculture and allied activities.
Q.4) The basic aim of the
Bank Scheme is that:
(a) big banks should try to open offices
in each district
(b) there should be stiff competition
among the various nationalized banks
(c) individual banks should adopt
particular districts for intensive
development
(d) all the banks should make intensive
efforts to mobilize deposits
Ans. (c)
• Explanation: Lead Bank Scheme (LBS)
was introduced in 1969, based on the
recommendations of the Gadgil Study
Group. The basic idea was to have
an “area approach” for focused and
targeted banking.
• Districts were the units for area
approach and each district could be
allotted to a specific bank which will
perform the role of a Lead Bank.
Q.5) Which of the following can be said
to be essentially the parts of Inclusive
Governance? 2012
1. Permitting the Non-Banking Financial
Companies to do banking
2. Establishing effective District Planning
Committees in all the districts
3. Increasing government spending on
public health
4. Strengthening the Mid-day
Scheme
Choose the correct answer:
(a) 1 and 2 only
(b) 3 and 4 only
(c) 2, 3 and 4 only
(d) 1, 2, 3 and 4
Ans. (c)
274
• Explanation: The Government has
strengthened the district as the unit of
planning in almost all Centrally sponsored
Lead
programmes.
2012
• The government has also consciously
structured the flagship programmes in a
manner that strengthens decentralized
management with the help of local
institutions.
• In the Sarva Shiksha Abhiyan and the
National Rural Health Mission (NRHM),
District level Plans are being prepared
and funded.
• In the National Rural Employment
Guarantee Programme, village
panchayat level plans are prepared
and aggregated at the District level as
a District Plan and funds released to
executing agencies which happen to be
largely the panchayats.
• Likewise in the urban regions, under
JNNURM, 63 cities have evolved medium-
term development plans for the cities
and have been supported with Central
Government funds. Each district planning
committee has a crucial role in building a
thoughtful vision for its district through a
participative and inclusive process.
Q.6) Disguised unemployment generally
means 2013
(a) A Large number of people remain
unemployed
(b) Alternative employment is not
available
(c) Marginal productivity of labour is
Meal zero
(d) Productivity of workers is low
Ans. (c)
• Explanation: Disguised unemployment
exists where part of the labour force
is either left without work or is working
in a redundant manner where worker
productivity is essentially zero.
• It is unemployment that does not impact
 aggregate output.
• An economy demonstrates disguised
unemployment when productivity is low
and too many workers are filling too few
jobs.
Q.7) Which of the following grants/
grant direct credit assistance to rural
households? 2013
1. Regional Rural Banks
2. National Bank for Agriculture and Rural
Development
3. Land Development Banks
Select the correct answer using the codes
given below:
(a) 1 only
(b) 1 and 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (c)
• Explanation: NABARD doesn’t give
“direct” credit assistance.
• It provides credit via intermediaries such
as Microfinance companies, cooperative
society, RRB.
• Therefore, 2 is false.
Q.8) What is the purpose of setting up of
Small Finance Banks (SFBs) in India? 2017
1. To supply credit to small business units
2. To supply credit to small and marginal
farmers
3. To encourage young entrepreneurs
to set up business particularly in rural
areas.
Select the correct answer using the code
given below:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
275
Ans. (a)
• Explanation: Small finance banks can
play an important role in the supply of
credit to micro and small enterprises,
agriculture and banking services in
unbanked and under-banked regions
in the country, the RBI has decided to
licence new “small finance banks” in the
private sector.
• While permitting small banks, however,
the issues relating to their size, capital
requirements, the area of operations,
exposure norms, regulatory prescriptions,
corporate governance and resolution
need to be suitably addressed in the light
of experience gained.
• The goals of setting up of small finance
banks (SFB) will be to further financial
inclusion by:
» Provision of savings vehicles, and
» Supply of credit to small and marginal
farmers, micro and small industries, small
business units, and other unorganized
sector entities, with the help of high
technology-low-cost operations.
Q.9) In a given year in India, official
poverty lines are higher in some States
than in others because 2019
(a) poverty rates vary from State to
State
(b) price levels vary from State to State
(c) Gross State Product varies from
State to State
(d) quality of public distribution varies
from State to State
Ans. (b)
• Explanation: In 2005, an expert group
to review methodology for poverty
estimation, headed by Suresh Tendulkar,
was constituted by the Planning
Commission to address the following
three shortcomings of the earlier
technique:
 (i) consumption patterns were linked
to the 1973-74 poverty line baskets
(PLBs) of goods and services, whereas
there were substantial changes in the
consumption patterns of the poor since
that time, which were not reflected in
the poverty estimates.
(ii) there were problems with the
adjustment of prices for inflation,
both spatially (across regions) and
temporally (across time).
(iii) earlier poverty lines assumed
that education and health would be
provided by the State and formulated
poverty lines accordingly.
• It suggested four major changes:
(i) A shift away from calorie consumption-
based poverty estimation.
(ii) A uniform poverty line baskets (PLB)
across rural and urban part of India.
(iii) A change in the price adjustment
process to correct spatial and temporal
issues with price adjustment; and
(iv) Incorporation of private expenditure
on health and education while
estimating poverty.
• The Committee proposed using Mixed
Reference Period (MRP) estimates rather
than Uniform Reference Period (URP)
estimates, which were previously used in
poverty estimation methods.
• It calculated consumption of cereals,
pulses, milk, edible oil, non-vegetarian
products, vegetables, fresh fruits, dry
fruits, sugar, salt & spices, other foods,
intoxicants, petrol, education, medical
(non-institutional and institutional),
entertainment, personal & toilet goods
clothes, footwear, other goods, other
services, and durables.
Q.10) If another global financial crisis
happens in the near future, which of the
following action/policies are most likely
to give some immunity to India.
1. Not depending on short- term foreign
276
borrowings
2. Opening up to more foreign banks
3. Maintaining full capital account
convertibility
Select the correct answer using the code
given below:
(a) 1 only
(b) 1 and 2 only
(c) 3 only
(d) 1, 2 and 3
Ans. (a)
• Explanation: If some global financial
crisis occurs in the future, lesser exposure
to the foreign financial markets is likely
to provide some immunity to India.
• Statement 1 is correct: Short -term
borrowings would lead to the onus of
paying back the debt and could result in
stressful circumstances for the borrowing
economy/India.
• Statement 2 is not correct: Opening up
to more foreign banks would lead to an
enhanced exposure to the international
economy, and hence the risk will be
increased.
• Statement 3 is not correct: Currency
convertibility implies to a condition in
which a currency can be converted into
a foreign currency, and vice -versa at
the prevailing exchange rate without
any government interference. In India,
we cannot completely convert rupees
to dollars - There are restrictions to the
same.
• Now, capital account convertibility is the
choice to convert national currency into
a foreign currency, and vice -versa with
respect to capital account transactions
of the Balance of Payments (BOPs)
accounts. It could also be the freedom to
convert domestic financial assets (such
as rupees)/liabilities into foreign assets/
liabilities and vice -versa. Therefore, It
is riskier, as the overseas investors can
withdraw all their money at once which
is known as capital flight.
 CHAPTER - 15
GLOBAL ECONOMIC INSTITUTIONS
International
Financial Institutions
• International financial institutions
provide financial support and technical
assistance for economic and social
development in developing nations
and uphold international economic
cooperation and stability.
• Examples of International Financial
institutions are the International
Monetary Fund (IMF), World Bank Group,
the African Development Bank, the Asian
Development Bank etc.
Bretton Woods
Institutions
• The World Bank and the International
Monetary Fund (IMF) are also known as
The Bretton Woods Institutions.
• In July 1944, the Institutions were
structured at a meeting of 43 countries in
Bretton Woods in New Hampshire in the
USA.
• Their targets were to support rebuilding
the shattered postwar economy and
to promote international economic
cooperation.
International
Monetary Fund (IMF)
• In 1945, IMF was established by
international treaty as the central
277
institution of the international monetary
system.
• The IMF is an organization consists
of 189 member nations, which are
working to promote global monetary
cooperation, assure financial stability,
facilitate international trade, promote
high employment as well as sustainable
economic growth and reduce poverty
around the world.
• IMF targets to tackle the crises in the
system by motivating nations to acquire
sound economic policies and monitoring
their fidelity to such policies; it is also
temporary to provide financing to address
the balance of payments problems.
• IMF engages in three types of activities:
» It monitors economic developments,
financial developments as well as the
policies, together in its member countries
as well as at the global level, offers policy
advice to its members.
» It lends to member countries facing
balance of payments problems, and
also support economic adjustment
and reforms aimed at correcting the
underlying problems.
» It provides the governments as well as
central banks of its member countries
with technical assistance and training in
its areas of expertise.
• Headquartered in Washington, D.C.
• Most resources for IMF loans are served
by member countries, principally through
their payment of quotas.
• Quota subscriptions are a primary
component of the IMF's financial
resources. Each member country of the
IMF is allotted a quota, based broadly on
its relative position in the world economy.
• All member nations of the IMF are
not sovereign states, and therefore all
"member nations" of the IMF are not
participants of the United Nations.
World Bank
• The World Bank is an international
financial institution that supports with
loans as well as grants to the governments
of poorer countries for the purpose of
pursuing capital projects.
• The World Bank was formed at the 1944
Bretton Woods Conference, along with
the International Monetary Fund (IMF).
• Originally, it provided loans to help
rebuild countries wrecked by World War
II. Eventually, the focus shifted from the
reconstruction to the development, with
a heavy emphasis on infrastructures
such as dams, electrical grids, irrigation
systems, roads, etc.
Organization
• The World Bank is similar to a cooperative
of 189 member countries.
• These member countries like shareholders
are constituted by a Board of Governors,
who are the topmost policymakers at the
World Bank.
The World Bank Group
IBRD IDA
The International Bank The International
for Reconstruction and Development
Development Association
I M A G E 15.1: WORL D BAN K GROUP
278
• Generally, the governors are member
countries’ finance ministers or
development ministers.
• They come together once in a year at
the Annual Meetings of the Boards of
Governors of International Monetary
Fund as well as the World Bank Group.
• The World Bank Group President is a
chairperson meetings of the Boards of
Directors and looks after the management
of the Bank.
• The Board of Executive Directors elect
the president for a five-year, renewable
term.
Objective of the World Bank
• To supply long-run capital to member
countries for economic reconstruction
and development.
• Focusing on social development, gover-
nance and institution-building as the
major elements of equitable growth.
• It helps in inducing long term capital for
improving the balance of payments and
thereby balancing international trade.
• To promote capital investment in member
nations by the following ways:
» To provide guarantee on capital
investment.
» Provide loans for productive activities on
considerate conditions.
IFC IBRD IBRD
The International The Multilateral The International
Finance Corporation Investment Guarantee Centre for Settlement
Agency of Investment Disputes
• The World Bank Group is an advanced
family of five international organizations.
» International Bank for Reconstruction
and Development (IBRD)
− It finances only sovereign
governments directly or projects
backed by sovereign governments.
− IBRD focuses its services on middle-
income countries or countries where
the per capita income ranges from
$1,026 to $12,475 per year.
− These countries include Indonesia,
India, and Thailand etc. which are
among the fast-growing economies
and are also home to 70% of world
poverty.
» International Finance Corporation (IFC)
− IFC is the largest global development
institution aimed exclusively on the
private sector in developing countries.
− It is a private-sector arm of the World
Bank Group, to advance economic
development by investing in for-
profit and commercial projects for
poverty reduction and promoting
development.
» International Development Association
(IDA)
− The World Bank's part IDA helps the
world's poorest countries.
− IDA supports a range of development
activities that pave the way toward
equality, economic growth, job
creation, higher incomes, and better
living conditions.
− IDA's work covers primary education,
basic health services, clean water
and sanitation, agriculture, business
climate improvements, infrastructure,
and institutional reforms.
» Multilateral Investment Guarantee
Agency (MIGA)
279
− The Multilateral Investment Guarantee
Agency (MIGA) is international
financial institution which provides
political risk insurance as well as the
credit enhancement guarantees.
− The guarantees support investors
protect foreign direct investments
against political and non-commercial
risks in developing countries.
− MIGA was formed in 1988 as an
investment insurance facility to
encourage confident investment in
developing countries
» International Center for Settlement of
Investment Disputes (ICSID)
− ICSID is international adjudication
institution structured in 1966 for
legal dispute resolution as well as
conciliation between international
investors.
− The ICSID does not direct arbitration
or conciliation proceedings itself but
only provides institutional as well as
procedural support to conciliation
commissions, tribunals, and other
committees which conduct such
matters.
India and World Bank
• India is an associate of four of the five
integrant of the World Bank Group which
are
1. International Bank for
Reconstruction and Development -
IBRD,
2. The International Development
Association (IDA),
3. The International Finance
Corporation (IFC), and
4. The Multilateral Investment
Guarantee Agency (MIGA).
• India is not a part of ICSID (International
Centre for Settlement of Investment
 Disputes).
• The World Bank (mainly through IBRD
and IDA) is providing funds to the India
for various development projects.
• India is one of the founder countries of
IBRD, IDA and IFC.
• India also has the executive director in
the Board of Directors of IBRD/IFC/IDA/
MIGA.
• The Executive Director from India is a
representative of the whole constituency
Bangladesh, Bhutan, and Sri Lanka along
with India.
World Bank Reforms
• In April 2010, the World Bank Group
permitted the General Capital Increase
as well as the Selective Capital Increase
for IBRD, after which the voting power
of the Developing Countries in IBRD will
increase by 3.13% and will reach 47.19%
of the total voting power at IBRD.
• India’s voting power will increase to
2.91% from 2.77% and India will move
on to become 7th largest shareholder
in IBRD from the present 11th largest
shareholder.
General Agreement
on Tariffs and Trade
- GATT
• GATT came into the action on 1 January
1948.
• 'The General Agreement on Tariffs and
Trade (GATT)' is a legal agreement
amongst those countries whose
overall determination was to promote
international trade by reducing or
eliminating trade barriers such as tariffs
or quotas.
• In October 1947, 23 countries including
India signed an agreement in Geneva,
280
which became effective from 1st Jan
1948.
• It remained in the operation until the
signature by 123 nations in Marrakesh
on 14 April 1994, of the Uruguay Round
Agreements which established the World
Trade Organization (WTO) on 1 January
1995.
• GATT supported establish a strong as
well as prosperous multilateral trading
system that became much more liberal in
the rounds of trade negotiations. But until
1980s the system required a thorough
overhaul. This resulted into the Uruguay
Round, and ultimately to the WTO.
World Trade
Organization
• The World Trade Organization i.e. WTO
is the one and only global international
organization dealing with the rules of
trade amongst the nations.
• The WTO supports a forum for negotiating
agreements targeted at decreasing
obstacles to international trade as well
as ensuring a level playing field, therefore
subscribing to the economic growth and
the development.
• Also, the WTO supports a legal as well
as the institutional framework for the
implementation and monitoring of
the agreements, as well as for settling
disputes arising from their interpretation
and application.
• The WTO currently constitutes of 164
members, of which 117 are developing
countries.
WTO Guiding Principles
• Pursuit of open borders i.e. opening of
national markets to international trade.
• Guarantee of Most-Favoured-Nation
 principle i.e. non-discriminatory
treatment by and among members.
• Commitment to transparency in the
course of its activities.
• Encouraging development and economic
reform.
• Predictability - Countries to adopt stable
and transparent policy.
• Increase in fair competition.
WTO Functions
• WTO's main activities are:
1. Negotiation of the reduction or
elimination of problems to trade
(import tariffs, other barriers to trade)
as well as agreeing on rules governing
the conduct of international trade
(e.g. antidumping, subsidies, product
standards, etc.)
2. Applications related to various
trades such as trade in goods,
trade in services, trade-related
intellectual property (IP) rights,
etc. are administer and monitor by
WTO's rules
3. Monitor and review the trade
policies of our members and ensure
transparency of regional as well as
the bilateral trade agreements
4. Settle the disputes between
the members related to the
interpretation as well as the
application of the agreements
5. Build capability of developing
country government officials in the
matter of international trade
6. Assist the process of accession of
some 30 countries who are not yet
members of the organization
7. Conducting economic research and
collecting and disseminating trade
data in support of the WTO's other
main activities
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WTO Organization
• The Secretariat is located in Geneva,
Switzerland.
• Final decisions in the WTO are generally
taken by consensus of the entire
membership.
• Ministerial Conference
» The highest institutional body, that is
the Ministerial Conference, which meets
roughly every two years.
• General Council
» A General Council leads the organization's
business in the intervals between
Ministerial Conferences.
» Representative of all countries, regular
meetings once in a year headed by
Directorate General.
» It serves as a secretariat of WTO.
• Trade Policy Review Body (TPRB)
» It conducts a review of trade policies of
each member country after two year to
ensure compliance of WTO norms by the
members.
• Dispute settlement Body
» It serves as the court of WTO.
• Appellate Authority
» Its decision is final and binding.
• The Twelfth Ministerial Conference
(MC12) is set to be held in Nur-Sultan,
Kazakhstan, in June 2020.
• English, French and Spanish are the three
official languages of the WTO.
Agreements of WTO
Trade Related Intellectual Property
Rights (TRIPS)
• The Agreement on TRIPS is a worldwide
legal agreement allying all the member
countries of the World Trade Organization
(WTO).
• It records minimum standards for the
direction by the national governments of
many forms of the intellectual property
(IP) as claimed to the nationals of other
WTO member nations.
• TRIPS was moderated at the end of the
Uruguay Round of the General Agreement
on Tariffs and Trade (GATT) from 1989 to
• Copyright rights
• Industrial designs
• Layout of Integrated Circuit
• Patent
Trade-Related Investment Measures
(TRIMs)
• The Agreement on Trade-Related
Investment Measures (TRIMs) rules that
are applicable to the domestic regulations
a country applies to foreign investors,
often as part of industrial policy.
• The objective of TRIMs is to ensure fair
treatment of investment in all member
countries.
• It has two-components:
» Tariffication: Tariffication is basically all
non-tariff barriers such as quotas etc.
need to be abolished and converted into
an equivalent tariff.
» National Treatment: Under this member
countries cannot impose a restriction on
foreign firms beyond a certain limit.
Agreement on Agriculture (AoA)
• The WTO Agreement on Agriculture
conceived in 1995, represents a significant
step towards reforming agricultural
trade and making it fairer and more
282
1990 and managed by the WTO.
• The TRIPS agreement established
intellectual property law into the
multilateral trading system for the
first time that remains the most
comprehensive multilateral agreement
on intellectual property to date.
• TRIPS also specifies enforcement
procedures, remedies, and dispute
resolution procedures.
• It includes:
• Geographical indications
• Trademarks
• Trade Secrets
• Trade names
competitive.
• As per the provisions of the Agreement,
1. Developed countries would complete
their reduction commitments within
6 years, i.e., by the year 2000.
2. Commitments of the developing
countries would be completed
within 10 years, i.e., by the year 2004.
3. The least developed countries are
not required to make any reductions.
4. The WTO Agreement on Agriculture
contains provisions in 3 broad areas
of agriculture and trade policy viz.
market access, domestic support,
and export subsidies.
» Market Access
− This constitutes tariffication, tariff
reduction and access opportunities.
− Ordinary tariffs constituting those
resulting from their tariffication are
to be reduced by an average of 36%
with a minimum rate of reduction of
15% for each tariff item over a 6-year
period.
 − Developing countries were
maintaining Quantitative Restrictions
due to balance of payment problems
were allowed to offer ceiling bindings
instead of tariffication.
− Members countries to provide
preferential market access to
agriculture product to tariff-rate
quota. It should be at least 5% of
domestic consumption.
» Domestic Support
− It includes the use of subsidies and
other support programmes that
directly stimulate production and
distort trade.
− Trade distorting subsidies to be
maintained within the limit.
− Aggregate Measure of Support (AMS)
comes under domestic support.
» Export Subsidies
− The Agreement consists of the
provisions regarding members
commitment to lower the Export
Subsidies.
− Developed countries are needed to
lower their export subsidy expenditure
by 36% and volume by 21% in 6 years,
in equal installment (from 1986 –1990
levels).
− For developing countries, the
percentage cuts are 24% and
14% respectively in equal annual
installment over 10 years.
» Patenting of Plant Varieties
− To protect plant varieties by three
methods namely
• Patent.
• Union for the conservation of the
New Varieties of Plant (UPOV)
• Sui Generis
» India chooses Sui-Generis and passed
283
Protection of plant varieties and Farmers
Rights Act, 2001.
Aggregate Measure of Support (AMS)
• The AMS means the annual level of
subsidies expressed in monetary terms
considering for an agricultural product
in benefit of the producers (product
specific) of the basic agricultural product
as well as the non-product specific
support supplied in favour of agricultural
producers in general.
• It covers all the support/subsidies or a
product-specific which does not qualify
for the exemption.
• According to the WTO norms, the AMS
can be provided up to 10 % of a country’s
agricultural GDP for developing
countries.
• While the limit is 5% for a developed
economy. This limit is called the de
minimis level of support.
Green Box Subsidy
• It includes non-trade distorting subsidies
or minimal trade-distorting subsidies i.e.
these are decoupled (or separated) on
production.
• For example, subsidy on research and
development, environment protection,
regional development, disease control,
direct cash transfer to farmers etc.
Amber Box
• It includes trade-distorting subsidies i.e.
linked with the production.
• For example, Subsidies on input, fertilizers,
seeds, pesticide, procurement subsidies
like MSP, etc.
• The ceiling for AMS:
» Developed Countries: up to 5% value of
domestic output.
» Developing Countries: up to 10% of value
 of domestic output.
Blue Box
• It is also known as Amber box with a
condition.
• It includes trade-distorting subsidies
which are not included in AMS under
certain condition.
• For example, subsidies that require
farmers to limit production.
General Agreement on Trade in
Services (GATS)
• GATS is an agreement of the World Trade
Organization (WTO) that came into
action in January 1995 as an outcome of
the Uruguay Round negotiations.
• The agreement was created to extend the
multilateral trading system to the service
sector, similarly, the General Agreement
on Tariffs and Trade supported such
system for merchandise trade.
• GATS objective is establishing a sound
multilateral framework or principles and
rules for trade in services.
• All members of the WTO are parties to
the GATS. Under this, members have to
liberalize trade-in service in a progressive
manner.
• According to GATS services are classified
into:
» Mode 1 (Cross Country Supply)
− Services supplied from one country to
another.
− For example, BPO, KPO etc.
» Mode 2 (Consumption Abroad)
− Consumer/firms making use of service
in another country.
− For example, Tourism.
» Mode 3 (Commercial Presence)
284
− Foreign companies abroad include
MNCs.
» Mode 4 (Movement of Natural Person)
− Individual traveling from their native
place to supply services in other
countries.
− For example, Job Visa etc.
Non-Agricultural Market Access
(NAMA)
• NAMA refers to the trade liberalization
rules about major non-agricultural goods
under WTO.
• It covers laws for the trading of items
like manufacturing and other industrial
goods, mining, jewellery, forestry etc.
Agreement on Anti-Dumping Duties
• It prescribes the process of estimation
of the extent of dumping and norms
and dealing with the imposition of Anti-
dumping duties.
Major achievements of WTO:
• Now overall combined share of global
trade of WTO members exceeds 90%
of the total international trade.
• After the establishment of WTO,
dollar value of global trade has nearly
quadrupled, while the real volume of
international trade has expanded
by 2.7 times. Important reason for
this is that the average tariffs have
almost halved from 10.5 percent to
6.4 percent during this period of time.
• The predictable market situations
given by the WTO combined with
improved communication has
enabled the growth of global value
chains (GVCs). Trade within these
GVCs today accounts for around 70%
of overall merchandise trade.
Doha Ministerial Conference
2001
• It started in November 2001 at Qatar,
Doha with the purpose of lowering trade
barriers and facilitating more trade in the
world.
• The Round is called semi-officially as
the Doha Development Agenda as a
fundamental objective is to improve
the trading prospects of developing
countries.
• The work programme provides about 20
areas of trade.
• Main issues of Doha Development Round:
» Implementation Issue
− These issues are concerns of
developing countries which are
related to inconsistency in WTO
norms.
» Relaxation in TRIPS
− Scope of compulsory licensing
increased.
− Scope of geographical Indication
increased.
» Special and Differentiated Treatment
(S&DT)
− S&DT to be made effective and
operational.
− Under S&DT certain unilateral
concessions are provided to
Underdeveloped countries (UDC)
under WTO provision/agreements.
» Special Safeguard Mechanism (SSM)
− Under this, developing countries can
impose restrictions on the import of
agricultural commodities in case of a
surge in import/fall in price.
» Special Products
285
− Underdeveloped Countries (UDC) can
specify certain products as special
products.
− Imports of such products can
be restricted to protect rural
development (mainly village and
cottage industries).
• Duty-free, quota-free market access by
developed countries to least developed
countries (LDC).
• Agricultural subsidies to be eliminated
by developed countries i.e. to be kept in
AMS.
• Labour issue to be taken by ILO i.e. WTO
would not take into account suo-moto by
itself.
• Singapore Issues to be taken up after
concluding DDA (Doha Development
Agenda) which was introduced by the USA
and European Union and deals with trade
and competition policy and transparency
in government procurement.
Bali Ministerial Meet and Bali
Package (Trade Facilitation
and Peace Clause), 2013
• The Bali Package is a trade agreement
structured from the Ninth Ministerial
Conference of the World Trade
Organization in Bali, Indonesia in 2013.
• It is targeted at lowering global trade
barriers as well as the first agreement
resulting from the WTO that is endorsed
by all its members.
• The accord consists of the provisions for
» Increasing import tariffs as well as
agricultural subsidies, with the intent
of making it easy going for developing
countries to trade with the developed
nations in global markets.
» Developed countries would scrap hard
import quotas on agricultural goods from
the developing world and alternatively
 would only be permitted to charge tariffs
on amounts of agricultural imports
exceeding specific limits.
» Acceptance of trade facilitation - The TFA
(trade facilitating Agreement) targets
to lower red-tape as well as streamline
customs. It will be legally binding which
would require some expense and a
certain level of technology.
» ‘Peace clause’ was agreed at. Peace
clause gave countries 4-year times to
adjust to the limit and avoid sanctions.
» Note: Later on, the Peace Clause
was made permanent. It was agreed
to provide perpetual protection to
public stockholding programmes of a
developing member countries for food
security purposes.
Nairobi Ministerial Meet, 2015
• The Tenth World Trade Organization
Ministerial Conference was held at
Nairobi, Kenya in 2015.
• The results of the Conference which
is referred to as the 'Nairobi Package'
contains Ministerial Decisions on
agriculture, cotton, issues related to least
developed countries (LDCs) as well.
• These cover:
» Special Safeguard Mechanism (SSM) for
developing countries
» Public stockholding for food security
purposes
» Commitment to scrap export subsidies
for farm exports,
» Measures related to cotton
• Decisions were made concerning
preferential treatment to LDCs in the
area of services as well as the criteria
determining if exports from LDCs may
benefit from the trade preferences.
• It extended the provision to avert
'evergreening' of patents in the
286
pharmaceuticals sector. This
determination would help in maintaining
affordable as well as the accessible
supply of generic medicines.
• Nairobi Ministerial Meet also dealt with
the rules on fisheries subsidies.
Factors affecting the working of WTO
• Trade war is going on among China and
US despite both being a participant
of WTO. This negates the core non-
discriminatory principle of WTO. China
and US have levied counter-productive
duties, condemning each other of
damaging their domestic interests.
• EU, Trans-Pacific Partnership (TPP),
Association of South East Asian
Countries (ASEAN), North American
Union etc., are some important platforms
that provide more liberal and seamless
access of member’s markets to fellow
member countries. This runs counter
to goals of WTO which seeks to set up
an international rule-based system of
trading with nominal barriers.
• The Doha Round of negotiations is
formally not completed.
• The two major areas that have impacted
implementation by developing nations
have been the TRIPS and the Sanitary and
Phytosanitary (SPS) measures agreements.
• Dispute settlement mechanism of
WTO is going through a crisis and It is
struggling to hire new members to its
understrength Appellate Body that hears
appeals in trade. In 2019, More than 20
developing nations met in New Delhi
to discuss various ways to prevent the
WTO’s dispute resolution system from
collapsing because of the logjam in these
appointments.
• While the international trade landscape
has altered significantly over the past
25 years, WTO guidelines have not kept
pace. The Covid-19 pandemic hastens
the shift to e-commerce, guidelines to
 regulate online trade will be more crucial
than ever.
• Technical functioning is now wholly
insufficient to meet the main challenges
to the strategic relevance of the WTO in
the 21st century. The organization has
failed to respond, adapt, or deliver in
critical areas.
Few important suggestions to improve
the functioning of WTO
• Every members of WTO will have to
accept the operative assumption of a
rules-based order steered by a market
economy, competition, and the private
sector.
• Launch negotiations to address the
intertwined issues related to market
access and agricultural subsidies.
• A credible trading system needs a dispute
settlement system that is accepted by
every members of WTO.
• The COVID 19 pandemic has seen
significant downward trends in
international trade. A conducive trade
policy can facilitate global trade with
the help of imports and exports through
reduced tariffs and non-tariff barriers
and dedicated lanes for release and
clearance of goods.
• Some of the other important
recommendations are: Closure of DOHA
Round and permanent solution to
peace clause, appointment to Dispute
Settlement Body (DSB) by majority rather
than reverse consensus mechanism and
launch serious negotiations to restore the
balance etc.
287
BRICS
• BRICS is the acronym for an alliance
of five important emerging national
economies: Brazil, Russia, India, China,
and South Africa. It's headquarter is at
Shanghai, China.
• The acronym BRIC was created by
Goldman Sachs in 2001 to mark the
emerging powers, side by side the United
States, the five largest economies of the
world in the 21st century.
• In 2006, BRIC countries initiated their
dialogue and from 2009, those take place
at annual meetings of heads of state and
the government.
• In 2011, with South Africa joined the
group. The BRICS reached its absolute
composition, incorporating a country
from the African continent.
• Unlike the European Union, these
countries are not a political alliance or a
formal trading association, instead, they
are a powerful economic block owing to
low production and labour costs.
• BRICS collectively representing about
42% of the world's population, 23% of
global GDP, 30% of the territory, and 18
% of world trade.
• In 2006, from the beginning of their
dialogue, these countries have sought to
establish fairest international governance,
one that would be more suitable to their
national interests.
• This aim would be achieved by means
of the rectification of the International
Monetary Fund quota system which
included, for the first time Brazil, Russia,
India, and China amongst the top ten
largest shareholders.
 I M A G E 15.2: BRICS M E M B E R S

New Development Bank (NDB) President to the Bank.

• Headquarter of NDB is in Shanghai.
• At the Fortaleza Summit (2014) (in
Brazil Important institutions), the • NDB’s Articles of Agreement specify that
New Development Bank (NDB) was all members of the United Nations could
established and the Contingent Reserve be members of the bank, however the
Arrangement (CRA) was announced. share of the BRICS nations can never be
less than 55% of voting power.
• K. V. Kamath from India was is the first
elected president of the NDB.
• NDB aims to authenticate cooperation
among BRICS as well as will support
the efforts of multilateral and regional
financial institutions for global
development and thus adding to
collective commitments for achieving
the target of strong, sustainable, and
balanced growth.
• The Bank shall have an initial sanctioned
capital of US$ 100 billion.
• The early contributed capital shall be
equally shared amongst the founding
members and shall be US$ 50 billion.
I M A G E 15.3: S H A R E H O L D I N G S T R U C T U R E OF THE
• India shall represent by giving the first ND B

288
• Unlike the World Bank, which assigns
votes based on capital share, in the New
Development Bank each participant
country will be assigned one vote, and
none of the countries will have veto
power.
Organization for
Economic Co-
operation and
Development
(OECD)
• It is an intergovernmental economic
organization of 36 member nations that
discuss as well as develop economic and
social policy.
• It was founded in 1961 to stimulate
economic progress and world trade.
• From 1949, it has been headquartered in
the Château de la Muette in Paris, France.
After the Marshall Plan ended, the OECD
focused on economic issues.
• It comprises democratic countries that
support free-market economies.
• The OECD has 37 countries that are its
members. They account for around 80%
of world trade and investment, giving it a
pivotal role in addressing the challenges
facing the world economy.
• India participates in selected OECD
Committees and their subsidiary bodies.
Indian ministers and officials have also
289
attended the OECD Ministerial Council
Meetings.
History
• In 1948, the US-financed Marshall Plan
for the reconstruction of a continent
ravaged by the war was regulated by
the Organization for European Economic
Cooperation (OEEC).
• It paved the way for new era of cooperation
by making individual governments
recognize the interdependence of their
economies, that was to change the face
of Europe.
• Motivated by the success as well as the
expectation of carrying its work ahead on
the global stage, Canada as well as the
US joined OEEC members in signing the
new OECD Convention on 14 December
1960.
Asian Development
Bank (ADB)
• The Asian Development Bank (ADB) is a
regional development bank constituted
on 19 December 1966, which is
headquartered in Manila, Philippines.
• ADB was conceptualized in the early
1960s as a financial institution which
was supposed to be Asian in character
and advance the economic growth and
cooperation in one of the poorest regions
in the world.
 I M A G E 15.4: A DB M E M B E R S
• The Asian Development Bank provides
assistance to its developing member
countries, the private sector, and public-
private partnerships through grants,
loans, technical assistance, and equity
investments to promote development.
• It has 68 shareholding members
including 49 from the Asia and Pacific
region.
• The ADB was designed similar to the
World Bank and has a closed weighted
voting system where votes are distributed
in accordance with members' capital
subscriptions.
• Japan holds the largest proportion of
shares at 15.677%, closely followed by the
United States with 15.567% capital share.
• China holds 6.473%, India holds 6.359%,
and Australia holds 5.812%.
• India started availing of ADB’s assistance
in 1986 in sectors like Industry, transport,
energy, agriculture, and human
development.
290
Asian Infrastructure
Investment Bank
(AIIB)
• It is a multilateral development bank with
a task to improve economic and social
outcomes in Asia.
• Headquartered in Beijing, it began
operations in January 2016 and have
now grown to 102 approved members
worldwide.
• 100 billion s is the Authorized Capital
Stock of the bank.
• The distributed shares are based on the
size of each member country's economy,
whether they are an Asian or Non-Asian
Member.
• Objective:
» To invest in sustainable infrastructure as
well as the other productive sectors in
Asia and beyond.
» To promote regional cooperation and
partnership in addressing development
challenges.
» To encourage private investment in
projects, enterprises and activities
 contributing to economic development
in the region.
• The Asian Infrastructure Investment Bank
(AIIB) investments in India with total in-
country financing stands at USD2.9
billion.
Regional Trade
Agreement (RTA)
• A regional trade agreement (RTA) is a
treaty between two or more governments
that define the rules of trade for all
signatories.
• It aims to encourage the free movement
of goods and services across the borders
of its members.
• Example of RTA is the European Union
(EU), Asia-Pacific Economic Cooperation
(APEC) etc.
Types of Regional Trade
Agreement (RTA)
• Various types of RTA are as follows:
Preferential Trade Agreement (PTA)
• A preferential trade agreement (PTA) is
an agreement that provides preference
to certain products from the participating
nations.
• This is done by lowering the tariffs but
not by abolishing them completely.
• For example, SAPTA by SAARC countries.
Free Trade Agreement (FTA)
• A free trade agreement i.e. FTA is
a preferential arrangement, where
members lower tariffs on trade by
between themselves while maintaining
their own tariff rates for trade with
291
nonmembers.
• For example, Free Trade Agreement
between India and ASEAN.
Customs Union (CU)
• A customs union is a free-trade
agreement, where members apply a
common external tariff (CET) schedule to
imports from nonmembers.
• For example, Southern African Customs
Union (SACU).
Common Market (CM)
• CM is a customs union, in which, the
movement of factors of production is
relatively free amongst member countries
• For example, BENELUX (Belgium-
Netherland- Luxemburg).
Economic Union (EU)
• An economic union is a common market, in
which, the member countries coordinate
macro-economic and exchange rate
policies.
• For example, European Union (EU).
Other Agreement
• Comprehensive Economic Co-operation
Agreement (CECA)/Comprehensive
Economic Partnership Agreement (CEPA)
» These are bilateral agreement to promote
trade cooperation among member
countries.
» These include liberalization of trade
policy, investment norms, movement of
labour etc.
» CECA include only "tariff reduction/
limination in a phased manner on listed/
all items except the negative list and
tariff-rate quota (TRQ) items.
» Also CEPA covers the trade in services
and investment and other areas of
economic partnership.
Advantages of RTA
• Lowered or Eliminated Tariffs.
• Trade promotion that leads to better
resource allocation.
• Regional Trade Agreement are more
flexible, and their terms are mutually
beneficial.
• Increased Foreign Direct Investment
(FDI) investment adds capital to expand
local industries and boost domestic
businesses.
Mega Regional Trade
Agreement
• Mega-regionals are deep integration
partnerships among the nations or
regions with a principal share of world
trade as well as the FDI.
• Along with increasing the trade links,
the deals target to improve regulatory
compatibility as well as supply a
rules-based framework for ironing out
differences in investment and business
climates.
• The two most significant mega-regional
trade agreements are the Trans-Pacific
Partnership (TPP) and the Transatlantic
Trade and Investment Partnership (TTIP).
292
Trans-Pacific Partnership (TPP)
• TPP is a suggested free trade agreement
among 11 Pacific Rim economies.
• The United States was included initially
but it withdrew from TPP in January 2017.
• The prevailing countries negotiated
a new trade agreement known as
Comprehensive and Progressive
Agreement for Trans-Pacific Partnership,
which integrates most of the provisions
of the TPP and which entered into force
on 30 December 2018.
• The 11 countries are Australia, Brunei,
Canada, Chile, Japan, Malaysia, Mexico,
New Zealand, Peru, Singapore, Vietnam.
• The TPP targets to achieve extensive
liberalization of both goods and services,
as well as entails complete coverage of
trade in services, investment, government
procurement, non-tariff measures and
many regulatory topics.
Transatlantic Trade and
Investment Partnership (TTIP)
• The TTIP negotiations which were
launched in June 2013, aim for a far-
reaching trade agreement between the
US and the EU.
• The goal was to abolish the trade barriers,
alignment, compatibility and possible
harmonization of regulations and
standards governing the goods, services,
investment, and public procurement
markets.
 I M A G E 15.5: T TIP AND TPP M E M B E R S

Regional Comprehensive Japan, New Zealand, and South Korea.

Economic Partnership (RCEP)
• RCEP is a recommended free trade
agreement in the Asia-Pacific region
among the ten-member province of the
Association of Southeast Asian Nations
shortly called as ASEAN, namely Brunei,
Cambodia, Indonesia, Laos, Malaysia,
Myanmar, the Philippines, Singapore,
Thailand, and Vietnam, and five of
ASEAN's FTA partners—Australia, China,
• RCEP negotiations were formally
established in November 2012 at the
ASEAN Summit in Cambodia.
• These nations account for approximately
half of the global population, contribute
over a quarter of world exports, and make
up nearly around 30% of international
Gross Domestic Product (the value of all
goods and services produced in a year).
• India, which is also ASEAN's FTA partner,
opted out of RCEP in November 2019.

I M A G E 15.6: RCEP M E M B E R S

293
India and RCEP
• There is fear that some of the Indian
domestic sectors may be hit by cheaper
alternatives from other RCEP nations.
Apprehensions have been expressed
that cheaper products of Chinese would
“flood” India.
• Industries such as dairy and steel have
demanded protection. The textile industry,
which has already raised concerns about
growing competition from neighbouring
countries with cheaper and more efficient
processes, fears the deal would impact it
negatively.
• Issue of Dairy Products: India is the
largest producer and consumer of
milk and milk products in the world.
Various dairy products from Australia
and New Zealand would have been
dumped into the Indian markets causing
massive losses to the Indian farmers and
producers. India would have had to cut
duties by almost 86% on dairy products
from these nations.
• Trade Deficit: Many of the Free Trade
Agreements signed amongst India and
the ASEAN, South Korea and Japan have
been to the disadvantage of India. The
nation has run huge amounts of trade
deficits with these nations. With respect
to China, India has over USD 50 Billion
trade deficit and China refuses to address
these concerns.
• Non-acceptance of Auto-trigger
Mechanism: To deal with imminent
increase in imports, India had been
seeking an auto-trigger mechanism.
Auto-trigger Mechanism would have
permitted India to raise tariffs on products
in instances where imports cross a certain
threshold. But other nations in the RCEP
were against this proposal.
Way forward
• According to many experts like Shri
294
Rajamohan, the RCEP can be a stepping-
stone to Act East Policy of India, however
at a time of increasing protectionism
and the China-US trade war, opening
our market to China (through RCEP) can
prove to be very disastrous, given the
structural issues in the Indian market.
Therefore, it is crucial that India focuses
on resolving the structural issues in the
domestic market, before finalizing the
RCEP negotiations.
• India needs to work on various reforms
and policies to prepare the economy for
facing international competition. This
can be done by Reforming Labor laws,
Easing land acquisition and Bridging
Infrastructure deficit etc.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) With reference to Trade - Related
Investment Measures (TRIMS), which of
the following statements is/are correct?
1. Quantitative restrictions on imports by
foreign investors are prohibited.
2. They apply to investment measures
related to trade in both goods and
services.
3. They are not concerned with the
regulation of foreign investment.
Select the correct answer using the code
given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans. (c)
• Explanation: Statement 1 correct: The
TRIMs Agreement prohibits certain types
of measures that violate the national
treatment (Article III) and quantitative
 restrictions requirements (Article XI) of the
General Agreement on Tariffs and Trade
(GATT) 1994. The list of TRIMs decided
to be inconsistent with these articles
comprises measures which involve:
» Certain levels of local procurement by an
enterprise (“local content requirements”)
» Restrict the value and volume of imports
such an enterprise can purchase.
• Statement 2 is not correct: Under
the Agreement on Trade - Related
Investment Measures of the World
Trade Organization (WTO), members of
WTO have decided not to apply certain
investment measures with respect to
295
trade in goods that distort or restrict
trade. (TRIMs is a multilateral agreement
on trade in goods, and not services).
• Statement 3 is correct: TRIMs Agreement
stipulates that certain types of measures
accepted by Governments to regulate
and control FDI can cause trade-
restrictive and distorting effects. But this
agreement is only concerned with the
trade effects of investment measures. It is
not expected to deal with the regulation
of investment as such and does not
affect directly on WTO members’ ability
to regulate and place restrictions upon
the entry and establishment of foreign
investment.
 CHAPTER - 16
AGRICULTURE AND FOOD MANAGEMENTS
Regardless of whether it is pre-
independence or post-independence,
agriculture remains the most important
field of the Indian economy. The vast
number of people who depend on it for
their survival, demonstrates this point
emphatically.
Situation of
Agriculture in India
• Agriculture plays a vital role in India’s
economy. Around 54.6% of the total
Item
2014-15 2015-16
GVA in Agriculture
20,93,612 22,27,533
and Allied Sectors
Percent to total
18.2% 17.7%
GVA
I M A G E 16.1: S H A R E
• There has been a continuous decline in
the share of agriculture and allied sectors
in the total GVA of the country from 18.2
percent in 2014-15 to 16.5 percent in
2019-20. A decline in share of agriculture
and allied sectors in GVA is an expected
outcome in a fast growing and structurally
changing economy.
• According to the Fourth Advance
Estimates for 2018-19, total food grain
production in the country is estimated
at 284.95 million tonnes which is higher
by 19.20 million tonnes than the previous
296
workforce in the country is engaged in
agricultural and allied sector activities
(Census 2011) and accounts for 16.5% of
the country’s Gross Value Added (GVA)
for the year 2019-20 (at current prices).
• According to the Land Use Statistics 2014-
15, the country's total geographical area
is 328.7 million hectares, with 140.1 million
hectares of reported net sown area and
198.4 million hectares of gross cultivated
area at 142 percent cropping rate. The
net sown area accounts for 43% of the
total geographical area. There are 68.4
million hectares of net irrigated land.
(Rs. in Crore)
Years
2016-17 2017-18 2018-19** 2019-20***
24,96,358 26,70,147 27,75,852 30,47,187
17.9% 17.2% 16.1% 16.5%
OF A G R I C U LT U R E IN GVA
five years’ (2013-14 to 2017-18) average
production of food grain.
• Total production of rice during 2018- 19
is estimated at a record 116.42 million
tonnes. Production of rice has raised by
3.66 million tonnes as compared to the
production of 112.76 million tonnes during
2017-18.
• Production of wheat, estimated at a
record 102.19 million tonnes, is higher
by 2.32 million tonnes as compared to
wheat production of 99.87 million tonnes
achieved during 2017-18.
• Entire oilseeds production in the country
during 2018-19 is estimated at 32.26 million
tonnes which is higher than the production
of 31.46 million tonnes during 2017-18.

Crops Area (Lakh hectare) Production (Million Tonnes) Yield (kg/hectare)

2016-17 2017-18 2018-19* 2016-17 2017-18* 2018-19* 2016-17 2017-18 2018-19*

Rice 439.9 437.7 437.9 109.7 112.8 116.4 2494 2576 2659

Wheat 307.9 296.5 291.4 98.5 99.9 102.2 3200 3368 3507

Nutri/Coarse
250.1 242.9 219.8 43.8 47.0 42.9 1750 1934 1954
cereals

Pulses 294.5 298.1 290.3 23.1 25.4 23.4 786 853 806

Food-grains 1292.3 1275.2 1239.4 275.1 285.0 284.9 2129 2235 2299

Oilseeds 261.8 245.1 255.0 31.3 31.5 32.3 1195 1284 1265

Sugarcane 44.4 47.4 51.1 306.1 379.9 400.2 69001 80198 78248

Cotton 108.3 125.9 126.6 32.6 32.8 28.7 512 443 386

Jute & Mesta 7.6 7.4 7.3 10.9 10.0 9.8 2585 2435 2403

I M A G E 16.2: A G R I C U LT U R E P R O D U C T I O N & Y I E L D

• Animal Rearing − The entire Livestock population is

» Animal rearing consists of rearing of
cows, buffaloes, goats, camels, pigs,
ships, etc., besides directly supporting to
the national income and socio-economic
development of the country.
» Some of the major significance: It is more
inclusive in nature, improve family income
and produces gainful employment in
the rural area, especially supports the
small and marginal farmers, landless
labourers and women and delivers cheap
nutritional food etc.
» The livestock sector alone contributes
close to around 25.6% of value of output
at current prices of overall value of output
in agriculture, fishing & forestry sector.
» 20th Livestock Census Report (2019)
around 535.78 million in the country
indicating a growth of about 4.6%
over Livestock Census-2012.
− Overall Bovine population (Cattle,
Buffalo, Yak and Mithun) has displayed
an increase of around 1%.
» Livestock sector has expanded at
a compound annual growth rate of
around 7.9% during last five years.
Indian Government has launched a new
Central Sector Scheme “National Animal
Disease Control Programme (NADCP) for
control of Foot & Mouth Disease (FMD)
and Brucellosis”. This program envisages
complete control of FMD by 2025 with
vaccination and its eventual eradication
by 2030.

297
 CATTLE BUFFALOES SHEEP GOATS
199.07

192.49
190.90

148.88
140.54

135.17
109.85
108.70
105.34

74.26
71.56

65.07
2007 2012 2019
I M A G E 16.3: A N I M A L R E A R I N G IN INDIA

• Milk production: understand the cropping seasons of India.

• India continues to be the leading
producer of milk in the world.
• Milk production in the country was
Around 187.7 million tonnes in 2018-19
and registered a growth rate of about
6.5% over the previous year.
• The per capita availability of milk has
attained a level of 394 grams/day during
2018-19.
Cropping Seasons of
India
There are specific special terms used to
India has three major crop seasons.
• Kharif season: It is mainly grown during
the monsoon season and harvested
during the onset of monsoon. Main crops
of this season are rice, maize, jowar, bajra,
cotton, sesamum, groundnut, etc.
• Rabi season: It starts with the onset of
winter and harvested in the summers.
Main crops of this season are wheat,
barley, jowar, gram and oil seeds such as
linseed, rapeseed, etc.
• Zaid season: It refers to summer crops
and mainly includes fruits and vegetables.
Recently, some pulses have also been
grown during this season.

Cropping Season Major Crops Cultivated

Northern States Southern States

Kharif Rice, Cotton, Bajra, Rice, Maize, Ragi,

June-September Maize, Jowar, Tur Jowar, Groundnut
Rabi Wheat, Gram, Rapeseeds Rice, Maize, Ragi,
October-March and Mustard, Barley Groundnut, Jowar
Zaid Vegetables, Fruits, Rice, Vegetables,
April - June Fodder Fodder

298
Note:The terms ‘kharif’ and ‘rabi’ originate
from Arabic language where kharif means
autumn and rabi means spring.
Land Reforms in
India
The official stance and emphasis on land
reforms in India have been changing over
the time in wake of the emerging issues,
which may be seen in the following two
phases.
Phase-1
• This phase commenced just after
Independence. All economies were
agrarian until they were industrialized;
the only difference being the time span.
The first thing developed countries did
after developing political regimes was
to complete agrarian reforms in a time-
bound manner. Since land remains the
primary source of income for the majority
of people in an agrarian economy,
agrarian reforms that were successfully
implemented benefited the greatest
number of people, thus improving their
economic circumstances.
• At the time of independence, India
had inherited an inequitable agrarian
system and was a traditional agrarian
economy. Land reforms would be a
big plank of independent India, and
the Indian National Congress pledged
to implement them as part of the
agrarian reforms in 1935. Land reform
in India had three aims, similar to those
sought by other economies in the past:
Removing institutional discrepancies
of the agrarian structure inherited from
the past which obstructed increasing
agricultural production, such as, the size
of agricultural land, land ownership, land
inheritance, tenancy reforms, abolition of
intermediaries, introduction of modern
institutional factors to agriculture, etc.
299
» The other objective of the land reforms
in India was related to the issue of socio-
economic inequality in the country.
The high inequality in land ownership
not only had a negative impact on the
economy; but it was badly intertwined
with the caste system in India and the
social respect and status, by the society
at large.
− The agrarian system, which had
inequitable ownership of the
commodity, i.e., land to gain money,
was inherited by more than 80% of the
population. On rational grounds and
with a public welfare approach, the
government decided to restructure
land ownership in the economy.
− As it attempted to abolish the
country's age-old agrarian system,
the aim of land reforms drew a lot of
socio-political attention. It became
such a contentious issue in India that
land reforms were dubbed a "poor
name," with the government seizing
land and allotting it to the landless
masses.
» The third objective of land reforms
in India was highly contemporary in
nature, which did not get enough socio-
political attention—it was the objective
of increasing agricultural production for
solving the inter-related problems of
poverty, malnutrition and food insecurity.
To realize the purposes of land reforms, the
government took three main steps which
had many internal sub-steps:
• Abolition of Intermediaries: Under this
step, the age-old exploitative land tenure
systems of the Zamindari, Mahalwari and
Ryotwari were fully abolished.
• Tenancy Reforms: Under this broader step,
three inter-related reforms protecting the
land-tenants were affected.
» Security of tenure so that a sharecropper
can feel secure about his future income
and economic security.
» Ownership rights to tenants so the
landless masses (i.e., the tenants, the
sharecroppers) can get the final rights to
the land they plough, “land to the tillers”.
• Reorganization of Agriculture: This step
had many interconnected and logical
provisions in the direction of rational
agrarian reforms:
» Redistribution of land among the landless
poor masses following the promulgation
of timely ceiling laws—the move failed
miserably with a few exceptions, such
as West Bengal, Kerala, and a portion of
Andhra Pradesh.
» Consolidation of land could only be
succeeded in the Green Revolution
regions.
» Cooperative farming, which had a high
socio-economic moral base, was only
used by the big farmers to save their
lands from the draconian ceiling laws.
Reasons for the
Failure of Land
Reform:
The whole attempt of land reforms in India
is considered a big failure by majority of
experts. Many consider the issue of land
reforms in India as the most complex
socio-economic problem of human history.
Out of the many reasons forwarded by the
experts responsible for the failure of the
land reforms in India, the following three
could be considered the most important
ones:
• Land in India is considered a symbol of
social prestige, status and identity unlike
the other economies which succeeded
in their land reform programmes, where
it is seen as just an economic asset for
income earning.
• Lack of political will, which was required
to affect land reforms and make it a
300
successful programme.
• Rampant corruption in public life, political
hypocrisy, and leadership failure in the
Indian democratic system.
Discouraging Achievements of Land
Reforms:
• Tenancy reforms provided tenants
with rights, but only on 4 per cent of
the total operated areas in the country
(14.4 million hectares of operated area
by 11 million tenants by 1992).
• Redistribution of ownership rights of
land took place, but only up to 2 per
cent of the total operated area in the
country (less than 2 million hectares
among the 4.76 million people by
1992).
• Taken together, the whole process
of land reforms could benefit only
6 per cent of the operated area of
the country with a negligible socio-
economic positive impact.
PHASE 2
The second phase of land reforms can be
traced to the process of economic reforms.
Economic reforms exposed the economy
to the new and emerging realities, such as,
land acquisition and leasing, food-related
issues and the agricultural provisions of
the World Trade Organization (WTO). We
see a shift (Economic Survey 2012–13) in
the thinking of the Government of India
towards the issue of land reforms—a clear
three step policy appears to be emerging:
• Mapping land carefully and assigning
conclusive title,
• Devising a fair but speedy process of
land acquisition, and
• Putting in place a transparent and
effective land leasing policy.
Finer points of this phase can be summed
up in the following way:
• Leasing seemed to be a better choice
in face of farmer’s opposition seen in
recent times in different states towards
attempt at land acquisition. Again, if the
country needs to attract investment from
the organized private sector (domestic
or foreign), land leasing seems a better
option than land acquisition.
• Corporate farming has not taken place
in the country in a big scale, especially
in the areas of food grains production,
which India needs to ensure food security
and compete in the global grain market,
in particular, and the agri-market in
general. This has become even more
important in the wake of the Right to
Food given to a large segment of the
population.
• Giving primacy to ‘leasing’ will solve
several problems:
» It will keep land ownership in the hands
of the existing farmers;
» It will prevent mass landlessness and
unemployment among the farmers;
» Farmers will get a permanent source of
income (in the meantime, they might be
imparted skills and be provided better
employment in industries) and
» It will make land easily available for use
of public and private purposes.
• The recent emphasis on the promotion
of the ‘manufacturing sector’ and ‘smart
cities’ are hugely dependent on smoother
and speedier process of land acquisition.
Without expanding the industrial sector
to its optimum levels, the agriculture
sector can emerge as a remunerative
profession—the country needs to migrate
the extra labour force of the agriculture
sector to industry, smoothly.
• The issue of land acquisition is to establish
a logical equation with ‘environmental
issue’, in order to make the process of
development sustainable.
301
Green Revolution
• It is the implementation of modern
agricultural methods that became known
as the Green Revolution (GR) in the early
1960s—first for wheat and then for rice
in the following decade. It revolutionized
the very conventional concept of food
production by increasing efficiency by
more than 250 percent.
• By the early 1960s, the Green Revolution
had centered on the use of the High
Yielding Variety (HYV) of seeds grown by
US agro-scientist Norman Borlaug while
conducting research in Mexico on a British
Rockfellor Foundation Scholarship.
• He said that the new wheat seeds he
produced in vitro increased productivity
by more than 200 percent. The seeds
had been successfully tested and were
being used by farmers in food-insecure
countries like Mexico and Taiwan by 1965.
Components of the Green
Revolution
The Green Revolution was built on the
timely and sufficient supply of many
inputs/components. A brief review on the
Green Revolution is given below:
The HYV Seeds
» These seeds were popularly termed as
the ‘dwarf’ variety of seeds. With the
help of repeated mutations, Mr. Norman
Borlaug had been able to develop a seed
which was raised in its nature of nutrients
supplied to the different parts of the
wheat plant— against the leaves, stem
and in favour of the grain.
• This caused the plant to become dwarfed
and the grain to become heavier,
resulting in a high yield. These seeds were
non-photosynthetic, which meant they
 weren't reliant on sunlight to produce the
desired results.
Chemical Fertilizers
• The seeds were meant to improve
productivity if they got enough nutrients
from the soil. Traditional compost does
not provide the amount of nutrients they
need because it has a low concentration
of nutrients and requires a larger area for
sowing, which means it will be shared by
more than one seed. As a result, high-
concentration fertilizers were needed,
which could only be applied to the
targeted seed—the only alternative was
chemical fertilizers such as urea (N),
phosphate (P), and potash (K).
Irrigation
• Controlled means of water supply was
needed for controlled crop growth and
adequate fertilizer dilution. It imposed
two major requirements: first, the region
of such crops must be free of floods, and
second, an artificial water source must
be built.
Chemical Pesticides and Ger-
micides
• Since the new seeds were less accustomed
to local pests, germs, and diseases
than the existing indigenous varieties,
pesticides and germicides became
important for achieving desired results
and yield protection.
Credit, Storage, Marketing/
Distribution
• In order for farmers to be able to use
the Green Revolution's new and more
expensive inputs, they needed simple and
affordable credit. Since the farmlands
302
suitable for this new type of farming
were area-specific (Haryana, Punjab,
and western Uttar Pradesh were the only
ones in India), the harvested crops had to
be stored in the region before they were
dispersed throughout the country.
• Again, the countries which went for Green
Revolution were food-deficient and
needed the new yield to be distributed
throughout the country and a proper
chain of marketing, distribution and
transport connectivity was necessary.
All these peripheral infrastructures were
developed by the countries going for
the Green Revolution with softer loans
coming from the World Bank—India
being the biggest beneficiary.
Some important outcomes of GR
• One of the most important impacts of
Green Revolution (GR) was on raising
the production and productivity of
cereal crops, especially wheat and
rice.
• After the implementation of the
Green Revolution, total food grains
production reached to 284.95 million
tonnes in 2018-19 from merely 82
million tonnes in 1960-61 (GOI, 2019)
thereby recording 3.5 times increase
in food grains in last seven decades.
• Economic empowerment of farmers
with increase in production of
food grains and other agricultural
commodities, incomes of farmers had
also increased.
• Reduced India’s dependence on other
countries for supply of food grains
and other agricultural commodities.
• The commercial crops like sugarcane,
cotton, jute, oilseeds also achieved a
significant increase in its production,
relatively later than food grains. Since
1960-61 sugarcane production has
been increased more than 3.5 times
while cotton production recorded
about 5 times increase.

Negative Impact
of the Green
Revolution
The Green Revolution had its positive and
negative socio-economic and ecological
impacts on the countries around the world.
• Socio-Economic Impact
» Food production grew to the point that
many countries became self-sufficient in
food (wheat in the 1960s, rice in the 1970s)
and some also became food exporting
countries (self-sufficiency in food must
not be confused with food security).
» However, the difference in farmers'
income increased inter-personal as
well as inter-regional differences and
inequalities in India.
» It is large farmers, who owned 10 hectares
or more land, who were benefitted the
most from the Green Revolution as they
had financial resources to buy better
seeds, fertilizers, and other required
inputs. Small and marginal farmers could
not get much benefits resulting in rise of
socio-economic disparities.
» Negative consequences included a rise
in malaria cases due to water-logging, a
change in balanced cropping patterns in
favour of wheat and rice, driving pulses,
oilseeds, corn, and barley to the margins,
and so on.
• Ecological Impact
» The Green Revolution's (GR) most
damaging negative effect was on
the climate. When the newspapers,
academics, scientists, and
environmentalists raised concerns about
it, neither the governments nor the
general public (let alone the farmers in
the GR area, who were not educated
enough to understand the GR's side
effects) were persuaded.
303
» But a time arose when the government
and other government agencies started
doing studies and surveys focused
around the ecological and environmental
problems.
− The following are the most important
amongst them:
− Degraded soil fertility: It was as a
result of farmers' repeated cropping
patterns, as well as overexploitation
of the land; lack of a suitable crop
combination and crop intensity, etc.
− Water table on the verge of
collapsing: Since the new HYV seeds
required a disproportionately large
amount of water for irrigation—5
tonnes of water were required to
produce 1 kg of rice—the new HYV
seeds were introduced.
• Environmental Degradation:
» Pesticides and herbicides have degraded
the atmosphere by increasing pollution
levels in soil, water, and air as a result of
improper and unregulated use of chemical
fertilizers, pesticides, and herbicides. It
is largely due to deforestation and the
expansion of agriculture in ecologically
sensitive areas in India.
» Green Revolution heartland like Punjab
and Haryana are almost devoid of forest
cover with around 3% of forest area in
both while UP is having slightly more
than 5% area under forest as forests
have been cleared to bring more lands
under cultivation.
• Toxic level in food chain: The toxic level in
India's food chain has risen to the point that
nothing created in the country is suitable
for human consumption. Essentially,
unrestricted usage of chemical pesticides
and weedicides, as well as their industrial
development, had contaminated the soil,
water, and air to such an alarming degree
that the entire food chain has become a
victim of high toxicity.
Second Green Revolution
• To see the negative impact of Green Revolution, new agriculture policy was
launched which aims at sustainable agriculture. It is popularly known as ‘second
Green Revolution’ or ‘EverGreen Revolution’.
• The Government, from time to time, also launched many other kind of programs in
furtherance of Second Green Revolution For example, “Bringing Green Revolution in
Eastern India” (BGREI) program in 2010-11 as a sub scheme of Rashtriya Krishi Vikas
Yojana.
• BGREI program was launched with aim of enhancing agricultural production in
seven states of Eastern India - Jharkhand, Odisha, West Bengal, Assam, Bihar,
Chhattisgarh, and eastern Uttar Pradesh.
• Recently, PM of India has also spoken about bringing Second Green Revolution to
India.
• Almost entire current policy of government can be covered under the category
of second Green Revolution. It aims at R&D, biotechnology revolution, information
technology revolution, biotechnology revolution, R&D and targeting of specific
crops etc.
• Some of the important government schemes aiming towards second Green
Revolution are Pradhan Mantri Krishi Sinchayee Yojana, National Mission for
Sustainable Agriculture, Paramparagat Krishi Vikas Yojana (PKVY), Rashtriya Krishi
Vikas Yojna and Soil Health Card.

Food Management season for specific crops. If the Market

• Since independence, the government
has made managing enough food in the
domestic market a top priority. When the
country entered the WTO, a new need
emerged for generating surplus and
competing with the rest of the world, so
that the agricultural sector could benefit
from globalization as well. The challenges
of food management in the country are
discussed in this segment.
• Minimum Support Price (MSP)
» The Minimum Support Price (MSP) is
a method of market intervention used
by the Indian government to protect
agricultural producers from a sharp
drop in farm prices by providing a
guaranteed price to keep farmers from
having to sell their land. On the basis of
the Commission for Agricultural Costs
and Prices' recommendations, MSPs are
announced at the start of the sowing
Price for the commodity falls below the
announced minimum price due to bumper
production and market glut, government
agencies purchase the entire quantity
offered by the farmers at the announced
minimum price.
» The MSPs are fixed at incentive level, to
fulfil the following purposes:
− To induce more investment by farmers
in the farm sector,
− To motivate farmers to adopt improved
crop production technologies, and
− To enhance production and thereby
farmers income.
• The Market Intervention Scheme (MIS)
• The Market Intervention Scheme (MIS)
is similar to the Minimum Support Price
(MSP), which is introduced at the request
of state governments for the procurement
of perishable and horticultural goods
when Market Prices decline. The scheme

304
 is implemented when there is a 10% rise
in demand or a 10% decrease in ruling
rates over the previous normal year.
The MIS proposal is accepted based
on a particular request from state/UT
governments, if the states/UTs are willing
to bear a 50% loss (or 25% in the case of
North-Eastern states) in the event of its
implementation.
• Procurement Prices
» The Indian government declared a
‘procurement price' for wheat in 1966–67,
which was marginally higher than the
MSP (the purpose being security of food
procurement for requirement of the PDS).
» The MSP was announced before
sowing, and the procurement price was
announced before harvesting, with the
intention of motivating farmers to sell a
little more and grow a little more. However,
this increased price was insufficient to
act as a reasonable incentive for farmers.
» It would have been preferable if it had
been revealed prior to sowing rather than
after harvesting. As a result, since fiscal
year 1968–69, the government has only
declared the MSP, which is also known as
the successful procurement price.
• Issue Price
» The price at which the government
allows offtake of food grains from the FCI
(the price at which the FCI sells its food
grains). The FCI has been fetching huge
losses in the form of food subsidies.
» The food grains procured are transported
to the godowns of the FCI located
across the country (counted in the buffer
stock). From here they head to the sale
counters—to the TPDS or Open Market
Sale.
» The transportation, storage, the cost
of maintaining the FCI carriage losses,
etc., make the food grains costlier (the
additional expenses other than the MSP
is known as the ‘economic cost of food
305
grains’.
» To make the food grains affordable to
the consumers, the issue prices for food
grains are set lower than the total cost of
procurement and distribution—the gap
converts into the ‘food subsidy'.
• Buffer stock
» India has a policy of keeping a minimum
inventory of food grains (only wheat and
rice) to ensure that food is available at
reasonable prices in the country all year.
The key supply from here goes to the
TPDS (the PDS was restructured in 1997
as the Targeted PDS) and, on occasion,
to the Open Market Selling to review
rising rates.
» The Buffer Stocking norms (of 2005) are
revised in the backdrop of increased
requirement of food grains to run the
TPDS in the last few years and with the
coming into force of the National Food
Security Act (NFSA).
Farm Subsidies
• Subsidies to farmers are an important
part of the government's budget.
Agricultural or farm subsidies account for
approximately 40% of overall budgetary
expenditure in developed countries, but
they are much lower (around 7.8% of
GDP) and of a different type in India.
• Direct farm subsidies: These are the
types of subsidies that pay farmers
direct cash benefits in order to make
their goods more competitive in global
markets. Agriculture, farm, and fisheries
subsidies account for a significant portion
of the annual budgets of developing
countries (the United States and Europe).
Direct farm subsidies are advantageous
because they provide the farmer with the
requisite buying power and can greatly
increase the rural poor's standard of
living. They also aid in preventing the
 misappropriation of public funds by
assisting in the proper identification of
beneficiaries.
Issues related to Direct Subsidies:
• Cash can be mismanaged by the
cultivators and diverted to non- farm
requirements.
• Lack of awareness amongst the
cultivators can hamper the overall
growth in agriculture.
• Cultivators will be open to the volatile
market structure and can be conned
by the middle man in the procedure.
• Indirect farm subsidies: These farm
subsidies include lower credit rates,
farm loan forgiveness, reduced irrigation
and electricity bills, fertilizer, seed, and
pesticide subsidies, as well as investments
in agricultural research, environmental
assistance, and farmer training, among
other things. These subsidies are also
provided to increase the competitiveness
of farm products on the global market.
Issues related to Indirect Subsidies:
• It can lead to crop centric cultivation
with distorted cropping pattern.
• Mostly not very successful in reaching
the target beneficiaries due to the
various loopholes such as corruption
and identification etc.
• Can be misused for political gains
during elections.
• Can lead to regional disparity and
sometimes biased towards large farm
holders.
• Exploitation of natural resources such
as ground water.
• The subsidies provided on the fertilizers as
‘input’ subsidies are in the form of indirect
subsidies. But if the government does not
incentivize the farmer by an effective
cost reduction in prices of the fertilizers,
but provides direct cash incentives after
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the produce, that is known as a direct
subsidy.
• The World Trade Organization (WTO)
has set some limits on the amount
of direct and indirect subsidies that
developing and developed countries can
provide because these subsidies distort
free market forces, which have their own
consequences.
WTO and
Agricultural
subsidies (AMS)
• The WTO refers to government subsidies
to the agricultural sector (i.e., domestic
support) as Aggregate Measure of
Support (AMS).
• It is measured in terms of subsidies for
both goods and inputs. The WTO believes
that product subsidies such as minimum
support rates and non-product subsidies
such as credit, fertilizers, irrigation,
and electricity would minimize farming
production costs and give such countries
an unfair advantage in their access to
the global market. Such subsidies are
referred to as "distortions" in world trade.
• Such subsidies are not permitted in one
sense because they are subject to a de
minimis limit set by the provisions, which
is 5% and 10% of total agricultural output
in developed and developing countries,
respectively.
The Boxes: In WTO terminology,
agricultural subsidies have been identified
by ‘boxes' that have been given the colours
of traffic lights—green (means permitted),
amber (means to be reduced), and red
(means to be eliminated/forbidden).
• Amber box
» All subsidies which are supposed to
 distort production and trade fall into the
amber box, i.e., all agricultural subsidies
except those which fall into the blue and
green boxes.
» These policies include minimum support
prices (also known as MSP in India) for
agricultural goods, as well as any other
assistance specifically related to output
quantities (as power, fertilizers, pesticides,
irrigation, etc.).
» Under the WTO provisions, these subsidies
are subject to reduction commitment to
their minimum level—to 5 per cent and
10 per cent 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 or green
box) must be reduced by the countries to
the prescribed levels.
» In the existing negotiations, various
proposals deal with issues like deciding
the amount by which such subsidies
should be reduced further, and whether
to set product-specific subsidies or to
continue with the present practice of the
‘aggregate’ method.
• Blue Box
» This is the amber box with strings
attached. The parameters are set up in
such a way that distortions are minimized.
Any subsidy that would usually be in the
amber box is moved to the blue box if it
allows farmers to achieve a certain level
of output. These subsidies are simply
such direct payments (i.e., direct set-
aside payments) provided to farmers by
the government as part of assistance
programmes to promote agriculture,
rural growth, and other activities.
» At present there are no limits on spending
on subsidies in the blue box. In the
current discussions, some nations want
to keep blue box as it is because they
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see it as a crucial means of moving away
from distorting the amber box subsidies
without causing too much hardship.
» Others want to set limits or reduction
commitments on it while some advocate
moving these subsidies into the amber
box.
• Green Box
» Agricultural subsidies that cause limited
to no trade distortions are placed in the
green box. They must not have any kind
of price support.
» This box essentially covers all government
expenditures that aren't aimed at a
specific commodity, as well as all direct
income support programmes for farmers
that aren't tied to current production or
price levels.
» This is a wide category that encompasses
all government subsidies, such as public
food storage, pest and disease control,
research and extension, and some direct
payments to farmers that do not stimulate
production, such as agricultural reform,
environmental conservation, regional
growth, crop and income insurance, and
so on.
» The green box subsidies are allowed
without limits, provided they comply with
the policy specific criteria. It means, this
box is exempted 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’.
Food Security
• By the late 1980s, India had achieved
food self-sufficiency, though food security
remained a concern. Food protection
refers to the availability of food at
reasonable prices to all people at all
times and without interruption. Though
 India’s GDP growth has been impressive
and the agricultural production has also
increased over the past few decades,
hunger and starvation still persist among
the poorer sections of the population.
Two vital things need consideration
regarding India’s food security:
• Enhancing its food production
• Strengthening supply chain
Because of the high rate of malnutrition
and the volatility of agricultural prices,
India has one of the most extensive food
security programmes in the world.
• There are entitlement feeding
programmes such as the Integrated
Child Development Scheme (ICDS: which
includes all children under the age of six,
pregnant women, and nursing mothers).
• Mid-Day Meal Schemes (MDMS),
• Food security is ensured by food subsidy
programmes such as the Targeted
Public Distribution System (through
which the National Food Security Act
is implemented), Annapurna (10 kgs of
free food grain for destitute poor), and
job programmes such as the Mahatma
Gandhi National Rural Employment
Guarantee Scheme (100 days of
employment at minimum wages).
PDS & Food Subsidy
• The Public Distribution System (PDS,
which was renamed Targeted PDS in
1997) aims to ensure food security by
distributing food grains to the BPL
population on a timely and affordable
basis, as this group cannot afford to pay
Market Prices for their food.
• This includes the government's
procurement of food grain at MSP, the
building up and maintenance of food
stocks, their preservation, and timely
308
distribution, making food grains available
to the disadvantaged sections of the
population at fair prices.
Despite enhanced availability in the
PDS and high inflation in Food grains,
dependence on the PDS is reducing. This
could be only due to two reasons:
• Food grains are not made available
timely by the PDS, and/or
• Quality of the PDS food grains are inferior
in comparison to their counterparts in the
open market.
There are certain anomalies in India’s food
management under the PDS which need
immediate attention:
• The percentage distribution of the
economic cost of wheat and rice has been
rising fast. The pooled cost of food grains
(MSP plus the Bonus which are offered
by the individual states) accounts for two
thirds of the economic cost of wheat and
rice. This has made the economic cost of
food grains to the Food Corporation of
India (FCI) increase over the years.
• Increasing costs of labour, fertilizers,
pesticides and other inputs have made
production of crops costlier over the
time. This forced the government to keep
on increasing the MSPs of the crops, too.
• Over the time, several discrepancies
seeped into the PDS, such as,
» High operation costs,
» High levels of leakages,
» High administrative costs,
» Corruption, and
» Mismanagement.
• According to the assessment of an expert
group established in 2009, PDS suffers
from nearly around 61 percent error of
exclusion and 25 percent inclusion of
beneficiaries, i.e. the misclassification of
the poor as non-poor people and vice
versa.
• Subsidies created some other problems
too. Firstly, subsidies brought distortions
in the market, which hamper the
domestic as well as the external interests
and secondly, caused a heavy drain on
the government exchequer. PDS poses
even higher challenge when domestic or
international prices are on the rise and
the government is forced to raise the
MSPs of crops.

Suggestions of Shanta Kumar Committee:

• Decrease the number of beneficiaries under the Food Security Act—from the
current 67% to 40%.
• Permit private companies or organizations to procure and store food grains.
• Stop bonuses on MSP given by states to cultivators and implement cash transfer
system so that food subsidy and MSP amounts can be directly assigned to the
cultivators account and food security beneficiaries.
• Food Corporation of India should involve itself in full-fledged grains procurement
only in those states which are poor in procurement process. In the case of those
states which are doing well, such as Haryana, Punjab, Chhattisgarh, Madhya
Pradesh, Andhra Pradesh, and Odisha, the states should do the procurement.
• Abolishing levy rice: Under levy rice policy, government purchases certain percentage
of rice (differs from 25 to 75 % in states) from the mills compulsorily, which is called
levy rice. Mills are permitted to sell only the remainder quantity in the open market.
• Deregulate fertilizer sector and give cash fertilizer subsidy of Rs. 7,000 per hectare
to cultivators.
• Outsource of stocking of grains: This committee calls for establishment of negotiable
warehouse receipt (NWR) system. In the new system, cultivators can deposit their
produce in these registered warehouses and get 80 % of the advance from bank
against their produce based on MSP.
• Clear and transparent liquidation strategy for buffer stock: Food Corporation of
India should be provided greater flexibility in doing business; it should offload extra
stock in open market or export, as per need.

» It will cover up to 75 per cent rural and

National Food 50 per cent urban population (around

Security Act two thirds of the total population) with

• The law was enacted by the Parliament
in December 2013, the Parliament had
passed the motion. It was a landmark
move to ensure food and nutritional
stability in India. It is India's most
ambitious and largest social welfare
programme which offers legal rights to
around 82 crore people for subsidized
food grains. The following are the
program's major highlights:
uniform entitlement of 5 kg food-grains
per month at highly subsidized prices of
Rs. 3, Rs. 2 and Rs. 1 per kg for rice, wheat
and coarse grains, respectively. The
poorest of poor households continue to
receive 35 kg food grains per household
per month under the Antyodaya Anna
Yojna at the same subsidized prices.
» It provides for a special emphasis on
nutritional support for women and
children, with pregnant women and
lactating mothers receiving a maternal

309
 bonus of at least Rs. 6,000 in addition
to receiving healthy meals as per the
prescribed nutritional norms. Children
aged 6 months to 14 years will be able to
take home rations or hot cooked food in
accordance with dietary guidelines.
» For the purpose of issuing ration cards, the
eldest woman of eighteen years of age or
older will be the head of the household;
if she is not present, the eldest male
member will be the head of the household.
The Act also includes provisions for PDS
reforms such as doorstep delivery of
food grains, the use of information and
communication technology (ICT) such
as end-to-end computerization, the use
of ‘Aadhaar' for beneficiary recognition,
and the diversification of commodities
under the TPDS, among other things.
» The Act establishes a redress process
at the state and district levels, with
appointed officers. States will be able
to use existing machinery for District
Grievance Redressal Officers (DGROs)
and State Food Commissions if they
want to avoid spending money on a new
redressal system.
» It also provides for penalty on public
servants or authority, if found guilty
of failing to comply with the relief
recommended by the DGRO.
• To guarantee transparency and
accountability, provisions have been
made for the publication of PDS data,
social audits, and the formation of
Vigilance Committees.
Agricultural
Marketing
• Agricultural marketing can be defined
as the commercial functions involved
in transferring agricultural products
consisting of farm, horticultural and
other allied products from producer to
310
consumer.
• It includes all activities involved in
moving agricultural produce through
time (storage), space (transport), form
(processing) and transferring ownership
at various levels of marketing channels.
Under its present form, agricultural
marketing in India is not uniform. There
is considerable regional variation in
methods of marketing. These processes
can be divided into three categories:
» Traditional Marketing Methods: This
generally start with sale by farmer and
involve many intermediaries at different
levels from rural markets to terminal
markets. Close to 50% of the agricultural
produce in India is sold via these channels.
» Cooperative based marketing: In this
method, agri-products are directly
purchased from farmers through
marketing network of NAFED (National
Agricultural Cooperative Marketing
Federation of India Limited), thus
eliminating middlemen.
− Over the course of time, there have
been numerous successful cooperative
marketing models like Anand Pattern
Cooperatives (APC), Chicory contract
farming coordination in Jamnagar,
Gujarat and Kerala Horticulture
Development Program (KHDP).
» Emerging models of agricultural
marketing: With the emergence of new
inputs and technologies in the market,
several innovative marketing methods
have evolved over the time, like
− National Agriculture Market
(e-NAM): It is a pan-India electronic
trading portal which networks the
existing APMC mandis to create a
unified national market for different
agricultural commodities.
− Commodity and Futures markets: To
create exchanges and trading options
to assist and better price discovery for
 farmers. E.g. National Spot Exchange
Limited (NSEL).
− Private sector initiatives: Several start-
ups and businesses created innovative
pilot solutions for agricultural
markets. For example, Indian Tobacco
Company’s e-choupal.
− Apart from these, there are some
other methodologies like Farmer
Producer Organizations (FPOs) and
Contract Farming.

Agricultural Produce Market Committee (APMC)

Agricultural Produce Market Committee (APMC) is a statutory market committee
constituted by a State Government in respect of trade in certain notified agricultural or
horticultural or livestock products, under the Agricultural Produce Market Committee
Act issued by that state government.
APMCs are intended to be responsible for:
• Ensuring transparency in pricing system and transactions taking place in market
area;
• Providing market-led extension services to farmers;
• Ensuring payment for agricultural produce sold by farmers on the same day;
• Promoting agricultural processing including activities for value addition in
agricultural produce;
• Publicizing data on arrivals and rates of agricultural produce brought into the
market area for sale; and
• Setup and promote public private partnership in the management of agricultural
markets
Since the State APMC Acts created fragment markets for agricultural commodities
and curtailed the freedom of farmers to sell their produce other than through the
commission agents and other functionaries licensed by the APMCs, the Ministry of
Agriculture (GoI) developed a Model APMC Act, 2003 and has been pursuing the state
governments to modify their respective Acts along its line.
The Model APMC Act provides the following new things:
• Direct sale of farm produce by the farmer to contract farming sponsors;
• Setting up ‘special markets’ for ‘specified agricultural commodities’— mostly
perishables;
• Permits private persons, farmers and consumers to establish new markets for
agricultural produce in any area;
• A single levy of market fee on the sale of notified agricultural commodities in any
market area;
• Replaces licensing with registrations of market functionaries, which would allow
them to operate in one or more different market areas;
• Establishment of consumers’ and farmers’ markets to facilitate direct sale of
agricultural produce to consumers;
• Creation of marketing infrastructure from the revenue earned by the APMCs;

311
• Provides some freedom to the farmers to sell their produce directly to the contract
sponsors or in the market set up by private individuals, consumers or producers;
• Increases the competitiveness of the market of agri-produce by allowing common
registration of market intermediaries.
Different issues faced by these
markets
• Institutional difficulties like licensing
barriers for owning a shop or godowns,
very high incidence of market charges (as
large as 15% in some cases) and absence
of standardized grading mechanism of
agricultural produce.
• Infrastructural difficulties like limited
access of Agricultural Produce Markets
in some areas in the country, faulty
Infrastructure in Agricultural Markets
(like Cold Storage facilities) and poor
economic viability of agricultural
infrastructure projects.
• Market information system issues like
absence of real time informational
channels creating lag in demand signals,
information to farmers is limited to major
commodities and poor awareness among
farmers regarding new channels of
information (like SMS based advisories).
• Issues related to APMCs
» As per the Economic Survey 2014–15, the
APMCs of the states levy multiples fees
of substantial magnitude which are non-
transparent and hence work as a source
of political power.
» They charge a market fee from buyers,
and they also charge a licensing fee from
the commissioning agents who mediate
between buyers and farmers.
» They also charge small licensing fees
from a whole range of functionaries
(warehousing agents, loading agents, etc.).
» In addition, commissioning agents
312
charge commission fees on transactions
between buyers and farmers.
» Even the model APMC Act treats the
APMC as an arm of the state and the
market fee, as the tax levied by the state,
rather than fee charged for providing
services. This is a crucial provision which
acts as a major impediment to creating
national common market in agricultural
commodities.
» Removal of this provision will pave the
way for creating competition and a
national common market for agricultural
commodities.
• Other issues:
» Limited public investment: Public
expenditure on agricultural marketing
sub-sector ranges 4-5 % of the total
public expenses on agriculture, while
expenditure on marketing infrastructure
development has been less than 1 %.
Recent Reform
The Government of India recently passed
three Acts with an aim to reform agriculture
in India
• The Farmers Produce Trade and
Commerce (Promotion and Facilitation)
Act, 2020
• The Farmers (Empowerment and
Protection) Agreement on Price
Assurance and Farm Service Act, 2020
• The Essential Commodities (Amendment)
Act, 2020.
THE FARMERS' PRODUCE levy for sale of agri-produce under the
new legislation.
TRADE AND COMMERCE
• The bill also includes a proposal for
(PROMOTION AND an electronic exchange in transaction
FACILITATION) ACT, 2020 network to ensure a smooth electronic
trade.
Main provisions:
• Farmers will be able to trade at farm gate,
• It will also promote barrier-free inter-state cold storage, warehouses, processing
and intra-state trade and commerce plants, and other locations, in addition to
beyond the physical premises of markets mandis.
notified under State Agricultural Produce
Marketing legislations. • Farmers will be able to participate in
direct selling, removing intermediaries
• Farmers will not be charged any cess or and achieving maximum price realization.

Clarification with respect to some doubt regarding the provision of the bill:
• Procurement at Minimum Support Price will continue, farmers can sell their produce
at MSP rates, the MSP for Rabi season would be announced soon.
• Mandis will not stop functioning, trading will continue here as before. Under the
new system, farmers will have the option to sell their produce at other places in
addition to the mandis.
• The e-NAM trading system will also continue in the mandis.
• Trading in farm produce will increase on electronic platforms. It will result in greater
transparency and time saving.

The Farmers (Empowerment the burden of market unpredictability

from the farmer to the sponsor. Farmers
and Protection) Agreement would be protected from Market Price
on Price Assurance and Farm fluctuations due to previous price
Service Act, 2020 determination.

Important provisions: • It will also give farmers access to new

• The new law would allow farmers to
compete on an equal footing with
processors, wholesalers, aggregators,
large retailers, exporters, and others.
Farmers get price guarantee right before
they plant their crops. Farmers will be
entitled to a higher selling price over and
above the minimum price in the event
of a higher Market Price. • It will shift
technology, better seed, and other
inputs, as well as lower marketing costs
and increase farm income.
• With specific deadlines for redress, an
effective dispute resolution process has
been established.
• Stimulus to research and new technology
in agriculture sector.

313
Clarification with respect to some doubt regarding the provision of the bill
• The farmer will have full power in the contract to fix a sale price of his choice for the
produce. They will receive payment within maximum 3 days.
• 10000 Farmer Producer organizations are being formed throughout the country.
These FPOs will bring together small farmers and work to ensure remunerative
pricing for farm produce.
• After signing contract, farmer will not have to seek out traders. The purchasing
consumer will pick up the produce directly from the farm
• In case of dispute, there will be no need to go to court repeatedly. There will be local
dispute redressal mechanism.

THE ESSENTIAL • The price rise will be determined based

COMMODITIES (AMENDMENT)
ACT, 2020
Important provisions of the bill:
• Food regulation: The Act stipulates that
the central government can only regulate
the supply of certain food products, such
as cereals, pulses, potatoes, onions,
edible oilseeds, and oils, in exceptional
circumstances. These include (i) war, (ii)
drought, (iii) unusual price increases, and
(iv) severe natural disasters.
• The Essential Commodities Act of
1955 gave the federal government the
authority to classify those commodities
as essential (such as food, fertilizers, and
petroleum products). The manufacture,
procurement, delivery, exchange, and
commerce of such vital commodities
may be controlled or prohibited by the
federal government.
• Stock limit: Any stock cap on agricultural
produce must be based on price
increases, according to the Act. Only if
the following conditions are met, will a
stock cap be imposed:
» A 100% increase in retail price of
horticultural produce; and
» A 50% increase in the retail price of non-
perishable agrarian food items.
on the price in effect for the previous 12
months, or the average retail price for the
previous five years, whichever is lower.
Issues related to the new reforms
• Against the Principle of Cooperative
federalism: The provisions of the new
reforms are viewed as against the spirit
of cooperative federalism enshrined in
the Indian Constitution, because matters
of trade and agriculture being the part
of subjects on the State list, have caused
resentment in many States.
• Farmers fear that the newly proposed
reforms will end the MSP regime. They
fear that promoting tax-free private
trade outside the APMC mandis will make
these notified markets unviable, which
could lead to a decline in government
procurement itself.
• Lack of statutory backing in the acts
for the MSP is a main point of concern,
particularly for cultivators from Haryana
and Punjab, where around 65% of wheat
(2019) is procured at MSP by the Food
Corporation of India (FCI) and state
agencies.
• Various mandis across the country
bring in revenue for the governments of
states. The deviation of agricultural trade
towards private mandis could lead to the

314
 loss of states’ incomes.
• The lack of ability of the small and
marginal cultivators to recognize the
terms of the contract may lead to the
exploitation of such farmers.
• Critics expect that the easing of
regulation of various food items would
lead to exporters, processors and traders
hoarding farm produce at the time of
harvest season, when prices are normally
lower, and releasing it later when prices
rise. This could damage food security.
Some suggestions and way forward
• Empowering State Farmers Commissions:
Rather than selecting for heavy
centralization, the focus should be on
empowering cultivators with the help of
State Farmers Commissions suggested
by the National Commission for Farmers,
to bring about a speedy government
response to issues.
• Develop better Agricultural Infrastructure
to Strengthen Competition: Government
should massively fund the expansion of
the APMC market system, make attempts
to remove trade cartels, and give farmers
good roads, logistics of scale and real
time information.
• Consensus Building: The Union
government should reach out to those
opposing the Bills, involving farmers,
explain to them the requirement for
reform, and get them on board.
Modernizing Agriculture
Present Situation:
• The current production levels of the
majority of crops are well below the
global average. Low irrigation, the use of
low-quality seeds, a lack of acceptance
of improved technologies, and a lack
of awareness about better agricultural
practices are the main causes. Water
stress affects nearly 53% of cropped
315
land. Rainwater management activities
and programmes are severely limited in
terms of resources. This limits a farmer's
ability to plant several crops at the same
time, resulting in wasteful land use.
• Ineffective extension delivery systems
have also resulted in large yield gaps. In
India, yield gaps exist on two levels. For
starters, there is a disconnect between
best scientific and best field practices.
The second divide is between the best
field practices and the average farmer's
practices.
• There exist significant yield gaps both
amongst and within states. Yield gaps
have been found to exist in even highly
productive states such as Punjab. Closing
these gaps provides an opportunity
to enhance productivity and incomes
significantly. This further implies that
states with low productivity (or large
yield gaps) have significant potential
for catch-up growth in their productivity
levels.
• Demand side factors favour the expansion
of area under fruits and vegetables, and
livestock products. These enterprises
also offer better income. Staple crops
(cereals, pulses and oilseeds) occupy 77
per cent of the total Gross Cropped Area
(GCA) but contribute only 41 per cent
to the output of the crop sector. High
Value Crops (HVCs) contribute an almost
similar amount to total output as staples
do, but they occupy only 19 per cent of
the GCA. Diversification into the fruits
and vegetables segment is also likely to
benefit small and medium farmers more
than large ones, according to research.
• New development initiatives intended
at modernizing agriculture have been
introduced in recent years. The Pradhan
Mantri Krishi Sinchai Yojana (PMKSY)
aims to increase irrigation coverage
while also encouraging efficient water
use. In the last four years, the area
under micro irrigation has increased
2.5 times. The Soil Health Card (SHC)
 scheme is currently in its second cycle,
which will focus on job creation and
entrepreneurship development through
local entrepreneurship models. In the
second cycle, 3.76 crore SHCs have been
distributed so far.
Important Objectives:
Increasing income and employment
by a paradigm shift that ensures food
security while maximizing value addition
in agriculture by modernizing agricultural
technology, increasing productivity,
efficiency, and crop diversification.
Constraints:
• The key cause of low crop and livestock
productivity is the use of obsolete and
ineffective technologies.
• Given the high proportion of small and
marginal farmers in Indian agriculture,
affordability becomes a major barrier to
farmers adopting new technology.
• There are many bottlenecks preventing
on-farm implementation of public-sector
technology.
• Agricultural research in the country is
constrained by resource inadequacy,
regulations, and intellectual property
rights (IPR).
• Farmers are confused by several private
and public outlets providing contradictory
details.
• There is a large gap between the demand
for and availability of agricultural skills,
preventing diversification, precision
agriculture adoption, and on-farm post-
harvest value addition.
• India has not caught up to the rest of the
world in terms of technology, resulting in
the dominance of inefficient development
methods at the farm level, such as flood
irrigation. To modernize agriculture in
India, a renewed emphasis on on-the-
ground absorption of technology, market
intelligence, skills and extension, and
316
modernizing trade and commerce in
agriculture is needed.
• Lack of sufficient capital affects both
production and marketing; low scale is a
severe constraint on the implementation
of improved practices both in the input
and export market.
Solution/Way Forward:
Productivity and efficiency
• Increase irrigation coverage: By 2022-
23.3, irrigation coverage must be
increased to 53% of gross cropped area
(GCA). Increased coverage by micro
irrigation should be the priority.
• Increase adoption of hybrid and
improved seeds: States must take the
lead through the following measures:
» Seed development plans that are
dynamic are needed. This could be
determined by crop area (each season
separately), seed rate per hectare used,
desired/targeted seed replacement rate,
and crop-specific seed requirements.
Crop-by-crop requirements should be
calculated based on historical patterns,
new variety introductions, and the
substitution of low-yielding varieties.
• Increase Variety Replacement Ratio
(VRR): To increase production, phase
out old seed varieties and replace them
with hybrid and improved seeds. Through
farmer participatory plant breeding
and farm varietal trials beginning in the
third year of seed production, the Indian
Council of Agricultural Research (ICAR)
and State Agricultural Universities (SAUs)
should grow climate resilient varieties of
crops suitable for the country's 128 agro-
climatic zones.
• Improve seed testing facilities: Both
staff and technological skills are required
to improve seed testing facilities. To
maintain the quality of test results, regular
performance monitoring is required.
• Reorient fertilizer subsidy policy: The
new asymmetric fertilizer subsidy policy
needs to put secondary and micro-
nutrients into the same nutrient-based
subsidy (NBS) network as phosphorus (P)
and potash (K).
• Control pesticide use: Align the pesticide
regulatory system with food safety laws to
ensure widespread adoption. Extension
activities should be strengthened to
ensure that best practices meet the
average farmer.
• Custom hiring centres: Madhya Pradesh's
custom hiring centre model has proven
to be effective in hastening the rate of
farm mechanization. This model, which
employs rural youth and encourages
entrepreneurship, should be replicated
throughout the country.
• Investment subsidies for micro-
irrigation: Rather than providing power
and water subsidies, the DBT mode can
be used to provide investment subsidies
for micro-irrigation.
• Liquid fertilizer subsidies: A targeted
subsidy on liquid fertilizers should be
given to promote fertigation with micro-
irrigation.
Strengthening extension systems
• Agriculture Technology Management
Agency (ATMA) and Krishi Vigyan
Kendras (KVKs) collaboration: To develop
Strategic Research Extension Plans, the
ATMA programme needs to be reoriented
to incorporate bottom-up preparation
at the district and block levels (SREP).
This program's success is contingent on
more decentralization and autonomy.
Subject matter specialists at KVKs can
use ATMA's block action plans to direct
their research.
• Public-private partnership in KVKs:
One of ATMA's guiding principles is to
promote PPP in extension delivery. KVKs
should incubate private sector projects
317
in extension delivery because each KVK
owns about 50 acres of land.
• Market-led extension: Prioritize
extension services that provide farmers
with information on (i) crop selection, (ii)
crop demand and supply, (iii) commodity
expected price, and (iv) infrastructure
facilities for storage, transportation, and
marketing of produce.
• Prioritize value added extension services
to reduce post-harvest losses by
transforming raw agricultural produce
to processed goods. This allows for
increased price realization, which helps
farmers earn more money.
Diversification: promotion of
high value crops (HVCs) and
livestock
High value crops
• Encourage diversification to HVCs:
Create an incentive system to encourage
farmers to switch from cereal crops to
HVCs. Every year, the area planted with
fruits and vegetables needs to grow by
5%.
• Practice of hybrid technology in the
vegetables: Vegetables can be shifted
to hybrid varieties. Hybrids currently
cover 10% of the cropped area in the
vegetable sector. Shifting to hybrids has
the potential to boost yields by 1.5 to 3
times and increase income significantly.
• Create regional production belts: Similar
to the cluster-based approach, regional
production belts for HVCs should be
developed and funded through the
Mission on Integrated Development
of Horticulture (MIDH). Make SHCs a
requirement in these areas.
• Fruit rootstocks: Rootstock technology
has demonstrated the ability to double
production while remaining resistant to
climate change. Efforts should be made
to standardize and encourage the use of
 rootstocks for fruit production.
• Strengthen the demand for organic
products: It is proposed that targeted
efforts be made to build a market for
niche products. The Spice Board should
brand spices that are exclusive to a state
in order to promote the development of
organic spices.
• Promote indigenous cattle breeding with
exotic breeds: To combat inbreeding,
indigenous cattle breeding with exotic
breeds should be encouraged. This would
result in greater gene coverage, less
diseases, and greater climate change
resistance.
• Promote and grow bull mother farms:
By using multiple ovulation and embryo
transfer technologies, these farms can
dramatically boost milk production
by providing farmers with cattle with
increased milk potential.
• Village-level procurement systems:
To promote dairy in states, bulk milk
chillers and facilities for high-value milk
conversion are required. At the village
level, the private sector should be
encouraged to establish a value chain for
HVCs and dairy products.
Food Processing
• A well-developed food processing sector
with a higher level of processing reduces
wastage, improves value addition,
promotes crop diversification, ensures a
better return to farmers, promotes jobs,
and increases export incomes.
• This segment is also capable of
addressing critical issues such as food
security, food inflation, and providing
wholesome, nutritious food to the world's
population.
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Development of Food
Processing and Technology:
• For decades, researchers have been
working in the area of food technology.
Nicolas Appert's invention of the canning
process in 1810 was a watershed moment.
Food preservation methods were greatly
influenced by canning. Later, in 1864,
Louis Pasteur's study on wine spoilage
and his explanation of how to prevent
spoilage was an early attempt to
scientifically ground food technology.
Pasteur studied the processing of alcohol,
vinegar, wines, beer, and milk sourness in
addition to wine spoilage. He invented
the method of pasteurization, which
involves processing milk to kill disease-
causing organisms. Pasteurization was
a major step forward in ensuring food's
microbiological protection.
• Food technology was first developed to
meet the needs of the military. World
wars, space travel, and increasing market
demand for a variety of goods all led to
the growth of Food Technology in the
twentieth century. Products like instant
soup mixes and ready-to-cook things
like meals were designed specifically for
working women's needs.
• In addition, the food industry was
forced to concentrate on health issues.
People began integrating food items/
preparations from various regions and
countries into their diets as their food
tastes and choices shifted. The desire to
eat seasonal foods throughout the year
has grown. Using new methods, food
technologists attempted to provide food
that was both safer and fresher.
• In the 21st century, food technologists
are challenged to produce foods
suitable for health and other changing
needs of consumers. Food technology
has provided a vast variety of safe and
convenient foods. In developing countries
this rapidly expanding and developing
field, has been helpful in improving food
 security and has opened avenues for
employment at all levels.
Basic concepts in food
processing methods to prevent
food spoilage are:
» Application of heat
» Removal of water moisture
» Lowering of temperature during storage
» Reduction of pH
» Controlling the availability of oxygen
Processed foods can be
classified on the basis of
extent and type of processing
as follows:
• Minimally processed foods: These
are processed as little as possible to
preserve the freshness of the ingredients.
Cleaning, trimming, shelling, chopping,
slicing, and storage at low temperatures
(refrigeration) are the most common
procedures.
• Preserved foods: The methods of
storage used do not significantly alter
the character of the commodity, such as
frozen peas and vegetables, dehydrated
peas and vegetables, and canned fruits
and vegetables.
• Manufactured foods: In these items, the
raw product's original characteristics
are lost, and certain basic preservation
techniques are used, which also include
the use of salt, sugar, oil, or even chemical
preservatives. Pickles, jams, marmalades,
squashes, papads, and wadis are some
examples.
• Formulated foods, such as bread, cookies,
ice cream, cakes, and kulfi, are made by
combining and processing individual
ingredients to produce reasonably shelf-
stable food items.
319
• Food derivatives: In the food industry,
components of foods may be purified
from raw materials, such as sugar from
sugarcane or oil from oil seeds. In certain
cases, the derivative or portion may
be further refined, such as when oil is
converted to vanaspati (the process is
called hydrogenation).
• Functional foods: These are foods that
can improve human wellbeing, such as
probiotics and lycopene.
• Medical foods: These are foods that
are used in the nutritional treatment of
illnesses, such as low sodium salt and
lactose–free milk for lactose intolerant
people.
Status of Food Processing
Sector
• At 2011-12 rates, the industry accounted
for approximately 8.83 percent and 10.66
percent of Gross Value Added (GVA)
in the Manufacturing and Agriculture
sectors, respectively, in 2017-18.
• This industry employs almost 7 million
people.
• Processed food exports totaled $35.30
billion in 2018-19, accounting for around
10.69 percent of India's total exports.
• Harvest and post-harvest losses of major
agricultural harvest totaled Rs.92,651
crore at the national level, based on
production data from 2012-13 at 2014
wholesale prices.
• India is a leading producer of food grains
in the world. It is the top producer of milk,
pulses, ginger, bananas, guavas, papayas
and mangoes. Additionally, India ranks
second in the world in the production
of rice, wheat and several other fruits
& vegetable. However, India’s share in
world export of food product is a meagre
2.31 per cent.
Constraints in the growth of
the sector:
Some of the specific problems faced by
food processors are:
• The key reasons for higher wastages,
higher production costs, and lower
value added in the food processing
sector have been described as a lack of
effective supply chain infrastructure and
insufficient expansion of processing and
storage capacity commensurate with
agriculture production.
• Perishable goods, such as meat, fish,
and fruits and vegetables, have a higher
rate of wastage and account for a small
percentage of total food production. Loss
minimization in the perishable segment
will necessitate significant investments
in farm gate infrastructure, storage and
cold chain infrastructure, and processing
capacity expansion.
• Despite being a major producer of
agricultural commodities, India's level
of food processing and value addition
remains poor, reducing our productivity,
export output, and farmer income.
• One of the major reasons for higher
agri produce wastage, especially in
perishable segments, is a significant gap
in Cold Chain capability. Individual food
processors cannot afford to invest in cold
chain infrastructure because it requires a
large upfront cost with a long payback
period.
• Inadequate linkage between processors,
exporters, and bulk purchasers and
farmers, resulting in a mismatch between
industry needs and farmer availability
of agri-produce. The problem is often
exacerbated by legal requirements
governing product storage and
movement restrictions.
• In the absence of an exclusive supportive
platform at the state level, processors
have trouble obtaining benefits under
programmes enforced by various
320
agencies of the federal and state
governments. Their issue is exacerbated
by a lack of understanding and an
effective information sharing and advice
platform.
• Setting up food processing units
necessitates multiple clearances.
• Sector-specific entrepreneurship
development training and incubation
services are two fields where the sector's
growth is being stifled.
• A number of research institutes are
undertaking R&D for product, process, and
technology improvement & development.
There is a need for coordinated action on
research and dissemination of research
output to the industry.
Way Forward/Solution:
Given the need for wastage reduction,
value addition and the high employment
potential of the sector, there is a need to
substantially step up the allocations, given
the importance of the sector in terms of its
contribution to the economy.
• Government initiative convergence:
To establish successful procurement
linkages, processing facilities, retail chains,
and export operation, coordination is
needed between the initiatives of the
Ministry of Agriculture, Food Processing,
and Commerce. This will help to create
synergies between various initiatives
such as the agriculture ministry's
Rashtriya Krishi Vikas Yojana (RKVY),
the Ministry of Commerce's viability gap
funding for cold chain and warehousing
infrastructure growth, and the Ministry
of Food Processing Industries' Pradhan
Mantri Kisan Sampada Yojana.
• Promote the production of export-
oriented clusters: The Agricultural and
Processed Food Export Development
Authority (APEDA) has long advocated for
the creation of export-oriented clusters
with shared infrastructure. A functional,
 end-to-end cold chain system, as well as
processing facilities, should be included
in these clusters.
• Regulatory frameworks to address
rejections in export markets: To reduce
the rate of rejection in the export sector,
regulatory frameworks for the use
of pesticides, growth hormones, and
antibiotics for marine produce must be
established and enforced effectively.
• Warehouse modernization: Pledge
financing at warehouses through
negotiable warehouse receipts (NWR)
must be embraced and popularized as
a viable alternative source of capital.
Guidelines for warehouse-based post-
harvest loans and e-NWR trading should
be established by the Department
of Agriculture and Farmers' Welfare
(DACFW).
• Infrastructure status for agriculture
value chains: Warehousing, packhouses,
ripening chambers, and cold storages,
including those set up at the village
level, should all be given complete
infrastructure status so that they can
benefit from the tax breaks that come
with it.
• Connect production and processing:
Fruit and vegetable collection centres
at the village level should be connected
to larger processing units. Engage the
private sector actively in the development
of processing facilities near rural periodic
markets (RPMs).
• Food processing: The food processing
industry should be given more attention
in order to improve value addition
in vegetable and fruit crops. The
government's focus has now turned to
supporting "agripreneurs." As a result, the
agricultural sector will rapidly modernize.
• There is also a necessity for greater
involvement of state governments
for better outreach, supervision and
monitoring (keeping this in view,
government has already launched
321
centrally sponsored National Mission on
Food Processing).
Some Important Recent Government
Initiatives Related to Agriculture:
• Pradhan Mantri Krishi Sinchai Yojana
(PMKSY):
» During the 2015-16 fiscal year, the
Pradhan Mantri Krishi Sinchayee Yojana
(PMKSY) was launched with the slogan
"Har Khet Ko Paani" to provide end-to-
end irrigation supply chain solutions,
including water sources, distribution
networks, and farm level applications.
» The PMKSY focuses on creating sources
for assured irrigation as well as protective
irrigation by harnessing rainwater at the
micro level, using "Jal Sanchay" and "Jal
Sinchan."
» PMKSY is made up of the following
elements:
− Ministry of Jal Shakti is implementing
the Accelerated Irrigation Benefit
Program (AIBP).
− Har Khet ko Pani (PMKSY): Ministry
of Jal Shakti is implementing this
programme.
− The Department of Land Resources is
implementing PMKSY-Watershed.
• National Mission for Sustainable
Agriculture (NMSA):
» The National Mission on Sustainable
Agriculture (NMSA) is one of the eight
missions outlined in the National Action
Plan on Climate Change (NAPCC),
with the aim of supporting sustainable
agriculture through climate change
adaptation measures.
» The main focus is on improving agriculture
productivity, especially in rainfed areas,
with an emphasis on integrated farming,
soil health management, and resource
conservation synergy. In addition,
 NMSA has set a goal to meet national
and international obligations to the
Sustainable Development Goals (SDG)
and Intended Nationally Determined
Contribution (INDC).
» Rainfed agriculture, soil health
management, organic farming, and other
NMSA components play an important
role in achieving the SDGs and INDC.
» NMSA is a programmatic intervention
that focuses on conservation agriculture
in order to make the farm sector more
effective, healthy, profitable, and climate
responsive by promoting location-specific
integrated/composite farming systems,
soil and moisture conservation initiatives,
holistic soil health management, and
mainstreaming rainfed technologies.
» One of the components of Rainfed Area
Development is NMSA.
• Soil Health Card Scheme:
» Launched in 2015, the scheme has been
introduced to assist State Governments
to issue Soil Health Cards to all farmers
in the country.
» The Soil Health Cards provide information
to farmers on nutrient status of their
soil along with recommendation on
appropriate dosage of nutrients to be
applied for improving soil health and its
fertility.
• Paramparagat Krishi Vikas Yojana
(PKVY):
» Paramparagat Krishi Vikas Yojana is
implemented with a view to promote
organic farming in the country.
» To improve soil health and organic matter
content and increase net income of the
farmer so as to realize premium prices.
• Important e-technology to assist the
farmers:
» National Agriculture Market (e-NAM)
322
− It provides e-marketing platform at
national level and supports creation of
infrastructure to enable e-marketing.
− This innovative market process is
revolutionizing agriculture markets
by ensuring better price discovery.
It brings in transparency and
competition to enable farmers to
get improved remuneration for their
produce moving towards ‘One Nation
One Market’.
» iMandi:
− It is the initiative launched by IFFCO
and it is in line with the Digital India
initiative to encourage rural digital
revolution.
− This Social Commerce app intends to
benefit the cultivators and to bring
the digital revolution to rural India
with the support of digital technology.
» Export Inspection Council (EIC):
− To promote ease of agricultural exports
from India, the Indian government
introduced digital initiatives by Export
Inspection Council (EIC).
− For this, three portals have been
developed to decrease transaction
time and cost in an effective
and transparent manner: Single
Laboratory for Accreditation and
Approvals, for Safe Food Export
Traceability, and for Monitoring Export
Alerts from importing regulators.
» Meghdoot:
− The Indian government has launched
this mobile application with the
intention to further the Digital India
initiative, and bring technology to
cultivators.
− This app will assist farmers by providing
various forecast information relating
to humidity, rainfall, temperature,
wind speed and direction, and how to
 take care of the crops and livestock.
» KisanSuvidha and PusaKrishi Mobile
App:
− This application gives different
information with respect to Market
Prices, pesticides, fertilizers, seeds,
weather, and agricultural machinery,
etc.
− It distributes information related to
the latest technologies developed
by the Indian Agricultural Research
Institute (IARI).
• Pradhan Mantri Kisan Sampada Yojana:
» PMKSY provides subsidy-based support
to create robust modern infrastructure
for agriculture and agro-based industries
along the entire value/supply chain. It is
expected to reduce wastage of agriculture
produce, increase the processing level,
enhance the export of the processed
foods, enable availability of hygienic
and nutritious food to consumers at
affordable prices.
» The scheme components are: Mega
Food Parks, Integrated Cold Chain and
Value Addition Infrastructure, Creation/
Expansion of Food Processing &
Preservation Capacities, Infrastructure
for Agro-processing Clusters, Creation
of Backward and Forward Linkages,
Food Safety and Quality Assurance
Infrastructure, Human Resources and
Institutions, and Operation Greens.

Farmer Groups Self Help Groups Individual farmers

Field collection
Centers
CC CC CC CC CC CC CC CC CC CC CC CC

Primary Processing
PPC PPC PPC Centers: Pre-cooling,
Grading, Pulping,
Sorting, waxing,
Packing, Temporary
storage

Central Processing
Importer
Value added Product

Centers: Pulping,
Mega Aseptic Packing,
Fresh Products

Chamber, Cold

Exporter Food Park storage QC lab,

Logistics center etc.

Domestic sales
CPC Domestic
Retail sales

I M A G E 16.4: M E G A F O O D P A R K

• Pradhan Mantri Fasal Bima Yojana » The government approved a dedicated

(PMFBY): Rs. 5,000 crore fund to bring more land
• Pradhan Mantri Fasal Bima Yojana area under micro-irrigation as part of its
(PMFBY) is the government sponsored objective to boost agriculture production
crop insurance scheme that integrates and farmers income.
multiple stakeholders on a single » The fund has been set up under NABARD,
platform. which will deliver this amount to states on
• Micro Irrigation Fund (MIF): concessional rate of interest to promote

323
 micro-irrigation, which currently has making agriculture more productive,
a coverage of only 10 million hectares sustainable, profitable, and climate
as against the potential of 70 million resilient by promoting location-
hectares. specific integrated/composite
farming systems, soil and moisture
conservation measures, comprehensive
National Mission for soil health management, efficient
water management practices, and
Sustainable Agriculture mainstreaming.
(NMSA)
• The NMSA, launched in 2011–12, aims at
enhancing food security and protection Under NMSA following ten
of resources such as land, water, deliverables are monitored:
biodiversity and genetic resources by I) Area under organic farming,
developing strategies to make Indian
agriculture more resilient to climate ii) Production of Bio-fertilizers,
change. iii) Precision Irrigation,
• Following are the impacts of Climate iv) SRI/Direct Seeded Rice from
Change on Indian Agriculture: Transplantation,
» Indian agriculture, with two-third rain- v) Crop diversification,
fed area remains vulnerable to various vi) Additional Area under plantation in
vagaries of monsoon, besides facing Arable land,
occurrence of drought and flood in many
vii) Climate Resilient Varieties (CRV)
parts of the country. Natural calamities
Identified/Released,
such as drought and flood occur
frequently in many parts of the country. viii) Identification of genotypes of crops
with enhanced CO2 fixation potential and
» Climate change will aggravate these less water consumption & Nutrients,
risks and may considerably affect food
security through direct and indirect ix) Climate Resilient genotypes with greater
effects on crops, soils, livestock, fisheries adaptation to drought, flood, salinity, and
and pests. Building climate resilience, high temperature,
therefore, is critical. x) Coverage of milch animals under ration
• From 2014-15, the National Mission balancing programme and
for Sustainable Agriculture (NMSA) xi) Establishment of bypass protein feed
has been operational, with the aim of making unit.

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 I M A G E 16.5: N AT I O N A L M I S S I O N S U N D E R NA PCC

Some important scheme/initiative National Food Security Mission (NFSM) for

related to NMSA
One of the Missions under the National
Action Plan for Climate Change (NAPCC)
is the National Mission for Sustainable
Agriculture (NMSA), which involves
programmatic approaches such as Soil
Health Card (SHC),
• Paramparagat Krishi Vikas
(PKVY),
• Mission Organic Value Chain
Development for North Eastern Region
(MOVCDNER),
• Rainfed Area Development (RAD),
• National Bamboo Mission (NBM) and
Sub-mission on Agro Forestry (SMAF).
These and other programmes including
Prime Minister Krishi Sinchayee Yojana
(PMKSY) are ensuring judicious use of natural
resources. Assistance is provided under
inter alia stress tolerant/climate resilient
varieties of food grains.
UPSC CSE PRELIMS
Previous Years
Yojana Questions
Q.1) In India, which of the following can
be considered as public investment in
agriculture?
1. Fixing Minimum Support Price for
agricultural produce of all crops
2. Computerization of Primary Agricultural
Credit Societies
3. Social Capital development
4. Free electricity supply to farmers
5. Waiver of agricultural loans by the

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 banking system
6. Setting up of cold storage facilities by the
governments.
Select the correct answer using the code
given below.
(a) 1, 2 and 5 only
(b) 1, 3, 4 and 5 only
(c) 2, 3 and 6 only
(d) 1, 2, 3, 4, 5 and 6
Ans. (c)
• Explanation: Here, Public Investment
implies to the formation of either physical
infrastructure or intangible capital.
Therefore, in this context, investment
is understood as either infrastructure
-related capital as presented in options
2 and 6 or social capital as mentioned in
option 3. Loan waivers and subsidies are
not investments.
Q.2) Which of the following factors/
policies were affecting the price of rice in
India in the recent past?
1. Minimum Support Price
2. Government's trading
3. Government's stockpiling
4. Consumer subsidies
Select the correct answer using the code
given below.
(a) 1, 2 and 4 only
(b) 1, 3 and 4 only
(c) 2 and 3 only
(d) 1, 2, 3 and 4
Ans. (d)
• Explanation: Option 1 is correct: MSP
results in a deviation of stocks from
the open market, therefore, driving up
the price for the ultimate consumers. In
addition to this, MSP prevents the prices
from going down (directly). Price will not
go lower than the MSP. The cultivator
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can sell the produce to the government
at the MSP. It will also prevent the price
from going up (indirectly)- The price will
shoot up only when the production is less,
however if the production will rise, then
the prices will not be very high.
• Option 2 is correct: Even Though factors
such as climatic shocks determine rice
prices and production in the short run,
the future scenario of rice prices must
be based on long-term estimates of rice
demand and supply. Trading results in an
increased demand in the global markets,
which also impacts the price of rice in
India.
• Option 3 is correct: Low stock levels
constrain the capability to buffer the
price rise causing from other factors.
• Option 4 is correct: Subsidies lower the
costs for the ultimate consumer.
Q.3) Consider the following statements:
1. In the case of all cereals, pulses and
oilseeds, the procurement at Minimum
Support Price (MSP) is unlimited in any
State/UT of India.
2. In the case of cereals and pulses, the
MSP is fixed in any State/UT at a level to
which the Market Price will never rise.
Which of the statements given above is/
are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans. (d)
• Explanation: Statement 1 is not correct:
Though the government announces
MSP for 23 crops, effective MSP linked
procurement takes place mostly for rice,
wheat, and cotton. The procurement is
also limited to a few states. Because of
limitations on the procurement side (both
state-wise and crop wise) and even after
 having an open-ended procurement at
MSP, all cultivators do not obtain benefits
of an increase in MSP.
• Statement 2 is not correct: CACP
considers numerous factors like the
productivity of crops, the cost of
327
cultivation and production, and Market
Prices for the determination of MSPs.
MSP fixed for each crop is uniform for the
entire country. But there is no instance
of MSP being fixed in any State/UT at a
level to which the Market Price will never
rise.
 CHAPTER - 17
INFRASTRUCTURE
Introduction/
Definition
• Infrastructure implies to the basic
systems and services that a nation or
organization requires in order to function
appropriately.
• Infrastructure is the lifeline of an economy.
Whatever the primary driving force of
an economy is, whether it is primary,
secondary, or tertiary, a suitable level of
infrastructure is needed for growth and
development.
• In a labor rich country like India,
infrastructure itself is a huge employment
provider.
• Infrastructure supports the key areas of
manufacturing and agricultural activity,
as well as domestic and international
trade and commerce.
• These services consist of roads, railways,
ports, airports, dams, power plants, oil
and gas pipelines, telecommunication
facilities, the country's educational
system, which includes schools and
colleges, health system, which includes
hospitals, sanitary system, which includes
clean drinking water facilities, and
monetary system, which includes banks,
insurance, and other financial institutions.
• There are three sectors which are
considered as the infrastructure,
universally around the world
namely power, transportation, and
communication.
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Types of
Infrastructure
At times, the infrastructure is divided into
two categories: economic and social.
• Economic: Infrastructure associated
with energy, transportation and
communication are included in this
category. Economic Infrastructure
is directly linked with the economic
development of a country or an
organization. it includes the basic
amenities and services that directly
influence and benefits the production
process economy distribution.
• Social: Those related to education,
health and housing are included in this.
Indirectly, social infrastructure aids the
country's economic growth. For example,
the education sector does not directly
contribute to a country's economic
development. However, it helps indirectly
by providing students with high-quality
education, resulting in the development
of physicians, scientists, engineers, and
technologists.
Importance/
Relevance of
Infrastructure:
• Infrastructure is the supporting framework
that enables a new industrial economy to
operate efficiently.
• Modern agriculture relies heavily on
it for the efficient and large-scale
transportation of seeds, pesticides,
fertilizers, and produce through modern
 highways, railways, and shipping facilities.
• Agriculture has become increasingly
reliant on insurance and banking services
in recent years as a result of the need to
operate on a large scale.
• It should be stressed that good
infrastructure is crucial not just for faster
economic growth but also for inclusive
growth. When we talk about sustainable
development, we mean that the benefits
of growth are shared by the majority of a
country's people. As a result of inclusive
development, poverty will be alleviated,
and income inequality will be reduced in
the country.
• Micro, small, and medium enterprises
(MSME) are distributed across the
economy, and their development and
growth necessitate access to high-quality,
dependable infrastructure facilities in
order to compete effectively with large-
scale enterprises, which can also develop
some of their own infrastructure, such
as small power plants or generators.
Furthermore, large-scale companies
may position themselves near ports and
transportation hubs where the requisite
Government
Initiatives and
Schemes
Growth Drivers
Infrastructure
Needs
Housing
Development
I M A G E 17.1: G R OW T H
329
infrastructure is available.
• On the other hand, small businesses
are distributed across the economy and
must rely on the availability of general
infrastructure facilities. As a result,
constructing general infrastructure
facilities aids small businesses in
competing efficiently with large-scale
firms, and being labor-intensive, creates
a large number of job prospects for
employees. This will aid in the reduction
of poverty in developed countries.
• In addition to the obvious correlation
between water and sanitation and
health, the quality of transportation
and communication systems will affect
access to health care. Improvements
in water supply and sanitation have a
significant impact by reducing morbidity
(meaning the likelihood of being ill)
from major waterborne diseases and
reducing the incidence of disease when it
occurs. Air pollution and transportation-
related safety hazards have an effect
on morbidity, particularly in densely
populated areas.
Public Private
Partnerships
(PPP)
International
Investment
(FDI & FII)
DRIVERS FOR INFRASTRUCTURE
THE STATE OF
INFRASTRUCTURE IN INDIA
ENERGY
• There are both industrial and non-
commercial energy sources. Coal,
petroleum, and energy are industrial
sources since they can be purchased and
sold. Firewood, farm waste, and dried
dung are also non-commercial energy
sources. Since they are found in nature/
forests, they are non-commercial.
• Solar energy, wind energy, and tidal power
are some examples of non-conventional
energy sources. Since India is a tropical
country, it has virtually unlimited capacity
for generating all three forms of energy if
appropriate cost-effective technologies
are used.
I M A G E 17.2: C O N S U M P T I O N O F E L E C T R I C I T Y
S E C TO R S I N I N D I A (2017-18)
Present status:
• As of 2020, Coal dominates India's
energy mix, accounting for around 75.9
of total energy consumption, led by
renewable energy (17.1%), Gas and Oil
(3.8% and nuclear energy (3.2%). India is
the world's third-largest user of energy.
In 2017, however, its per capita energy
consumption was about 625.6 kilograms
330
of oil equivalent (kgoe), compared to
1860 kgoe globally. In 2015, per capita
energy consumption in the United States
and China was 6800 kgoe and 2170 kgoe,
respectively.
• In the power sector, India's total installed
capacity is about 334 GW, with 62 GW
of renewable energy. Energy-related sub-
sectors continue to face difficulties.
• In terms of energy supply, India is still
heavily reliant on petroleum imports
to meet its needs. In 2017, we imported
about 82 percent of crude oil and 45
percent of natural gas.
• There are still approximately 16000 km of
gas pipeline networks in use today.
• In the coal industry, the government only
recently approved commercial mining
in 2018. Furthermore, power companies,
especially state government utilities,
continue to face financial difficulties.
Some of the Important objectives/
targets of Government
The government's new energy policies seek
to "provide affordable, secure, renewable,
and modern energy to all." It also expects
to pass through the following checkpoints
along the way:
• By 2022, produce 175 GW of renewable
energy potential.
• By 2022-23, cut oil and gas imports by ten
BY
percent.
• Continue to reduce GDP-based emission
intensity in a way that will assist India in
achieving its 2030 INDC target.
Constraints:
• The constraints on achieving the
milestones set for 2022-23 can be divided
into two broad categories: overall energy
sector and sub-sector specific.
• Overall energy Subsidies and taxes:
» Various subsidies and taxes distort the
energy market and encourage the use of
inefficient fuels over efficient fuels, as well
as making Indian exports and domestic
output uncompetitive since energy taxes
are not covered by the GST, and therefore
no input credit is provided.
Solution/way forward:
• Oil, natural gas, electricity, and coal
should be subjected to GST to allow for
input tax credit.
• To ensure a level playing field, all sources
of energy should have the same GST rate.
• End-consumers should be given all
types of subsidies as practical subsidies,
allowing them to select the most
appropriate and cost-effective energy
source for them.
Power
• Inefficient plants are still working, whereas
more modern plants are underutilized.
• Distribution Companies (DISCOMs) use
load shedding to mitigate losses as the
difference between average cost of supply
(ACS) and average revenue realized (ARR)
remains due to high aggregate technical
and commercial (AT&C) losses.
• Although legally independent, Regulatory
Commissions are unable to fully regulate
DISCOMs and fix rational tariffs.
• Unmetered power supply to farming
provides no incentive to farmers to use
electricity efficiently.
• There is a lot of hidden demand because
of unreliable supply and load shedding.
• Owing to their poor financial health,
state power utilities are unable to invest
in system upgrades, and the industrial/
business tariff and cross-subsidy regime
have harmed the productivity of the
industrial and commercial sectors.
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Solution/Way forward:
• Promote smart grid and smart meters.
• All PPAs, including those with state-
owned power companies (GENCO’s),
should be competitively bid. To promote
flexible capacity for peak demand and
intermittency, a capacity market should
be created.
• AT&C losses may be minimized by
privatizing state delivery utilities and/or
using a franchisee model.
• Discoms in rural areas which use
a franchisee model for their retail
business and set minimum performance
requirements, such as the use of
decentralized generation and storage
systems for local reliability and resilience.
• Regulatory bodies must be strengthened
even further and made fully autonomous.
• Instead of offering separate subsidies
for fertilizers, energy, crop insurance,
and other products, an upfront subsidy
per acre of land through Direct Benefit
Transfer (DBT) could be considered for
agriculture.
• Encourage the use of solar pumps for
agricultural purposes. The farmer's
surplus power should be purchased by
local utilities.
• DISCOMs may be fined for load shedding.
• Ensure effective enforcement of a cap on
cross subsidy and open access. It is also
essential to remove high open access
charges.
• Actively encourage cross-border electricity
exchange in order to maximize the use of
current and future generation assets.
• Introducing performance-based rewards
into the tariff system is a good idea.
• To control power demand, 100 percent
metering, net metering, smart meters,
and metering of electricity supplied to
agriculture must be enforced.
Oil & Gas
• There is no nondiscriminatory access
to the gas pipeline network for private
and public sector firms, and the lack of
market-driven gas prices for old fields
discourages further development.
• The gas pipeline infrastructure is also
inadequate.
Solution/Way forward:
• Ensure a single carrier and unrestricted
access to gas pipelines.
• Land can be leased by the government
to oil marketing companies (OMCs) for
energy crops, similar to how ‘solar parks'
can be extended to biofuels.
• Separate the Petroleum and Natural
Gas Regulatory Board (PNGRB)
developmental and legislative roles.
• Ensure that the National Gas Grid is up
and running as soon as possible.
• Promote city gas delivery so that natural
gas can be piped in (PNG).
• Review contract terms and provide the
necessary flexibility to render stranded
oil and gas assets operational.
• Enhance production from ONGC and
OIL's existing fields with cutting-edge
technology within a system of production
enhancement contracts.
• Take into account consumer rates for
blocks that are not viable due to low gas
prices.
• Provide for shared infrastructure for
evacuation of oil and gas from small and
scattered onshore and offshore fields.
• 2G bio-ethanol ventures should be
designated as a "priority area."
• The government should provide 2G
ethanol project developers/technology
partners with feasibility gap funding/
financial assistance.
• Declare regasified liquefied natural gas
(R-LNG) as a transportation fuel and
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encourage compressed natural gas
(PNG) in rural areas.
• Create strategic reserves through various
policy options.
Coal
• Land for coal mining is becoming scarce,
and there is a move toward expanding
opencast mining while discouraging
underground operations, including
for higher-quality coal reserves. This
exacerbates the land scarcity problem.
• There is no demand for coal that is
competitive.
Solution/way forward:
• Full comprehensive exploration as quickly
as possible using exploration-cum-
mining leases based on a production/
revenue sharing model.
• Make it the duty of concerned state
governments to provide the land required
for mining.
• Commercial coal mining should be
operationalized as soon as possible.
Renewable energy
• High energy prices cause old power
purchase agreements (PPAs) to be
reneged on, eroding their sanctity. This
creates confusion about power use,
putting future investments at risk.
• Generating flexibility and balance
criteria for renewable energy integration
are emerging as major issues.
• In the production of biomass power, there
are supply chain problems.
Solution/Way forward:
• Provide a method for balancing the
 power grid at a low cost (gas-based,
hydro or storage).
• Renewable purchase obligations (RPOs)
should be strictly followed, and interstate
renewable energy purchases should be
made simpler.
• The costs of balancing interstate
transmission systems (ISTS) linked power
plants should be socialized over the
entire grid, on the lines of the point of
connection (PoC) or a similar mechanism,
by central level agencies like the Central
Electricity Regulatory Commission or the
National Load Dispatch Centre.
• In rural areas, decentralized renewable
energy combined with the discoms' grid
will provide reliability.
• Solar PV + biomass hybrid renewable
energy systems should be investigated.
Subsidies for consumers are required to
encourage commercial biogas.
Energy efficiency
• Restricted technological capacities, high
initial capital investment, and industry
and policy concerns have all hindered
energy conservation efforts.
• Energy efficiency investments are
unattractive for investors due to high
transaction costs (which include
appointing suitable consultants and
vendors for execution) in relation to
project size, particularly in the micro,
small-scale, and medium-scale enterprise
(MSME) market.
Solution/Way forward:
• State designated agencies (SDAs) should
be more empowered and equipped
with sufficient resources to enforce EE
related programmes. The Bureau of
Energy Efficiency (BEE) should release a
white paper on its 5-year plan on energy
efficiency in different sectors and define
333
energy consumption norms.
• It is necessary to ensure greater
participation of energy service
companies (ESCOs) through the use of
appropriate financing models with a risk
sharing mechanism, especially by public
sector banks.
• States should incorporate the second
edition of the Energy Conservation
Building Code (ECBC) into their building
codes and ensure that it is implemented
more quickly.
• Encourage the use of LED lighting
in government buildings and the
replacement of old appliances with
five-star appliances. Lower-income
households and small businesses should
be the priority of the UJALA (Unnat Jyoti
by Accessible LEDs for All) programme.
It is suggested that the number of
appliances protected by the Standards
and Labelling (S&L) programme be
increased.
• Expand and deepen the Perform,
Achieve, and Trade (PAT) programme;
make Energy Saving Certificate trading
under the PAT scheme more successful
by enforcing stringent penalties against
defaulters.
• BEE should develop cluster-specific
programmes for energy intensive
industries in the MSME sector to
implement energy efficient technologies.
• For new power plants, the Forum
of Regulators and State Electricity
Regulatory Commissions (SERCs) should
set lower heat rate standards. Plants
that consume more than the threshold
amount of energy should be phased out
over time.
• Encourage people to use public
transportation. Electric public
transportation networks may be
transformed in a timed manner. Expand
the corporate average fuel efficiency
requirements (CAFE) to include other
vehicle segments besides passenger cars.
UDAY scheme
Without improving the performance of the electricity distribution companies (DISCOMs)
of the state governments efforts towards 100 per cent village electrification, 24x7 power
supply and clean energy cannot bear fruit. For financial and operational turnaround
of DISCOMs and to ensure a sustainable permanent solution to the problem, the UDAY
(Ujwal DISCOM Assurance Yojana) was launched by the GoI, in November 2015.
The salient features of the scheme are as given below:
• States shall take over 75 per cent of the DISCOM debt—50 per cent in 2015–16 and
25 per cent in 2016–17. This will reduce the interest cost to 8–9 per cent, from as high
as 14–15 per cent.
• GoI will not include the debt taken over by the states in the calculation of fiscal
deficit of the States in the financial years 2015–16 and 2016–17.
• States will issue non-SLR including SDL (State Development Loan) bonds in the
market or directly to the respective banks and Financial Institutions (FIs).
• DISCOM debt not taken over by the State shall be converted by the Banks and FIs
into loans or bonds with interest rate not more than the bank’s base rate plus 0.1
per cent. Alternately, this debt may be fully or partly issued by the DISCOM as State
guaranteed DISCOM bonds at the prevailing market rates which shall be equal to
or less than bank base rate plus 0.1 per cent.
• States to take over the future losses of DISCOMs in a graded manner.
• States accepting UDAY and performing as per operational milestones will be
given additional/priority funding through Deendayal Upadhyaya Gram Jyoti
Yojana (DDUGJY),Integrated Power Development Scheme (IPDS), Power Sector
Development Fund (PSDF) or other such schemes of Ministry of Power and Ministry
of New and Renewable Energy. States not meeting operational milestones will be
liable to forfeit their claim on IPDS and DDUGJY grants.
• Such States shall also be supported with additional coal at notified prices and, in
case of availability through higher capacity utilization, low-cost power from NTPC
and other Central PSUs.
• UDAY is optional for all States. However, States are encouraged to take the benefit
at the earliest as benefits are dependent on the performance. [By March 2017, most
of the states/UTs had joined the scheme.]

Roadways/Surface
Transport
• India has the world's second largest
road network, with around 52.32 lakh
kilometers of National Highways, State
Highways, and other roads. The country's
NHs cover a total distance of 1,00,475 km
and carry about 40% of all traffic.
• Present Situation:
» In India, the road transport sector
accounts for the bulk of passenger and
freight movement.
» The total number of registered vehicles in
India increased from 58.9 million in 2001-
02 to 182.4 million in 2012-13, a CAGR of
almost 11% during this time. Access to
and the efficiency of public transit, on the
other hand, must continue to improve.

334
» Increased use of personal vehicular
transportation in urban areas causes
traffic congestion, longer travel times, and
higher levels of air and noise pollution.
» Expansion of the public transport fleets
has been hampered by the short supply
of vehicles. The total demand for buses
was approximately 3.40 lakh in FY 2017,
while the availability/supply was only
about 1 lakh.
• Some of the government objective:
Enhancing connectivity and internal
and external trade needs improving the
coverage and efficiency of roads and
highways. We should reach the following
targets by 2022-23.
• Expand the road network to improve
connectivity:
» Complete 24,800 km of Bharatmala
Phase-I roads by 2021-22, including 2,000
km of coastal and port connectivity
roads.
» Finish Phase I of the Pradhan Mantri
Gram Sadak Yojana (PMGSY), with
quality assurance at each point.
» Raise the length of national highways
(NHs) from 1.22 lakh km to 2 lakh km by
2022-23.
− Increase the width of single/
intermediate lane (SL/IL) highways
and reduce the length of SL/IL
highways to less than 10% of total
length by 2022-23, down from 26.46
percent now.
» Improve the regulatory framework for
roads to achieve better compliance,
seamless connectivity, road safety and
quality.
» As a signatory to the Brasilia Declaration,
reduce the number of road accidents and
fatalities by 50 per cent by 2020.
• Constraints:
» Capacity of existing highways: The
335
existing length of the NH network is
1.22 lakh km, which is 2.2 per cent of
the country’s entire road network of
56.03 lakh km. The existing NH length
with 4-lane and above NH standards is
27,658 km (22.59 per cent), and that with
single/intermediate lane (SL/IL) width is
32,395 km (26.46 per cent); the remaining
62,379 km (50.95 per cent) is of 2-lane
NH standard. Further, national and
state highways are already overstrained,
carrying more than 65 per cent of the
road traffic. National highways carry 40
per cent of India’s total road traffic.
» Inadequate funds for maintenance of
existing infrastructure: The annual outlay
earmarked for maintenance and repair
of national highway stretches is only
about 40 per cent of the funds required.
This is one of the main reasons for the
inability to take up timely maintenance
interventions.
» Accidents and safety concerns: Road
safety is a major issue in the country
with nearly 400 road related deaths
being recorded daily. In 2013, India had
an accident death rate of 18.9 for every
100,000 people, higher than other South
Asian countries such as Bangladesh (11.6),
Mauritius (12.2) and Sri Lanka (13.7).9 At
least a part of the fatalities is because of
the poor quality of roads.
» Cost escalation for roads: Delays in
acquiring land can affect project costs as
the average cost of land has escalated
from Rs. 0.80 crore per hectare during
2012-13 to Rs. 3.20 crore per hectare
during 2017-18.
• Solution/Way forward
» Increase connectivity by expanding the
road network
− Improve State/UT Public Works
Departments (PWDs) implementation
capacity through institutional
strengthening and training.
− By 2022-23, each city with a population
 of more than 1 million people would
need a dedicated Metropolitan Urban
Transportation Authority.
» Improve road maintenance and safety
− Implement a maintenance
management framework to protect
NH properties (MMS). Set aside
money from the Central Road Fund
(CRF) for upkeep.
− India should begin by allocating
10% of its annual budget to road
and highway maintenance in order
to achieve the developed world
standard of allocating 40% to 50%
of the budget to road and highway
maintenance.
− Incorporate harsh penalties for low
operations and maintenance (O&M)
efficiency into contracts in all contract
modes.
» Streamline land acquisition
» Skill development
− Develop road construction vocational
training courses in Industrial Training
Institutes (ITIs).
− Collaborate with original equipment
manufacturers and other stakeholders
to create commercial vehicle driver
training centres (DTCs).
− Introduce technologically advanced
approaches such as the automated
driving testing system to ensure
stringent testing of driving skills
before issuing driving licenses.
» Increase emphasis on research and
development
− Set aside 0.1 percent of the Ministry of
Road Transport Highways operating
budget for research and development.
− Create a national transportation data
centre for applied road analysis.
− Enhance R&D on IT-enabled traffic
336
management systems.
− Develop new materials/techniques
for construction.
» Increase the capacity and reach of
public transport
− Improve public transportation,
rural transportation, and last-mile
connectivity by transforming state
road transport undertakings (SRTUs).
− Additional funding for public
transportation and the creation
of interoperable systems will help
expand the reach and capacity of
public transport.
» Expand the reach of the electronic toll
collection (ETC) system
− Make the ‘FASTag' charging system
more effective.
− Work with stakeholders and
concessionaires (for PPP toll plazas)
to ensure that all toll plazas are
equipped with the required ETC
infrastructure.
» Complete targets for rural connectivity
Railways
• Indian Railways (IR) constantly faced
number of challenges. For speedy
capacity creation, IR recognizes the
importance of enhancing project
execution capabilities. Considering the
enormity of the resources required for
plan investment in rail infrastructure, and
given the limitation of public resources,
efforts are on by IR to generate sufficient
internal surplus, and tap innovative
methods of financing, to meet these
needs.
• The focus is on prioritizing investments
in vital areas like dedicated freight
corridors, high speed rail, high capacity
rolling stock, last mile rail linkages and
 port connectivity, and attracting private
and FDI investments to supplement
available resources.
Present situation:
• The Indian Railways (IR) is the fourth
largest network in the world in terms of
route km (67,368 km in Financial year
2017).
• It is also the world's largest passenger
(1,150 billion passenger kilometers in
Financial year 2017) and fourth largest
freight (620 billion net-tonne kilometers
in Financial year 2017) railway system.
In Financial year 2017, 13,329 passenger
trains carried over 22.24 million
passengers a day, almost the entire
population of Australia, and 1.1 billion
tonnes of freight was transported.
• Despite its extensive reach and the
substantial growth in freight load,
the modal share of railways in the
transportation of surface freight has
declined from 86.2 per cent in 1950-51
to 33 per cent in 2015, in part due to a
shortfall in carrying capacity and lack of
price competitiveness.
• Because passenger and freight traffic
in India share the same tracks, we have
not been able to substantially increase
speed or capacity in relation to global
benchmarks.
• Railway spending as a percentage of
total transportation spending dropped
from 56 percent in 1985-90 (7th plan) to
30 percent in 2007-12. (11th plan).
Important government
objective:
• Increase the capability of current railway
infrastructure.
• By 2022-23, increase infrastructure
construction speed from 7 km/day to 19
km/day.
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• By 2022-23, achieve “100 percent”
electrification of broad-gauge track, up
from 40% in 2016-17.
• Increase freight and mail/express train
average speeds to 50 km/hr (from around
24 km/hr in 2016-17) and 80 km/hr (from
around 60 km/hr), respectively.
• Increase the capability of current railway
infrastructure.
• By 2022-23, increase infrastructure
construction speed from 7 km/day to 19
km/day.
• By 2022-23, achieve “100 percent”
electrification of broad-gauge track, up
from 40% in 2016-17.
• Increase freight and mail/express train
average speeds to 50 km/hr (from around
24 km/hr in 2016-17) and 80 km/hr (from
around 60 km/hr), respectively.
Constraints:
• Congested networks: Over-stretched
infrastructure with 60 per cent plus routes
being more than 100 per cent utilized,
leading to a lessening in average speed
of passenger and freight trains.
• Organizational structure: Delays in
decision making, insufficient market
orientation and long project approval
durations lead to slow turnover times and
delays in the implementation of railways
projects.
• Internal capital generation: Low non-
fare revenues and high freight tariffs have
resulted in a freight share that is less than
ideal. The decline in the share of railways
has been attributed to the lower relative
cost of transporting freight by road. Low
and stable passenger segment prices
have also led to low internal resource
generation.
• Protection and poor service delivery: In
recent years, there have been a range
of incidents and safety problems in the
IR. Train and station cleanliness, train
 departure/arrival delays, food quality,
and ticket booking difficulties are all
major concerns.
• Efficiency of terminals: Poor terminal
facilities lengthen loading and unloading
times. Eighty per cent of railway loads
come from terminals. The functioning of
terminals needs to be strengthened to
improve rail freight.
• Economies of scale: The shortage of
scale economies especially impact
management quality and system
accountability.
Solution/Way forward:
• Better use of existing infrastructure to
address congestion
• Boost capacity efficiency by prioritizing
ongoing projects. These ventures will
produce more revenue if they are
completed on time. Simultaneously, we
must preserve and update the current
network to ensure that supply meets
demand.
• Ensure that the dedicated freight
corridors (DFCs) and the Mumbai-
Ahmedabad High Speed Rail (MAHSR)
are completed on time, especially by
completing land acquisition for the DFCs
in a timely manner.
• Ease organizational rigidity through
structural reforms:
» Consider allowing the private sector to
own and operate freight terminals, as well
as locomotives and rolling stock, under
a straightforward, neutral (non-railway)
and equitable regulatory framework.
This would boost efficiency while also
attracting private investors and players.
» Consider transferring coach and
locomotive manufacturing and repairs
to private players. However, since human
safety is involved in the case of coaches
and wagons, IR should continue to have
regulatory and technical control over
338
their manufacture and maintenance to
ensure the safety of users in compliance
with the General Rules of IR.
• Separate suburban commuter transit
from the rest of the network and create
a light rail system in all major urban
areas under the jurisdiction of local
governments.
• Rationalize fare structures and subsidies,
and monetize assets to generate
revenues:
» Reconsider IR's pricing model in order
to keep the passenger and freight
segments viable. Tariffs for freight should
be comparable with those for road
transport.
» Using railways to monetize land resources,
especially by developing non-railway
revenues such as retail or other activities.
» Invest in infrastructure, modernize
stations, and lease space to private
players to boost retail revenues from
railway stations.
• Enhance safety of trains to reduce
accidents and modernize stations:
» In 2017-18, the government formed the
Rashtriya Rail Sanraksha Kosh (RRSK) to
resolve critical safety issues.
» To avoid collisions, remove level crossings
and cattle crossings, and fence railway
tracks in areas with high levels of traffic.
» Implement the 22 suggestions of Dr.
Kakodkar's High-Level Safety Review
Committee.
» By-pass crossings and grade separations
should be upgraded and kept in good
working order.
• Enhance the ease of doing business:
» Set up an independent homologation
and standardization agency to adopt
new railway technology and improve
the speed and reliability of the railway
network.
» An internationally accepted liability
regime for domestic and international Civil aviation
transportation and (ii) common carrier
status to all rail-based service providers. • Airport infrastructure development
continues to be a matter of concern.
» Ensure that there are no interim Upgradation of many airports, including
amendments to tariff and non-tariff
construction of new terminals, for
regulations to improve legitimacy.
improving air navigation services the
» To increase asset efficiency and Airport Authority of India (AAI) installing
utilization, use technology to plan and the new ATS automation system.
route freight industry.

180
158.4
160
134.9
Number of Passengers (Million)

140
115.8
120 103.7
98.9 97.9
100 88.9
71.6 77.4
80 68.4

60
40
20
0
2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

International Passengers Domestic Passengers Total Passengers

I M A G E 17.3: C I V I L A V I AT I O N S TAT I S T I C S

Present situation: • India is also catching up with other

leading aviation markets in terms of
• In 2014, India's civil aviation sector market penetration.
contributed USD8.9 billion to the
• Domestic passenger traffic amplified at
country's GDP, supporting 1.31 million
a CAGR of almost 10 per cent between
direct, indirect, and induced aviation
2007- 08 and 2016-17 and international
employment.
passenger traffic grew at a CAGR of 8.07
• In 2016, China's domestic air travel per cent during the same period.
demand was twice that of the United
States.
• The Ministry of Civil Aviation's regional Important government
connectivity scheme, UDAN, is a 10-year objectives:
initiative to facilitate sustainable regional
development and make flying accessible • Make travel more affordable so that
to the general public. It will improve domestic ticket sales can rise from 103.75
access to the country's under served and million in 2016-17 to 300 million by 2022.
unserved airports. • Increase air cargo handling from 3.3

339
 million tonnes in 2017-18 to 6.5 million
tonnes in 2018-19.
• Raise the maintenance, repair, and
overhaul (MRO) industry from USD 1.8
billion to USD 2.3 billion in 2017.
• Boost airport capacity by more than
five times in order to accommodate one
billion annual trips.
• By means of the Regional Connectivity
Scheme, Ude Desh Ka Aam Naagrik,
increase the availability and affordability
of regional air connectivity and revive/
upgrade 56 underserved airports and 31
underserved helipads (RCS-UDAN).
• Ensure that airport tariffs, fuel taxes,
landing fees, passenger facilities, freight
fees, and other fees are calculated in a
timely, equitable, and transparent manner.
Constraints:
• Infrastructure and capacity:
» As India's civil aviation sector grows,
airspace, parking bays, and runway
slots will become increasingly scarce in
the coming years, especially at metro
airports.
» Capacity and infrastructure constraints
could reduce efficiency and safety while
also having a negative impact on the
economy.
• Skilled workers:
» According to a Ministry of Civil Aviation
Report, Indian aviation could sustain
1.0 to 1.2 million jobs directly by 2035.
This means that over the next ten years,
approximately 0.25 million people would
need to be educated.
» Shortage and gaps in availability of
industry-recognized skills, from airline
pilots and crew to maintenance and
ground handling personnel, could
constrain the growth of different
segments of the sector.
340
• High cost to passengers and of air cargo:
» Tariff determination: All airports must
move from a single to a hybrid structure,
according to the Ministry of Civil Aviation.
While this is advantageous because it
encourages infrastructure investment, it
increases airline and passenger prices.
» Taxes on aviation turbine fuel (ATF):
ATF is relatively expensive in India due
to high taxes and a lack of competition
among providers. Since it is not part of
the GST network, there are regional price
differences. Because of high central and
state taxes, the price of aviation fuel in
India may be up to 60% higher than in
ASEAN and Middle Eastern countries.
India has a 45 percent fuel cost as a
proportion of operating costs, compared
to a global average of 30 percent.
» Incidence of GST on Aircraft Leases and
Spare Parts: GST of 5 per cent is applied
on aircraft lease rentals; GST ranges
between 5 per cent and 28 per cent on
aircraft engines and spare parts. This
also raises costs for the sector.
• Aviation safety: Despite the fact that
the amount of aviation safety violations
in 2017 (337) is down from 2016 (442), the
overall number remains large.
Solution/Way forward:
• Enhance aviation infrastructure
» Complete the planned airports under the
UDAN initiative as soon as possible. The
rehabilitation of 50 under-served and
un-served airports/airstrips is scheduled
to be completed.
» In addition to completing two new
airports in Delhi and Mumbai by 2022, the
infrastructure capacity of the world's ten
busiest airports should be substantially
increased.
• Increase investment in the sector
 through financial and infrastructure
support:
» Increase aircraft parking infrastructure
and facilities at metro airports.
» Create additional parking hubs at
suitable locations, accessible through
short haul flights, to accommodate
additional aircraft.
» Monetize vacant real estate near AAI
airports in every major centres of traffic
to increase non-aeronautical revenues.
• Address shortage of skilled manpower:
» Promote cooperation between original
equipment manufacturers (OEMs),
industry, and educational institutions
to teach the most up-to-date concepts
in the aviation industry, such as
management principles, aviation
information technology, and so on.
» Establish a manufacturing ecosystem in
the country by establishing long-term
plans for advanced research in aviation
technologies.
» Facilitate greater involvement of the
private sector in sponsoring aviation
institutions, industrial training, and R&D
projects.
• Promote Air Cargo growth:
» Using the National Air Cargo Community
System (NACCS) network, create an
integrated digital supply chain or e-cargo
gateway.
» Promote "Fly-from-India" by creating
trans-shipment hubs. Ease the regulatory
environment for airports.
» Deregulate the aviation industry even
further and help India increase passenger
and freight traffic.
» Adopt a consistent model for assessing
tariffs in order to reduce passenger costs.
» Consider putting aviation turbine fuel
(ATF) under the GST umbrella to match
taxation and pricing systems with global
341
benchmarks.
» Strengthen regulatory capacity with
respect to public private partnerships and
streamline the judicial review process to
ensure timely implementation of DGCA’s
decisions.
» Meet the regulatory and security
requirements prescribed by the
International Civil Aviation Organization
(ICAO) at all times. Additional skilling
of personnel may be required for this
and the DGCA should adequately build
the capabilities of its staff to ensure
compliance.
• Prioritize Aviation Safety:
» Shift the attention to preventing and
avoiding injuries and incidents.
» Security breaches should be viewed with
zero tolerance.
» For an effective aviation safety oversight
scheme, the DGCA should be granted
autonomy.
» For all aviation-related transactions,
requests, and grievances, the DGCA
should develop a single-window system.
Ports, Shipping, and
Inland Waterways
Present situation:
• Ports and Shipping:
» India has a 7,500-kilometer coastline,
making it one of the world's largest
peninsulas, and ports handle roughly
90% of the country's foreign trade by
volume and 70% by value. On India's
coast, there are 12 major ports and 205
minor ports.
» Despite this, roads and railways remain
the most popular modes of cargo
transportation.
» Despite being the most cost-effective
 and efficient mode, water transport programme, emphases on modernizing
accounted for 6 per cent of freight and developing ports, enhancing
transport in India in 2016-17. port connectivity, supporting coastal
3.5
3
communities, and stimulating port-linked
3
in Industrialization.
2.5
» Sagarmala intends to reduce the logistics
Rs/Tonne Km

1.5
1.5 costs for foreign and domestic trade,
1
leading to an overall cost savings of INR
35,000 to INR 40,000 crore annually by
0.5 0.3
0.15
2025. It moreover aims to double the
0
Road Rail WaterwaysP ipelines share of water transportation in the
I M A G E 17.4: V A R I O U S M O D E S OF T R A N S P O R TAT I O N modal mix.
» The Ministry of Shipping’s Sagarmala

Port Modernizatio
n Port Connectivity Port-led Coastal
Capacity New road/rail Industrializatio
n Community
augmentation conectivity Industrial clusters Development
New ports Up-gradation of Coastal Economic Skill development
Efficiency roads/railway Zones Coastal tourism
improvement Coastal shipping Maritime clusters projects
Inland water Development of
transport fishing harbours,
Logistics parks fish processing
centres

I M A G E 17.5: P O R T L E D D E V E L O P M E N T

• Inland waterways: NWs through the Central Road Fund

» Inland Water Transport (IWT) transports
less than 2% of India's organized freight
and very little passenger traffic.
» The annual freight volumes carried
on inland waterways using National
Waterways (NW-1, NW-2, and NW-3) and
Goa Waterways was 21.91 MMT in 2016-
17. Moreover, Maharashtra Waterways
alone transported over 33.29 MMT. The
Inland Waterways Authority of India
(IWAI) is responsible for developing and
maintaining fairway, navigational aids,
and terminal infrastructure.
» The government is also proposing to fund
(CRF).
» The ministry is augmenting the capacity
of NW-l under the 'Jal Marg Vikas' project.
Important government
objectives
• Increase the proportion of freight
transported by coastal and inland
waterways from 6% in 2016-17 to 12% by
2025.
• By 2022-23, raise port handling capacity
to 2,500 million metric tonnes (MMT).

342
• By 2022-23, reduce turnaround times at
major ports from 3.44 days (2016-17) to
1-2 days (global average).
• Increase inland waterway throughput
from 55.20 MMT in 2016-17 to 60-70 MMT
by 2022-23.
• Increase the minimum usable depth to
increase inland water transport capability.
Constraints:
• Roads (54 per cent) continue to be
the dominant mode of transporting
cargo, followed by rail (33 per cent).
Transportation of cargo through
waterways (shipping and inland water)
accounts for a minuscule modal share (6
per cent) despite it being the most cost
effective and efficient mode.
• Drought levels: Due to insufficient depth,
most Indian container handling ports are
unable to accommodate large container
vessels; mother vessels must dock at
ports with a minimum drought depth of
18 meters. With foreign trade preferring
more economically viable mother vessels,
a port's capacity to become a hub port is
harmed by shallow drought.
• Connectivity to ports: Weak hinterland
connectivity between production centres
and gateway ports often leads to higher
costs and delays because of sub-optimal
mode choices.
• Transshipment port: A large percentage
of containers in India are currently
transshipped through other ports, such as
Colombo (just south of India), Singapore
(East), Dubai and Salalah (West) due to
the absence of a transshipment port in
the country. This has led to additional
costs and delays due to the feeder
voyage from India to the hub port.
• Charges by the shipping lines: The
business practices of shipping lines have
played a key role in the present negative
perception of sea transport. A long
pending concern has been the high rate
343
and multiplicity of charges imposed by
shipping lines.
• Capital for inland vessels: At present, the
cost of capital is very high and makes
IWT freight uncompetitive. It is tough to
attract capital for building inland vessels,
as it is a significant investment.
• Technical issues in inland waterways:
The varying and limited depths due to
the meandering and braiding of alluvial
rivers and the erosion of their banks
causing excessive siltation, lack of cargo
earmarked for IWT, non-mechanized
navigation lock systems and insufficient
unloading facility at terminals hinder the
use of IWT by shippers.
• Inland waterway regulatory issues:
Ferries Acts from different years regulate
cross-ferry movement, which can pose
an obstacle to inland navigation because
the legislation may not take safety into
account.
Solution/Way forward:
• Open up India’s dredging market
» The government needs to open up the
dredging market to attract more players,
especially foreign players, to increase
and sustain draught depth at ports in
order to attract large vessels and allow
them to become hub ports.
» At the moment, the Indian dredging
market is served by the Dredging
Corporation of India (DCI) and a small
number of private vendors, limiting
competition.
» If the government takes steps like
consolidating dredging contracts
through cohorts of ports and removing,
at least temporarily, the right of first
refusal granted to Indian vendors, foreign
players would be attracted to the market.
• Expedite the implementation of
Sagarmala
» Expedite the accomplishment of
various projects under Sagarmala,
especially those aimed at improving port
connectivity, setting up coastal economic
zones (CEZs) and establishing new ports.
» The setting up of a single window facility
for cargo clearance and putting in
place fully mechanized cargo handling
infrastructure will be critical to increase
throughput.
• Ease the business environment around
shipping and ports
» The Indian government needs to rethink
its import policy on a "Free on Board"
basis (FoB policy) in order to balance risk
between importers and exporters.
» Enhance technology use in ports
and, wherever feasible, draw lessons
from successful global ports such as
Rotterdam, Felixstowe and Singapore to
improve efficiency.
• Enhance last mile connectivity to inland
waterways
» IWT should be integrated to multi-
modal/inter-modal connectivity. Inland
terminals with proper road and/or rail
connectivity and seamless transfer of
goods from one mode to the other are
important for an efficient logistics supply
chain.
» Procure floating terminals and cranes
and place them suitably so that access
to roads is possible.
• Facilitate access to capital for inland
vessels
» Inland vessel financing could be included
in priority sector lending by banks.
» Categorizing inland vessels as
infrastructure equipment would make it
easier to access resources for a sector
with high capital and maintenance costs.
344
Address technical and
regulatory constraints in inland
waterways to ease movement
of inland vessels
• CCEA, led by the Hon’ble Prime Minister
approved the implementation of the Jal
Marg Vikas project (JMVP) to augment
the capacity of National Waterway-1
(NW-1) with technical assistance and
investment support from the World Bank
at a cost of INR 5369.18 crore. It should
be ensured that the project is completed
by March 2023.
• From a regulatory standpoint, detention
of a vessel without a valid reason should
not be allowed.
• A clear directive needs to be issued for
security of inland vessels, crew, and
cargo.
• Strengthen existing Inland Water
Transport Directorates or Maritime
Boards or set them up in states where
they do not exist to ease the IWT business
and to ensure efficient regulation and
facilitation of IWT for cargo movement.
Smart Cities
• The GoI has launched the Smart Cities
Mission with the collaboration of
states and UTs for urban development.
The purpose of the mission is to drive
economic growth and improve the quality
of life of people by enabling local area
development and harnessing technology,
especially technology that leads to smart
outcomes.
• The Mission targets promoting cities
that provide core infrastructure and give
a decent quality of life to its citizens, a
clean and sustainable environment and
application of ‘smart’ solutions. The
smart city includes the following core
infrastructure development:
» Adequate water supply » Safety and security of citizens, particularly
» Assured electricity supply Women, children, and the elderly; and

» Sanitation, including solid waste » Health and education

management
• Strategy: The strategic components of
» Efficient urban mobility and public area-based development in the mission
transport are:
» Affordable housing, especially for the
poor
» City improvement (retrofitting)

» Robust IT connectivity and digitalization » City renewal (redevelopment)

» Good governance, especially

» City extension (greenfield development)
e-Governance and citizen participation » A pan-city initiative in which smart
solutions are applied.
» Sustainable environment

Pradhan Mantri Awas Yojana -Urban

• This initiative was launched in 2015 by the Ministry of Housing and Urban Affairs,
in which affordable housing will be given to the urban poor people with a goal of
building 20 million affordable houses by 31st March 2022.
• It provides central support to Urban Local Bodies (ULBs) and other types of
implementing agencies with the help of States/UTs.
• Eligibility criteria: Every statutory towns as per Census 2011 and towns notified
subsequently would be qualified for coverage under the scheme.
• Provisions:
» Credit Linked Subsidy.
» Affordable Housing in Partnership.
» In-situ Rehabilitation of existing slum dwellers utilizing land as a resource with the
help of private participation.
» Subsidy for Beneficiary-led individual house construction/enhancement.
• The initiative encourages women empowerment by offering the ownership of
houses in the name of female members of family or in joint name.

Present situation: of integration between different

• The Government of India has so far
selected 99 cities with an outlay of INR
2.04 lakh crore.
• These cities have started implementing
projects such as smart command and
control centres, smart area-based
development, smart roads, solar rooftops,
intelligent transport systems and smart
parks.
• These projects have the unique feature
infrastructural elements of the projects.
As of 14 May 2018, projects worth INR
4,800 crores have been completed and
works worth more than INR 20,000
crores are underway, as per the Ministry
of Housing and Urban Affairs’ Smart City
MIS portal.
Important objective:
Leverage the ‘Smart Cities’ concept in
select urban clusters to:

345
• Drive job creation and economic growth. • A solid spatial plan that serves as an
• Significantly improve efficiencies in overarching structure for smart city
service delivery. planning and implementation.

• By 2022-23, use technology to encourage • Ingenious strategies for amplifying the

inclusive, sustainable, and participatory voices of urban poor, slum dwellers,
growth. refugees, and other marginalized people.
• A digital strategy and road-map, or a
digital master plan.
Constraints: • Decision-making based on data
The key operational challenge areas in for service delivery and resource
the Smart City Mission include the non- sustainability.
availability of the following: • Human resources with the necessary skills
• For successful implementation, an to manage different functional domains
operational framework for inter-agency are available.
collaboration, including special purpose • Financing smart cities and ensuring
vehicles (SPVs). the financial viability of urban local
governments.

Solution/Way forward:
Four paradigms to leverage Smart Cities Mission

Engagement

Leveraging
Environment Economy
SCM

Equity

I M A G E 17.6: F O U R PA R A D I G M S TO L E V E R A G E SMART CITIES MISSION

• Economy and citizen participation.

» Scaling area-based development: − The federal government might think

about moving the lessons learned
− Existing area-based development from such neighborhood-based
initiatives must be evaluated for their development initiatives to other cities.
effect on living conditions, economic States should also be encouraged to
growth, investments, job creation, create state-level missions for other
cities.

346
 Mobility:
− A centralized metropolitan
transport authority, or an integrated
institutional framework for planning
and organizing mobility regulation, is
required.
− Land-use and transportation planning
should be incorporated in spatial
plans to promote more mixed-use
growth that boosts economic activity,
decreases travel time, and enhances
environmental quality.
− Public transportation, including
current intermediate and para-transit
systems, requires special attention,
especially in smaller cities.
» Achieving desired service delivery levels:
− Complementary missions such as
the Atal Mission for Rejuvenation
and Urban Transformation (AMRUT),
Swachh Bharat Mission (SBM), and
Housing for All provide funds for
the provision of basic services and
infrastructure (HFA).
− A policy is needed that mandates
measurable outputs and outcomes
for all infrastructure and utility
investments in cities.
» Digital transformation roadmap:
− Traditional approaches overlook the
importance of human interactions
among people, with city infrastructure
(such as highways, bridges, and
parks), and with the environment.
These interactions involve data and
knowledge, and digital technology
has the ability to recognize and
capture the meaning hidden in them.
− Cities must implement a digital
transformation roadmap that
includes both hard infrastructure and
software applications in order to take
advantage of internet access and its
diverse applications in governance
347
and service delivery. Once the
information that flows through the
"systems of systems" is captured, the
whole becomes greater than the sum
of its components, according to a
digital transformation roadmap.
− In addition, the digital transformation
roadmap will build on the significant
work done in cities on geographic
information systems (GIS) and apply
these for geo-locating, mapping,
and publishing public assets in the
city such as parks, playgrounds,
public toilets, bus stops, streetlights,
manholes, water and sewerage lines,
storm water drains, power lines, and
so on, and linking these for grievance
redressal.
• Equity
» Inclusive development:
− Cities must ensure that urban poor
and slum dwellers, including recent
refugees, have access to city facilities
and subsidies, as well as financial
inclusion, through the Jan Dhan
Yojana. To determine if benefits
meet the targeted poor, a dedicated
benchmark may be considered.
− Cities should set aside a single-
window facility for the urban poor
to access basic facilities like water,
sanitation, and sewerage, as well as
affordable housing in the form of
dormitory and rental housing.
− Urban poor communities and
slums, benefitted by area-based
development (ABD) or pan city
proposal (PCP) solutions, should
be mapped in conjunction with
improvements in parameters such as
access to public assets and reducing
service deficit including in the areas
of education and health.
• Environment
» Resilient cities:
− It is strongly recommended that India
should mainstream the resilient cities
approach and integrate it with service
levels as indicated in the chapter
on Approach to Sustainability in our
National Building Code 2016.
− The resilient cities strategy should
also align with the 11th Sustainable
Development Goal (SDG), which
focuses on the long-term development
of cities and communities.
− Environmental protection should be
viewed as a separate objective that
can be calculated as part of service
quality. In this regard, the Ministry of
Housing and Urban Affairs (MoHUA)
has the authority to issue model
guidelines.
• Engagement
» More than 20 smart command and control
centres are under implementation and an
equal number are under tendering. About
six of these centres have been completed
in Vishakhapatnam, Kakinada, Surat,
Nagpur, Vadodara, and Ahmedabad,
with nearly all of them using open-source
codes.
» There is need to use the information
available in these centres to develop
urban data observatories with a flexible
architecture and continue open source
accessibility. The purpose of such
observatories is to serve as a decision
support mechanism for policy makers
and to engage citizens.
» The MoHUA guidelines should
institutionalize the need for regulation
around data observatories and make
them open source in nature (by limiting
private ownership of such data), while at
the same time protecting the privacy of
citizens.
» The data observatory incubated by the
National Institute of Urban Affairs offers
348
one such model. Institutionally, there is
need to leverage information to achieve
better interagency coordination within
ULBs and with SPVs.
Logistics Sector
» Logistics is the backbone of supply
chain (management of flows of goods
from the point of origin to the point of
consumption). It includes transportation,
inventory management, warehousing,
materials handling, packaging, and
integration of information.
» Government has identified the action
points to develop this sector in an
integrated way. These action points
are—adopting new technology,
improved investment, skilling, removing
bottlenecks, improving inter-modal
transportation, automation, single
window system for giving clearances,
and simplifying processes.
Present situation:
• The logistics industry in India employs
over 22 million people (as of 2016).
The logistics sector's value grew at a
compound annual growth rate (CAGR) of
7.8% between 2011-12 and 2015-16.
• However, existing logistics costs in India
are high relative to other countries.
Logistics costs have been estimated at 14
per cent of India’s GDP relative to 9 per
cent of GDP in the United States, 11 per
cent in Japan, 12 per cent in Korea and
14.9 per cent in China.
• Recognizing the importance of logistics
for exports and development, the
government has included it in the
infrastructure subsector's harmonized
master list.
• This will ease access to credit and simplify
the approvals process for building
infrastructure in the sector.
• The government has also created a
new Logistics Division in the Ministry of
Commerce and Industry that will focus
on the integrated development of the
logistics sector.
Important objectives of
Government:
• Achieve multi-modal cargo movement
that meets global logistics requirements.
• Reduce the cost of logistics to less than
10% of GDP, down from the current level
of 14%.
• Boost the logistics market to USD215
billion by 2020, up from USD160 billion
now.
• Increase the number of jobs in the
logistics sector to 40 million by 2022-23,
up from around 22 million in 2016.
Constraints:
• Cost of logistics: Logistics costs are
still high due to difficulties securing
funding, underdeveloped infrastructure,
inadequate connectivity, and an
unfavourable modal mix.
• Lack of Coordination: Transportation,
warehousing, freight forwarding, and
value-added logistics make up the bulk
of the logistics market. Each of these is
subject to various forms of regulatory
regulation, adding to the system's
complexity. Duplicate procedures are
normal when several entities are involved.
• Warehousing capacity and fragmented
structure: Handling and warehousing
facilities are still largely un-mechanized
with manual loading, unloading,
and handling in the case of many
commodities.
• Competition and underutilized
capacity: There is no level playing field
as the public sector is provided benefits
349
that are not available to private players
such as container train operators or
foreign vessel owners, leading to limited
competition, capacity underutilization
and other inefficiencies.
• Interoperable technology across modes:
The lack of interoperability of software
systems used by the authorities governing
different modes of transport leads to
inefficiencies as it increases transit time
and the need for manual intervention
when switching modes.
• Border compliance and document
processing time: India’s average border
compliance time (including customs
regulations and mandatory inspections)
for exports is 106 hours and for imports
264 hours. India’s document processing
time (including documentary compliance
for various agencies including regulators)
is an average of 38 hours for exports and
61 hours for imports.
Solution/Way forward:
• Tariff policies need to be rationalized.
The Railways chapter provides details
on rail freight while the Civil Aviation
chapter highlights the need to determine
air cargo tariffs in a consistent manner
across airports.
• Improve the efficiency of warehouses and
their operations, especially to optimize
food storage.
• Establish an overarching body
that maintains a repository of all
transportation data. Setting up multi-
modal logistics parks will help address
issues related to underdeveloped
infrastructure, an unfavourable modal
mix and connectivity.
• There is no level playing field for private
container train operators (CTOs) vis-à-
vis the Container Corporation of India
(CONCOR). Providing shared space at
CONCOR terminals to private CTOs
will help utilize the infrastructure better.
 Similarly, opening up port terminals to
private players at a fee will enhance
capacity utilization.
• To increase efficiency and ensure
compatibility, we should gradually
adopt international standards, especially
in operations, and adopt global
benchmarking on unit load devices
such as containers and pallets. While
this will require changes in the overall
infrastructure of ships, ports, and railways,
it will help realize savings in cost, time,
and accounting.
PPP models
• Managing adequate amount of fund for
infrastructure development has been
always a challenge for India. In reform
era, the government evolved the idea of
public private partnership (PPP) for the
sector aimed at attracting investments
from the private sector (domestic as well
as foreign). A brief review of the major
PPP models (few of them are non-PPP
models, too).
• BOT-TOLL:
» The ‘Build-Operate- Transfer-Toll’ was
one of the earliest models of PPP. Other
than sharing the project cost (with the
Government), the private bidder was to
build, maintain, operate the road, and
collect toll on the vehicular traffic.
» The bid was given to the private
company offering to share maximum toll
revenue to the government. The private
party used to cover “all risks” related to—
land acquisition, construction (damage),
inflation, cost over-runs caused by
delays and commercial. The government
was responsible for only regulatory
clearances.
» Due to inherent drawbacks, this model
proved to be unsustainable for the
private bidder—undue delay in land
acquisition due to litigation, cost
over-runs and uncertainties in traffic
350
movement (commercial risk)—made the
road projects economically unviable.
• BOT-ANNUITY:
» This was an improvement over the BOT-
TOLL model, which sought to reverse
private companies' declining interest in
road projects by reducing risk for private
players.
» Apart from sharing project costs, the
private player was to build, maintain,
and operate road projects without being
responsible for collecting traffic tolls.
» The private players were offered a fixed
amount of money annually (called
‘annuity’) as compensation—the party
bidding for the minimum ‘annuity’ used
to get the project. Toll collection was the
responsibility of the Government.
» This was different from the previous
model (BOT-TOLL) in one sense— private
players were not having any commercial
risk (traffic)—but they remained very
much exposed to other risks (land
acquisition delays, inflation, cost over-
runs, construction). Even this model, over
the time proved to be unviable for the
private sector due to the leftover risks
they were exposed to.
• EPC MODEL:
» The PPP model which was seen to be
a better way out to promote the infra
projects were visibly failing by the year
2010 and Government was unable to
attract the private players towards the
road sector. It was in this backdrop that the
Engineering-Procurement-Construction
(EPC) Model was announced.
» In this model, project cost was fully
covered by the Government (it means,
it was not a PPP model and was like
normal contracts given to the bidders)
together with majority of the risks—land
acquisition, cost over-runs due to delay,
inflation and commercial.
» The private developers were supposed
 to design, construct and hand over
the road projects to the government—
maintenance, operation and toll
collection being the government’s
responsibilities.
» Contract was given to the private player
who offered to construct roads at the
quality levels. It means, the private
player in this model was only exposed to
the construction-related risks which is a
normal risk involved in any contract given
by the government to the private party.
» EPC Model could have been a temporary
way out to develop road projects as it was
fully funded by the government—reform
era had aimed to attract investment
from the private players by evolving a
‘business model’ for the road sector—
need was to develop a new PPP model.
In this backdrop we see the government
coming up with a new PPP model for
the road projects—the Hybrid Annuity
Model.
• HAM:
» The Hybrid Annuity Model (HAM) is a
cross between the EPC and the BOT-
ANNUITY models. The cost of the project
is split 40:60 between the government
and the private player in this model.
» The private player is responsible for
building and handing over the roads to
the government, which will raise tolls (if
desired)—maintenance is the private
player's responsibility until the annuity
period ends. The government pays a
fixed amount of economic compensation
(called annuity, similar to the BOT
ANNUITY model of the past) to a private
player for a set period of time (normally
15 years, though it is flexible).
» The contract is awarded to the private
player who offers the lowest annuity (in
bidding). The government covers the
majority of the major risks in this model,
including land acquisition, clearances,
351
operation, toll collection, and commercial,
while the risks of inflation and cost
overruns are shared in proportion to the
project cost sharing.
» However, the private sector is still exposed
to construction and maintenance risks
(delays from the government side in
clearances and land acquisition have
chances to enhance the degree of risks
private players are exposed to).
» But generally, this is the best PPP model
for the time being, which is devoid of
most of the flaws of past. Private sector
has shown good response to this model.
By early 2018, this model was notified by
the Government for other infra sectors
too.
• Swiss Challenge Model:
» Government of India, for the first time,
announced the use of this model for
redevelopment of railway stations in
the country (by late 2015). This is a very
flexible method of giving contracts (i.e.,
public procurement) which can be used
in PPP as well as non- PPP projects.
» In this, one bidder is asked by the
government to submit the proposal for
the project which is put in public domain.
Afterwards, several other bidders submit
their proposals aimed at improving
and beating the original (first) bidder—
finally an improved bid is selected (called
counter proposal). If the original bidder is
not able to match the counter proposal,
the project is awarded to the counter
bidder. Government has made it an
online method.
» Though, the Government of India used this
model for the first time, this has already
been used by several states by now—
Karnataka, Andhra Pradesh, Rajasthan,
Madhya Pradesh, Bihar, Punjab, and
Gujarat—for roads and housing projects.
In 2009, the Supreme Court sanctioned
the method for award of contracts.
UPSC CSE PRELIMS
Previous Years
Questions
Q.1) In India, the term "Public Key
Infrastructure is used in the context of
(a) Digital security infrastructure
(b) Food security infrastructure
(c) Health care and education
infrastructure
352
(d) Telecommunication and
transportation infrastructure
Ans. (a)
• Explanation: Public Key Infrastructure is
a technology for authenticating devices
and users in the digital space. The basic
concept is to have one or more trusted
parties digitally sign documents certifying
that a specific cryptographic key belongs
to a particular device and user.
 PREVIOUS
YEAR
QUESTIONS

353
1. Explain intra-generational and inter-
generational issues of equity from
the perspective of inclusive growth
and sustainable development. 2020
2. Define potential GDP and explain its
determinants. What are the factors
that have been inhibiting India from
realizing its potential GDP? 2020
3. What are the main constraints in
transport and marketing of agricultural
produce in India? 2020
4. What are the challenges and
opportunities of food processing sector
in the country? How can income of the
farmers be substantially increased by
encouraging food processing? 2020
5. Explain the meaning of investment
in an economy in terms of capital
formation. Discuss the factors to
be considered while designing a
concession agreement between a
public entity and a private entity. 2020
6. Explain the rationale behind the Goods
and Services Tax (Compensation to
States) Act of 2017. How has COVID-19
impacted the GST compensation fund
and created new federal tensions? 2020
7. What are the major factors responsible
for making rice-wheat system a
success? In spite of this success how has
this system become bane in India? 2020
8. Do you agree with the view that
steady GDP growth and low inflation
have left the Indian economy in
good shape? Give reasons in support
of your arguments. 2019
354
9. It is argued that the strategy of
inclusive growth is intended to meet
the objectives of inclusiveness and
sustainability together. Comment
on this statement. 2019
10. Enumerate the indirect taxes which
have been subsumed in the Goods and
Services Tax (GST) in India. Also, comment
on the revenue implications of the GST
introduced in India since July 2017. 2019
11. The public expenditure management
is a challenge to the government of
India in the context of budget-making
during the post-liberalization period.
Clarify it. 2019
12. How can biotechnology improve the
living standards of farmers? 2019
13. How far is the Integrated Farming
System (IFS) helpful in sustaining
agricultural production? 2019
14. Elaborate on the impact of the
National Watershed Project in
increasing agricultural production from
water-stressed areas. 2019
15. Elaborate on the policy taken by
the government of India to meet the
challenges of the food processing
sector. 2019
16. How was India benefited from the
contributions of Sir M.Visvesvaraya and
Dr. M. S. Swaminathan in the fields of
water engineering and agricultural
science respectively? 2019
17. What are the reformative steps taken
by the government to make food grain
distribution system more effective? 2019
18. How are the principles followed
by the NITI Aayog different from
those followed by the erstwhile
Planning Commission in India? 2018
19. Comment on the important changes
introduced in respect of the Long-
term Capital Gains Tax (LCGT) and
Dividend Distribution Tax (DDT) in
the Union Budget for 2018-2019. 2018
20. With growing energy needs should India
keep on expanding its nuclear energy
programme? Discuss the facts and fears
associated with nuclear energy. 2018
21. Access to affordable, reliable,
sustainable and modern energy is the
sine qua non to achieve Sustainable
Development Goals (SDGs). Comment
on the progress made in India in
this regard. 2018
22. How would the recent phenomena
of protectionism and currency
manipulations in world trade affect
macroeconomic stability of India? 2018
23. Sikkim is the first ‘Organic State’ in India.
What are the ecological and economical
benefits of Organic State? 2018
24. Assess the role of National Horticulture
Mission (NHM) in boosting the production,
productivity and income of horticulture
farms. How far has it succeeded in
increasing the income of farmers? 2018
25. Examine the role of supermarkets in
supply chain management of fruits,
vegetables and food items. How do they
eliminate number of intermediaries? 2018
26. How has the emphasis on certain crops
355
brought about changes in cropping
patterns in recent past? Elaborate
the emphasis on millets production
and consumption. 2018
27. What do you mean by Minimum Support
Price (MSP)? How will MSP rescue the
farmers from the low income trap? 2018
28. Among several factors for India’s
potential growth, savings rate is
the most effective one. Do you
agree? What are the other factors
available for growth potential? 2017
29. Account for the failure of manufacturing
sector in achieving the goal of labour-
intensive exports rather than capital-
intensive exports. Suggest measures
for more labour-intensive rather than
capital-intensive exports. 2017
30. What are the salient features of
‘inclusive growth’? Has India been
experiencing such a growth process?
Analyze and suggest measures for
inclusive growth. 2017
31. One of the intended objectives of
Union Budget 2017-18 is to ‘transform,
energize and clean India’. Analyse the
measures proposed in the Budget 2017-
18 to achieve the objective. 2017
32. Examine the developments of Airports
in India through Joint Ventures under
Public-Private Partnership (PPP) model.
What are the challenges faced by the
authorities in this regard. 2017
33. “Industrial growth rate has lagged
behind in the overall growth of Gross-
Domestic-Product(GDP) in the post-
reform period” Give reasons. How
far the recent changes in Industrial
 Policy are capable of increasing the
industrial growth rate? 2017
34. What are the major reasons for
declining rice and wheat yield in
the cropping system? How crop
diversification is helpful to stabilize the
yield of the crop in the system? 2017
35. Explain various types of revolutions, took
place in Agriculture after Independence
in India. How these revolutions have
helped in poverty alleviation and food
security in India? 2017
36. What are the reasons for poor
acceptance of cost effective small
processing unit? How the food processing
unit will be helpful to uplift the socio-
economic status of poor farmers? 2017
37. How do subsidies affect the cropping
pattern, crop diversity and economy
of farmers? What is the significance of
crop insurance, minimum support price
and food processing for small and
marginal farmers? 2017
38. Pradhan Mantri Jan-Dhan Yojana
(PMJDY) is necessary for bringing
unbanked to the institutional finance
fold. Do you agree with this for financial
inclusion of the poorer section of the
Indian society? Give arguments to
justify your opinion. 2016
39. Comment on the challenges for
inclusive growth which include careless
and useless manpower in the Indian
context. Suggest measures to be taken
for facing these challenges. 2016
40. Women empowerment in India needs
gender budgeting. What are the
requirements and status of gender
356
budgeting in the Indian context? 2016
41. What are ‘Smart Cities? Examine their
relevance for urban development
in India. Will it increase rural-
urban differences? Give arguments
for Smart Villages’ in the light of
PURA and RURBAN Mission. 2016
42. Justify the need for FDI for the
development of the Indian economy.
Why there is gap between MOUs signed
and actual FDIs? Suggest remedial
steps to be taken for increasing
actual FDIs in India. 2016
43. How globalization has led to the
reduction of employment in the formal
sector of the Indian economy? Is
increased informalization detrimental
to the development of the country? 2016
44. What is water-use efficiency? Describe
the role of micro-irrigation in increasing
the water-use efficiency. 2016
45. What is allelopathy? Discuss its
role in major cropping systems of
irrigated agriculture. 2016
46. Given the vulnerability of Indian
agriculture to vagaries of nature, discuss
the need for crop insurance and bring
out the salient features of the Pradhan
Mantri Fasal Bima Yojana (PMFBY). 2016
47. Discuss the role of land reforms in
agricultural development. Identify the
factors that were responsible for the
success of land reforms in India. 2016
48. The nature of economic growth in India
in described as jobless growth. Do you
agree with this view? Give arguments
in favour of your answer. 2015
49. Craze for gold in Indians have led
to a surge in import of gold in recent
years and put pressure on balance of
payments and external value of rupee.
In view of this, examine the merits
of Gold Monetization Scheme. 2015
50. “Success of ‘Make in India’ programme
depends on the success of ‘Skill India’
programme and radical labour reforms.”
Discuss with logical arguments. 2015
51. In what way could replacement of
price subsidy with Direct Benefit
Transfer (DBT) change the scenario
of subsidies in India? Discuss 2015
52. There is a clear acknowledgement
that Special Economic Zones (SEZs)
are a tool of industrial development,
manufacturing and exports. Recognizing
this potential, the whole instrumentality
of SEZs requires augmentation. Discuss
the issues plaguing the success of SEZs
with respect to taxation, governing
laws and administration. 2015
53. How can the ‘Digital India’ programme
help farmers to improve farm productivity
and income? What steps has the
Government taken in this regards? 2015
54. Livestock rearing has a big potential
for providing non-farm employment
and income in rural areas. Discuss
suggesting suitable measures to
promote this sectors in India. 2015
55. In view of the declining average size
of land holdings in India which has
made agriculture non-viable for a
majority of farmers, should contract
farming and land leasing be promoted
in agriculture? Critically evaluate
the pros and cons. 2015
357
56. What are the impediments in marketing
and supply chain management in
industry in India? Can e-commerce help
in overcoming these bottlenecks? 2015
57. Capitalism has guided the world
economy to unprecedented prosperity.
However, it often encourages
shortsightedness and contributes
to wide disparities between the
rich and the poor. In this light,
would it be correct to believe and
adopt capitalism driving inclusive
growth in India? Discuss. 2014
58. While we found India’s demographic
dividend, we ignore the dropping
rates of employability. What are
we missing while doing so? Where
will the jobs that India desperately
needs come from? Explain. 2014
59. The right to fair compensation
and transparency land acquisition,
rehabilitation and resettlement
act, 2013 has come into effect from
1 January 2014. What implication
would it have on industrialisation and
agriculture in India? 2014
60. National urban transport policy
emphasizes on moving people instead
of moving vehicles. Discuss critically
the success of various strategies of the
government in this regard. 2014
61. Explain how private public partnership
agreements, in longer gestation
infrastructure projects, can transfer
unsuitable liabilities to the future. What
arrangements need to be put in place
to ensure that successive generations’
capacities are not compromised? 2014
62. Normally countries shift from
agriculture to industry and then later to
 services, but India shifted directly from
agriculture to services. What are the
reasons for the huge growth of services
vis-a-vis industry in the country? Can
India become a developed country
without a strong industrial base? 2014
63. Foreign direct investment in the defence
sector is now said to be liberalised.
What influence this is expected to have
on Indian defence and economy in
the short and long run? 2014
64. Examine the impact of liberalization
on companies owned by Indian.
Are the competing with the MNCs
satisfactorily? 2014
65. Discuss the impact of FDI entry into
multi-trade retail sector on supply chain
management in commodity trade
pattern of the economy. 2014
66. Though India allowed foreign direct
investment (FDI) in what is called
multi brand retail through joint
venture route in September 2012, the
FDI even after a year, has not picket
up. Discuss the reasons. 2014
67. There is also a point of view
that agriculture produce market
committees (APMCs) set up under the
state acts have not only impeded the
development of agriculture but also
have been the cause of food inflation
in India. Critically examine. 2014
68. “In the villages itself no form of credit
organisation will be suitable except the
cooperative society.”: All Indian rural
credit survey. Discuss this statement
in the background of agriculture
finance in India. What constrain and
challenges do financial institutions
supplying agricultural finances? How
can technology be used to better
358
reach and serve rural clients? 2014
69. With a consideration towards the
strategy of inclusive growth, the new
companies bill, 2013 has indirectly
made CSR a mandatory obligation.
Discuss the challenges expected in
its implementation in right earnest.
Also discuss other provisions in the
bill and their implications. 2013
70. What are the reasons for introduction
of Fiscal responsibility and Budget
Management (FRBM) act, 2003?
Discuss critically its salient features and
their effectiveness. 2013
71. What is meaning of the term tax-
expenditure? Taking housing sector
as an example, discuss how it
influences budgetary policies of the
government. 2013
72. Discussion the rationale for introducing
Good and services tax in India.
Bring out critically the reasons for
delay in roll out for its regime. 2013
73. Adaptation of PPP model for
infrastructure development of the
country has not been free from
criticism. Critically discuss the
pros and cons of the model. 2013
74. India needs to strengthen measures
to promote the pink revolution in food
industry for better nutrition and health.
Critically elucidate the statement. 2013
75. Establish the relationship between land
reform, agriculture productivity and
elimination of poverty in Indian Economy.
Discussion the difficulty in designing
and implementation of the agriculture
friendly land reforms in India. 2013
76. Food security bill is expected to
eliminate hunger and malnutrition 77. What are the different types of
in India. Critically discuss various agriculture subsidies given to farmers
apprehensions in its effective at the national and state levels?
implementation along with the Critically analyze the agriculture
concerns it has generated in WTO. 2013 subsidy regime with the reference
to the distortions created by it. 2013

359
 KEY HIGHLIGHTS OF ECONOMIC SURVEY
2020-21
The Economic Survey for the Year 2020-21
was presented by Union Finance Minister in
both Houses of the Parliament. It is normally
presented a day before the Union Budget.
The key highlights of this Economic Year for
the year 2020-2021 is the following:
Saving Lives and Livelihoods
amidst a Once-in-a-Century
Crisis
1. Saving lives was the most important
task for the government in view of the
growing COVID-19 pandemic which has
resulted in more than 1 crore cases in
India. A lockdown was initiated to this
effect which resulted in a downward
spiral of the economy, which by many
estimates is expected to experience
a GDP contraction of about 7%
(according to a study by the SBI).
2. GDP growth will recover from the
temporary shock caused by the
pandemic and is expected to rebound
this Financial Year (2021-2022).
3. India’s strategy ensured that the
COVID-19 curve flattened after the
month of September. As PM had
indicated “Jaan hai toh Jahaan hai”.
4. Various Supply Chain infrastructure
problems were tackled and reforms
were undertaken as part of the reforms
undertaken under the Aatmanirbhar
Bharat Abhiyan.
5. The initiatives of the government and
the RBI also enhanced the demand side
of the economy which had remained
muted due to the economic crisis and
the lockdown throughout the nation.
360
6. A public investment programme
cantered around the National
Infrastructure Pipeline (2019-25) was
initiated to lead the recovery process.
This was in accordance with the
principles of Keynesian economics.
State of the Economy in 2020-
21: A Macro View
1. COVID-19 pandemic has severely
impacted the global economy due to
the lockdown and social distancing
norms implemented across the world.
Global economic output is estimated
to fall by 3.5% in 2020 (IMF January
2021 estimates).
2. Governments and central banks across
the world have devised various methods
such as interest rate reductions, fiscal
stimulus amongst others to revive the
economies.
3. India adopted a four-pillar strategy of
containment, fiscal, financial, and long-
term structural reforms.
4. The monetary and fiscal policies
announced by the government and the
RBI has yielded benefits to the tune of
Rs. 27.1 Lakh crores.
5. According to the NSSO estimates, after
contracting about 7% in FY 2020-2021,
the Real GDP for FY 2021-22 is expected
to grow at 11% and the Nominal GDP
to 15%. As the vaccines are rolled out,
economic activities are expected to be
normalised.
6. Government consumption and
net exports cushioned the growth
from diving further down, whereas
investment and private consumption
pulled it down.
7. The recovery in second half of FY2020-
21 is expected to be powered by
government consumption, estimated to
grow at 17% YoY.
8. Exports expected to decline by 5.8%
and imports by 11.3% in the second half
of FY21
9. India expected to have a Current
Account Surplus of 2% of GDP in FY21,
a historic high after 17 years.
10. Agriculture set to cushion the shock of
the COVID-19 pandemic on the Indian
economy in FY21 with a growth of 3.4%.
It is expected to lead the economic
recovery process, even as other sectors
such as manufacturing and service
sector have been severely impacted by
the pandemic.
11. Industry and services estimated to
contract by 9.6% and 8.8% respectively
during FY21
12. India remained a preferred investment
destination in FY 2020-21 with FDI
pouring in amidst global asset shifts
towards equities and prospects
of quicker recovery in emerging
economies.
13. Net FPI inflows recorded an all-time
monthly high of US$ 9.8 billion in
November 2020, as investors’ risk
appetite returned. India remained
a bright spot amongst emerging
economies as it continued to receive
copious amounts of FII.
14. Reignited inter and intra state
movement and record-high monthly
GST collections have marked the
unlocking of industrial and commercial
activity. These are considered as some
of the green shots of the improving
economy.
15. The external sector provided an
effective cushion to growth with India
recording a Current Account Surplus of
3.1% of GDP in the first half of FY21.
361
16. Strong services exports and weak
demand leading to a sharper
contraction in imports (merchandise
imports contracted by 39.7%) than
exports (merchandise exports
contracted by 21.2%)
17. FOREX reserves increased to a level so
as to cover 18 months’ worth of imports
in December 2020
18. External debt as a ratio to GDP
increased to 21.6% at end-September
2020 from 20.6% at end-March 2020.
Does Growth lead to Debt
Sustainability?
• Growth leads to debt sustainability in the
Indian context but not necessarily vice-
versa:
» Debt sustainability depends on the
‘Interest Rate Growth Rate Differential’
(IRGD), i.e., the difference between the
interest rate and the growth rate.
− In India, interest rate on debt is less
than growth rateby norm, not by
exception.
• Negative IRGD in India is not due to
lower interest rates but much higher
growth rates. This prompts a debate on
fiscal policy, especially during growth
slowdowns and economic crises.
• Growth causes debt to become
sustainable in countries with higher
growth rates; such clarity about the
causal direction is not witnessed in
countries with lower growth rates.
• During pandemic like situations, higher
fiscal deficit is witnessed. Nations with
higher fiscal deficit who also experience
higher growth rates have not much to
worry about.
Does India’s Sovereign
Credit Rating Reflect Its
Fundamentals? No!
• The fifth largest economy in the world
has never been rated as the lowest rung
of the investment grade (BBB-/Baa3) in
sovereign credit ratings:
» Reflecting the economic size and thereby
the ability to repay debt, the fifth largest
economy has been predominantly rated
AAA.
− China and India are the only
exceptions to this rule. China was
rated A-/A2 in 2005 and now India is
rated BBB-/Baa3
• India’s sovereign credit ratings do not
reflect its fundamentals:
• Credit ratings map the probability
of default and therefore reflects the
willingness and ability of borrower to
meet its obligations:
• India has never defaulted in the past and
the size of its foreign exchange reserves
are enough to satisfy analysts of its
credentials.
• Sovereign credit rating changes for
India have no or weak correlation with
macroeconomic indicators.
• Sovereign credit ratings methodology
should be made more transparent, less
subjective and better attuned to reflect
economies’ fundamentals.
• The PM has in the past reiterated the
importance for nations, especially in the
BRICS grouping to have a separate rating
agency that can correctly identify issues
and provide a more accurate analysis of
various issues.
Inequality and Growth:
Conflict or Convergence?
• The relationship between inequality
362
and socio-economic outcomes vis-à-vis
economic growth and socio-economic
outcomes, is different in India from that
in advanced economies.
• Inequality and Per Capita Incomes have a
similar relationship in India as compared
to the rest of the world.
• It is only economic growth that will led
to poverty alleviation and reduction in
inequalities.
• Expanding the overall pie: redistribution
in a developing economy is feasible only
if the size of the economic pie grows.
It is generally estimated that a GDP growth
of 1% leads to a poverty reduction of 1.5%.
Healthcare takes centre stage,
finally!
• COVID-19 pandemic emphasized the
importance of healthcare sector and
its inter-linkages with other sectors.
It has showcased how a health crisis
transformed into an economic and social
crisis.
• National Health Mission (NHM) played a
critical role in mitigating inequity as the
access of the poorest to pre-natal/post-
natal care and institutional deliveries
increased significantly.
• Emphasis on NHM in conjunction with
Ayushman Bharat should continue.
• An increase in public healthcare spending
from 1% to 2.5-3% of GDP can decrease
the out-of-pocket expenditure from 65%
to 35% of overall healthcare spending.
• A regulator for the healthcare sector must
be considered given the market failures
stemming from information asymmetry.
• Telemedicine needs to be harnessed
to the fullest by investing in internet
connectivity and health infrastructure.
Process Reforms
• India over-regulates the economy
resulting in regulations being ineffective
even with relatively good compliance
with process.
• Increase in complexity of regulations,
intended to reduce discretion, results in
even more non-transparent discretion.
• The solution is to simplify regulations
and invest in greater supervision which,
by definition, implies greater discretion.
• Discretion, however, needs to be balanced
with transparency, systems of ex-ante
accountability and ex-post resolution
mechanisms.
• The above intellectual framework has
already informed reforms ranging from
labour codes to removal of onerous
regulations on the BPO sector.
Regulatory Forbearance an
emergency medicine, not staple
diet!
• During the Global Financial Crisis,
regulatory forbearance helped borrowers’
tide over temporary hardship.
• Banks exploited the forbearance window
for window-dressing their books and
misallocated credit, thereby damaging
the quality of investment in the economy.
• Forbearance represents emergency
medicine that should be discontinued at
the first opportunity when the economy
exhibits recovery, not a staple diet that
gets continued for years.
• An Asset Quality Review exercise must
be conducted immediately after the
forbearance is withdrawn.
Innovation: Trending Up but
Needs Thrust, Especially from
the Private Sector
• India entered the top-50 innovating
countries for the first time in 2020 since
363
the inception of the Global Innovation
Index in 2007, ranking first in Central
and South Asia, and third amongst lower
middle-income group economies.
• India’s gross domestic expenditure on
R&D (GERD) is lowest amongst top ten
economies. It is at less than 1% of the
GDP.
• The government sector contributes a
disproportionately large share in total
GERD at three times the average of top
ten economies.
• The business sector’s contribution
to GERD, total R&D personnel and
researchers is amongst the lowest when
compared to top ten economies.
• This situation has prevailed despite
higher tax incentives for innovation and
access to equity capital.
• India’s business sector needs to
significantly ramp up investments in
R&D.
• Indian resident’s share in total patents
filed in the country must rise from the
current 36% which is much below the
average of 62% in top ten economies.
• For achieving higher improvement in
innovation output, India must focus
on improving its performance on
institutions and business sophistication
innovation inputs.
JAY Ho! PM‘JAY’ Adoption and
Health outcomes
• Pradhan Mantri Jan Arogya Yojana (PM-
JAY) is the ambitious program launched
by Government of India in 2018 to provide
healthcare access to the most vulnerable
sections demonstrates strong positive
effects on healthcare outcomes in a
short time.
• PM-JAY is being used significantly for
high frequency, low-cost care such
as dialysis and continued during the
COVID-19 pandemic and the lockdown.
• Causal impact of PM-JAY on health
outcomes by undertaking a Difference-
in-Difference analysis based on National
Family Health Survey (NFHS)-4 (2015-16)
and NFHS-5 (2019-20) is following:
» Enhanced health insurance coverage:
The proportion of households that had
health insurance increased in Bihar,
Assam and Sikkim from 2015-16 to 2019-
20 by 89% while it decreased by 12%
over the same period in West Bengal.
» Decline in Infant Mortality rate: from
2015-16 to 2019-20, infant mortality rates
declined by 20% for West Bengal and by
28% for the three neighbouring states.
» Decline in under-5 mortality rate: Bengal
saw a fall of 20% while, the neighbours
witnessed a 27% reduction.
» Modern methods of contraception,
female sterilization and pill usage went
up by 36%, 22% and 28% respectively in
the three neighbouring states while the
respective changes for West Bengal were
negligible.
» While West Bengal did not witness any
significant decline in unmet need for
spacing between consecutive kids, the
neighbouring three states recorded a
37% fall.
» Various metrics for mother and child care
improved more in the three neighbouring
states than in West Bengal.
Bare Necessities
• Access to the ‘bare necessities’ has
improved across all States in the country
in 2018 as compared to 2012
− It is highest in States such as Kerala,
Punjab, Haryana and Gujarat while
lowest in Odisha, Jharkhand, West
Bengal and Tripura.
− Improvement in each of the
five dimensions viz., access to
water, housing, sanitation, micro-
364
environment and other facilities.
− Inter-State disparities declined across
rural and urban areas as the laggard
states have gained relatively more
between 2012 and 2018
• Improved access to the ‘bare necessities’
has led to improvements in health
indicators such as infant mortality and
under-5 mortality rate and also correlates
with future improvements in education
indicators.
• Thrust should be given to reduce variation
in the access to bare necessities across
states, between rural and urban and
between income groups.
• The schemes such as Jal Jeevan Mission,
SBM-G, PMAY-G, etc., may design
appropriate strategy to reduce these
gaps.
• A Bare Necessities Index (BNI) based
on the large annual household survey
data can be constructed using suitable
indicators and methodology at district
level for all/targeted districts to assess the
progress on access to bare necessities.
Fiscal Developments
• India adopted a calibrated approach
best suited for a resilient recovery of
its economy from COVID-19 pandemic
impact, in contrast with a front-loaded
large stimulus package adopted by many
countries.
• Expenditure policy in 2020-21 initially
aimed at supporting the vulnerable
sections but was re-oriented to boost
overall demand and capital spending,
once the lockdown was unwound.
• Monthly GST collections have crossed
the Rs. 1 lakh crore mark consecutively
for the last 3 months, reaching its highest
levels in December 2020 ever since the
introduction of GST.
• Reforms in tax administration have
begun a process of transparency and
 accountability and have incentivized tax
compliance by enhancing honest tax-
payers’ experience.
• Central Government has also taken
consistent steps to impart support to the
States in the challenging times of the
pandemic.
External Sector
• COVID-19 pandemic led to a sharp
decline in global trade, lower commodity
prices and tighter external financing
conditions with implications for current
account balances and currencies of
different countries.
• India’s FOREX reserves at an all-time
high of US$ 586.1 billion as on January
08, 2021, covering about 18 months’ worth
of imports.
• India experiencing a Current Account
Surplus along with robust capital inflows
leading to a BoP surplus since Q4 of
FY2019-20.
• Balance on the capital account is
buttressed by robust FDI and FPI inflows:
− Net FDI inflows of US$ 27.5 billion
during April-October, 2020: 14.8%
higher as compared to first seven
months of FY2019-20
− Net FPI inflows of US$ 28.5 billion during
April-December, 2020 as against US$
12.3 billion in corresponding period of
last year.
• India to end with an Annual Current
Account Surplus after a period of 17
years.
• India’s merchandise trade deficit
was lower at US$ 57.5 billion in April-
December, 2020 as compared to US$
125.9 billion in the corresponding period
last year.
• In April-December, 2020, merchandise
exports contracted by 15.7% to US$
200.8 billion from US$ 238.3 billion in
April-December, 2019:
365
• Total merchandise imports declined by
(-) 29.1% to US$ 258.3 billion during April-
December, 2020 from US$ 364.2 billion
during the same period last year.
• Trade balance with China and the US
improved as imports slowed.
• Net services receipts amounting to US$
41.7 billion remained stable in April-
September 2020 as compared with US$
40.5 billion in corresponding period a
year ago.
• Resilience of the services sector was
primarily driven by software services,
which accounted for 49% of total services
exports.
• Net private transfer receipts, mainly
representing remittances by Indians
employed overseas, totalling US$ 35.8
billion in H1: FY21 declined by 6.7% over
the corresponding period of previous
year.
• At end-September 2020, India’s external
debt around US$ 556.2 billion, a decrease
of US$ 2.0 billion (0.4%) as compared to
end-March 2020.
• Improvement in debt vulnerability
indicators:
− Ratio of FOREX reserves to total and
short-term debt (original and residual)
− Ratio of short-term debt (original
maturity) to the total stock of external
debt.
− Debt service ratio (principal
repayment plus interest payment)
increased to 9.7% as at end-
September 2020, compared to 6.5%
as at end-March 2020
• Rupee appreciation/depreciation:
− in terms of 6-currency nominal
effective exchange rate (NEER) (trade-
based weights), Rupee depreciated by
4.1% in December 2020 over March
2020; appreciated by 2.9% in terms
of real effective exchange rate (REER)
 − in terms of 36-currency NEER (trade-
based weights), Rupee depreciated by
2.9% in December 2020 over March
2020; appreciated by 2.2% in terms of
REER.
• RBI’s interventions in FOREX markets
ensured financial stability and orderly
conditions, controlling the volatility and
one-sided appreciation of the Rupee.
• Initiatives undertaken to promote
exports:
− Production Linked Incentive (PLI)
Scheme.
− Remission of Duties and Taxes on
Exported Products (RoDTEP)
− Improvement in logistics infrastructure
and digital initiatives.
Money Management and
Financial Intermediation
• Accommodative monetary policy during
2020: Repo Rate cut by 115 bps since
March 2020.
• RBI undertook various conventional and
unconventional measures like:
− Open Market Operations.
− Long Term Repo Operations.
− Targeted Long Term Repo Operations.
• Gross Non-Performing Assets ratio of
Scheduled Commercial Banks decreased
from 8.21% at end-March, 2020 to 7.49%
at end-September, 2020.
• The monetary transmission of lower
policy rates to deposit and lending rates
improved during FY2020-21.
• The recovery rate for the Scheduled
Commercial Banks through IBC (since its
inception) has been over 45%
366
Prices and Inflation
• Headline CPI inflation:
− Averaged 6.6% during April-
December, 2020 and stood at 4.6% in
December, 2020, mainly driven by rise
in food inflation (from 6.7% in 2019-20
to 9.1% during April-December, 2020,
owing to build up in vegetable prices).
− CPI headline and its sub groups
witnessed inflation during April-
October 2020. It was driven by
substantial increase in price
momentum due to the initial
disruptions caused by COVID-19
lockdown.
− Moderated price momentum by
November, 2020 for most sub groups,
coupled with positive base effect
helped ease inflation.
• Rural-urban difference in CPI inflation
saw a decline in 2020:
• During April-December, 2019 as well
as April-December, 2020-21, the major
driver of CPI-C inflation was the food
and beverages group:
» Contribution increased to 59% during
April-December, 2020, compared to
53.7% during April-December, 2019
• Thali cost increased between June 2020
and November 2020, however a sharp fall
in the month of December reflecting the
fall in the prices of many essential food
commodities. Concept of Thalinomics
was given in the previous Economic
Survey.
• Steps taken to stabilize prices of food
items:
» Banning of export of onions.
» Imposition of stock limit on onions.
» Easing of restriction on imports of pulses.
• Gold prices:
» Sharp spike as investors turned to gold as
a safe haven investment amid COVID-19
induced economic uncertainties.
» Compared to other assets, gold had
considerably higher returns during
FY2020-21.
• Consistency in import policy warrants
attention:
» Increased dependence on imports of
edible oils poses risk of fluctuations in
import prices.
» Imports impacting production and prices
of domestic edible oil market, coupled
with frequent changes in import policy of
pulses and edible oils, add to confusion
among farmers/producers and delay
imports.
Sustainable Development and
Climate Change
• India has taken several proactive steps to
mainstream the SDGs into the policies,
schemes and programmes.
• Localisation of SDGs is crucial to any
strategy aimed at achieving the goals
under the 2030 Agenda.
» Several States/UTs have created
institutional structures for implementation
of SDGs.
• Sustainable development remains core
to the development strategy despite
the unprecedented COVID-19 pandemic
crisis.
• Eight National Missions under National
Action Plan on Climate Change (NAPCC)
focussed on the objectives of adaptation,
mitigation and preparedness on climate
risks.
• India’s Nationally Determined
Contributions (NDC) states that finance
is a critical enabler of climate change
action.
367
• The financing considerations will
therefore remain critical especially as the
country steps up the targets substantially.
• The goal of jointly mobilizing US$
100 billion a year by 2020 for climate
financing by the developed countries has
remained elusive.
• Despite overall growth in the global
bond markets, green bond issuance in
the first half of 2020 slowed down from
2019, possibly as a result of the on-going
COVID-19 pandemic.
• International Solar Alliance (ISA)
launched two new initiatives, ‘World
Solar Bank’ and ‘One Sun One World
One Grid Initiative’, which are poised
to bring about solar energy revolution
globally.
Agriculture and Food
Management
• India’s Agricultural (and Allied Activities)
sector has shown its resilience amid
the adversities of COVID-19 induced
lockdowns with a growth of 3.4% at
constant prices during 2020-21 (first
advance estimate).
• The share of Agriculture and Allied
Sectors in Gross Value Added (GVA) of the
country at current prices is 17.8% for the
year 2019-20 (CSO-Provisional Estimates
of National Income, 29th May, 2020).
• Total food grain production in the
country in the agriculture year 2019-20
(as per Fourth Advance Estimates), is 11.44
million tonnes more than during 2018-19.
• The actual agricultural credit flow was
₹13,92,469.81 crores against the target of
₹13,50,000 crores in 2019-20. The target
for 2020-21 was ₹15,00,000 crores and a
sum of ₹ 9,73,517.80 crores was disbursed
till 30th November, 2020:
» 1.5 crore dairy farmers of milk cooperatives
and milk producer companies were
targeted to provide Kisan Credit
 Cards (KCC) as part of Prime Minister’s
AatmaNirbhar Bharat Package after the
budget announcement of February 2020.
» As of mid-January 2021, a total of 44,673
Kisan Credit Cards (KCCs) have been
issued to fishers and fish farmers and an
additional 4.04 lakh applications from
fishers and fish farmers are with the
banks at various stages of issuance.
• The Pradhan Mantri Fasal Bima Yojana
covers over 5.5 crore farmer applications
year on year.
» Claims worth Rs. 90,000 crores paid, as
on 12th January, 2021.
» Speedy claim settlement directly into the
farmer accounts through Aadhar linkage.
» 70 lakh farmers benefitted and claims
worth Rs. 8741.30 crores were transferred
during COVID-19 lock down period.
• An amount of Rs. 18000 crores have been
deposited directly in the bank accounts
of 9 crore farmer families of the country
in December, 2020 in the 7th installment
of financial benefit under the PM-KISAN
scheme.
• Fish production reached an all-time high
of 14.16 million metric tons during 2019-20:
» GVA by the Fisheries sector to the national
economy stood at ₹2,12,915 crores
constituting 1.24% of the total national
GVA and 7.28 % of the agricultural GVA.
• Food Processing Industries (FPI) sector
growing at an Average Annual Growth
Rate (AAGR) of around 9.99 % as
compared to around 3.12 % in Agriculture
and 8.25 % in Manufacturing at 2011-
12 prices during the last 5 years ending
2018-19.
• Pradhan Mantri Garib Kalyan Anna
Yojana:
» 80.96 crore beneficiaries were provided food
grains above NFSA mandated requirement
free of cost till November, 2020.
368
» Over 200 LMT of food grains were
provided amounting to a fiscal outgo of
over Rs. 75000 Crores.
• Aatmanirbhar Bharat Package: 5 kg per
person per month for four months (May
to August) to approximately 8 crores
migrants (excluded under NFSA or state
ration card) entailing subsidy of Rs. 3109
crores approximately.
Industry and Infrastructure
• The broad-based recovery in the IIP
resulted in a growth of (-) 1.9 % in Nov-
2020 as compared to a growth of 2.1 %
in Nov-2019 and a nadir of (-) 57.3 % in
Apr-2020.
• Further improvement and firming up in
industrial activities are foreseen with
the Government enhancing capital
expenditure, the vaccination drive
and the resolute push forward on long
pending reform measures.
• Aatma Nirbhar Bharat Abhiyan with a
stimulus package worth 15 % of India’s
GDP announced.
• India’s rank in the Ease of Doing Business
(EoDB) Index for 2019 has moved upwards
to the 63rd position in 2020 from 77th in
2018 as per the Doing Business Report
(DBR):
» India has improved its position in 7 out of
10 indicators.
» Acknowledges India as one of the top 10
improvers, the third time in a row, with an
improvement of 67 ranks in three years.
» It is also the highest jump by any large
country since 2011.
• Government has announced a
Production-Linked Incentive (PLI) Scheme
in the 10 key sectors under the aegis of
AatmaNirbhar Bharat for enhancing
India’s manufacturing capabilities and
exports:
» To be implemented by the concerned
ministries with an overall expenditure
estimated at Rs.1.46 lakh crores and with
sector specific financial limits.
Services Sector
• India’s services sector contracted by
nearly 16 % during H1: FY2020-21, during
the COVID-19 pandemic mandated
lockdown, owing to its contact-intensive
nature.
• Key indicators such as Services
Purchasing Managers’ Index, rail freight
traffic, and port traffic, are all displaying
a V-shaped recovery after a sharp decline
during the lockdown.
• Despite the disruptions being witnessed
globally, FDI inflows into India’s services
sector grew robustly by 34% Y-o-Y during
April-September 2020 to reach US$ 23.6
billion.
• The services sector accounts for over 54
% of India’s GVA and nearly four-fifths
of total FDI inflow into India.
• The sector’s share in GVA exceeds 50%
in 15 out of 33 States and UTs, and is
particularly more pronounced (greater
than 85%) in Delhi and Chandigarh.
• Services sector accounts for 48% of total
exports, outperforming goods exports in
the recent years.
• The shipping turnaround time at ports
has almost halved from 4.67 days in
2010-11 to 2.62 days in 2019-20.
• The Indian start-up ecosystem has been
progressing well amidst the COVID-19
pandemic. India being home to 38
unicorns, it added a record number of 12
start-ups to the unicorn list last year.
• India’s space sector has grown
exponentially in the past six decades:
» Spent about US$ 1.8 billion on space
programmes in 2019-20.
» Space ecosystem is undergoing several
369
policy reforms to engage private players
and attract innovation and investment.
Social Infrastructure,
Employment and Human
Development
• The combined (Centre and States) social
sector expenditure as % of GDP has
increased in 2020-21 compared to last
year.
• India’s rank in HDI 2019 was recorded at
131, out of a total 189 countries:
» India's GNI per capita (2017 PPP $) has
increased from US$ 6,427 in 2018 to US$
6,681 in 2019.
» Life expectancy at birth improved from
69.4 years in 2018 to 69.7 years in 2019.
• The access to data network, electronic
devices such as computer, laptop, smart
phone etc. gained importance due to
online learning and remote working
during the pandemic.
• Major proportion of workforce engaged
as regular wage/salaried in the urban
sector during the period of January
2019-March 2020 (quarterly survey of
PLFS).
• Government’s incentive to boost
employment through AatmaNirbhar
Bharat Rozgar Yojana and rationalization
and simplification of existing labour
codes into 4 codes.
• Low level of female LFPR in India:
» Females spending disproportionately
more time on unpaid domestic and care
giving services to household members
as compared to their male counterparts
(Time Use Survey, 2019).
» Need to promote non-discriminatory
practices at the workplace like pay
and career progression, improve work
incentives, including other medical
 and social security benefits for female
workers.
• Under PMGKP announced in March,
2020, cash transfers of up to Rs.1000 to
existing old aged, widowed and disabled
beneficiaries under the National Social
Assistance Programme (NSAP).
• An amount of Rs. 500 each was transferred
for three months digitally into bank
accounts of the women beneficiaries
under PM Jan Dhan Yojana, totalling
about Rs. 20.64 crores.
• Free distribution of gas cylinders to about
8 crore families for three months.
• Limit of collateral free lending increased
from Rs. 10 lakhs to Rs. 20 lakhs for 63
lakh women SHGs which would support
6.85 crore households.
370
• Wages under Mahatma Gandhi NREGA
increased by Rs.20 from Rs.182 to Rs.202
w.e.f. 1st April, 2020.
India’s fight against COVID-19:
• Initial measures of lockdown, social
distancing, travel advisories, practicing
hand wash, wearing masks reduced the
spread of the disease.
• As part of its self-reliance campaign
or Aatmanirbharta, the country is now
manufacturing its own devices such as
surgical instruments, PPE suits, vaccines
and more.
• World’s largest COVID-19 vaccination
drive commenced on 16th January, 2021
using two indigenously manufactured
vaccines.
 REFERENCES
1. https://www.indiabudget.gov.in/economicsurvey/ 11. https://www.thehindu.com/business/

2. https://www.rbi.org.in/ 12. https://indianexpress.com/

3. https://finmin.nic.in/ 13. Indian Economy by Mishra and Puri

4. h t t p s : // p i b . g o v . i n / P r e s s R e l e a s e P a g e . 14. Development Economics by H L Ahuja

aspx?PRID=1693231

15. Macroeconomics by H. L. Ahuja

5. NCERT Class IX: Economics.

16. Indian Economy by Datt and Sundaram

6. NCERT Class X: Understanding Economic
Development.
17. Economic and Political Weekly

7. NCERT Class XI: Indian Economic Development.

18. Budget 2020 and 2021

8. NCERT Class XII: Introductory Microeconomics.

19. Economic Survey 2020-21

9. NCERT Class XII: Introductory Macroeconomics

10. https://www.livemint.com/

371
 AUTHOR'S NOTE
This book tries to exhaustively cover the complete syllabus of UPSC CSE Preliminary &
Mains examination in an integrated approach for “Economy”. The purpose is to enable
the learners to correctly approach and solve the questions asked and thereby achieve
top ranks in UPSC CSE Examination.

Despite being exhaustive, we have tried to be as precise and accurate as we can to

supplement your smart study. We have tried to include recent events within and outside
India relevant for the CSE examination and present it in a manner in which UPSC
examination demands. The current issues have been linked with the static portion of the
syllabus (wherever possible) so as to develop a better understanding and have a better
grasp over the subject. The aim is to ensure that learners develop a knack of identifying
important subjects and topics from newspapers and magazines thereby saving their
precious time that usually gets wasted in reading the irrelevant stuff.

All this will not only prepare learners for the examination but also give a better
understanding of events happening around us in the society, polity, economy, global
affairs and prepare them for the challenges that they will have to tackle after clearing
the examination.

However, there is always scope for further improvement. It may so happen that learners
might have some suggestions about further improving the quality of the book. Such
suggestions would not only help us in assisting better but also the future learners to
do well. Any such suggestions would be welcome and can be communicated at
upscnotessuggestions@unacademy.com

Vinod Subramanian, Rahul Patil, Suraj Singh have contributed to the creation of the
content in the book. With their profound experience in the field of UPSC and in the field,
they were responsible for selection of topics, content creation and editing of the content
in the notes.

We wish you all the success in your efforts towards UPSC CSE Examination.

Team UNACADEMY

UPSC | Economy

372
UPSC | Economy