Economic Environment

Economic Environment
Board of Studies
Prof. H. N. Verma Prof. M. K. Ghadoliya

Vice- Chancellor Director,
Jaipur National University, Jaipur School of Distance Education and Learning
Jaipur National University, Jaipur
Dr. Rajendra Takale
Prof. and Head Academics
SBPIM, Pune
___________________________________________________________________________________________
Subject Expert Panel
Dr. Daniel J. Penkar Vijayalakshmi R.H

Director, SBS, Sinhgad Subject Matter Expert
Pune
___________________________________________________________________________________________
Content Review Panel
Shreya Saraf
Subject Matter Expert
___________________________________________________________________________________________
Copyright ©
This book contains the course content for Economic Environment.
First Edition 2013
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Index
I. Content....................................................................... II
II. List of Figures..........................................................VI
III. List of Tables........................................................ VII
IV. Abbreviations......................................................VIII
V. Case Study.............................................................. 114
VI. Bibliography......................................................... 118
VII. Self Assessment Answers................................... 121
Book at a Glance
I
Contents
Chapter I........................................................................................................................................................ 1
Economic and Non-Economic Environment.............................................................................................. 1
Aim................................................................................................................................................................. 1
Objectives....................................................................................................................................................... 1
Learning outcome........................................................................................................................................... 1
1.1 Introduction............................................................................................................................................... 2
1.2 Objectives of the Study of Economic Environment................................................................................. 2
1.3 Non-Economic Environment.................................................................................................................... 2
1.4 Technological Environment...................................................................................................................... 4
1.5 Demographic Environment....................................................................................................................... 4
1.6 Natural Environment................................................................................................................................. 4
1.7 External Environment............................................................................................................................... 5
1.7.1 Micro-environment................................................................................................................... 5
1.7.2 Macro-environment.................................................................................................................. 5
1.8 Economic Environment............................................................................................................................ 6
1.8.1 Various Components of Economic Environment...................................................................... 6
1.9 Non-Economic Environmental Factors..................................................................................................... 6
1.9.1 Socio-cultural Environment...................................................................................................... 7
1.9.2 Political-Legal Environment..................................................................................................... 8
1.10 Economic Planning................................................................................................................................. 8
1.11 Need for Planning in Underdeveloped Countries................................................................................... 9
1.12 The Structure of the Planning Commission of India ........................................................................... 10
1.12.1 Functions................................................................................................................................11
1.12.2 Functional Area......................................................................................................................11
1.13 Objectives of Planning Commission......................................................................................................11
1.14 Tenth Five Year Plan............................................................................................................................. 12
1.14.1 Approach, Strategy and Policy Reforms during the Tenth Five Year Plan........................... 13
1.14.2 Overview of Performance during the Tenth Five Year Plan................................................. 13
1.14.3 Achievements during the Tenth Five Year Plan.................................................................... 14
1.15 Approach and Strategy for the Eleventh Five Year Plan....................................................................... 14
1.16 Comparison between Tenth and Eleventh Five Year Plan.................................................................... 15
Summary...................................................................................................................................................... 17
References.................................................................................................................................................... 17
Recommended Reading.............................................................................................................................. 17
Self Assessment............................................................................................................................................ 18
Chapter II.................................................................................................................................................... 20
Problems of Indian Economy..................................................................................................................... 20
Aim............................................................................................................................................................... 20
Objectives..................................................................................................................................................... 20
Learning outcome......................................................................................................................................... 20
2.1 Introduction............................................................................................................................................. 21
2.2 Current Population of India.................................................................................................................... 21
2.3 Population of India: Pre-Independence Era............................................................................................ 21
2.4 Population: Post Independence Period.................................................................................................... 21
2.5 Present scenario: The Facts..................................................................................................................... 22
2.6 Implication of Growing Population in India........................................................................................... 22
2.7 How to Combat Population Growth India?............................................................................................ 23
2.8 Demographic Trends in India.................................................................................................................. 23
2.9 Causes of Rapid Growth of Population.................................................................................................. 23
2.10 Effect of Population Growth on Indian Economic Development......................................................... 24
2.11 Poverty.................................................................................................................................................. 25
2.11.1 Poverty in India..................................................................................................................... 25
II
2.12 Unemployment...................................................................................................................................... 26
2.12.1 Types of unemployment........................................................................................................ 26
2.13 Parallel Economy.................................................................................................................................. 27
2.14 Balance of Payments (BoP).................................................................................................................. 30
2.14.1 A Simple Three-Item Model of the Balance of Payments.................................................... 30
Summary...................................................................................................................................................... 32
References.................................................................................................................................................... 32
Self Assessment . ......................................................................................................................................... 33
Chapter III................................................................................................................................................... 35
Economic Policies........................................................................................................................................ 35
Aim............................................................................................................................................................... 35
Objectives..................................................................................................................................................... 35
3.1 Introduction............................................................................................................................................. 36
3.2 Objective of Policy................................................................................................................................. 36
3.3 Growth Performance............................................................................................................................... 37
3.4 Fiscal Policy . ......................................................................................................................................... 38
3.4.1 Objectives of Fiscal Policy .................................................................................................... 38
3.4.2 Fiscal Policy Tools.................................................................................................................. 38
3.5 Monetary Policy . ................................................................................................................................... 38
3.5.1 Objectives of Monetary Policy............................................................................................... 39
3.6 Instruments of the Monetary Policy........................................................................................................ 40
3.6.1 Liquidity Management . ......................................................................................................... 40
3.6.2 Interest Rate Management ..................................................................................................... 40
3.6.3 Foreign Exchange Management ............................................................................................ 41
3.7 Difference between Fiscal Policy and Monetary Policy......................................................................... 41
3.7.1 Foreign Investment Policy...................................................................................................... 41
Summary...................................................................................................................................................... 44
References.................................................................................................................................................... 44
Self Assessment............................................................................................................................................ 45
Chapter IV................................................................................................................................................... 47
Industrial Development and Industrial Policy......................................................................................... 47
Aim............................................................................................................................................................... 47
Objectives..................................................................................................................................................... 47
4.1 Industrial Performance and Policies....................................................................................................... 48
4.2 Problems Related to Industrial Growth (A Critical Analysis)................................................................ 48
4.3 Policy Initiatives Taken........................................................................................................................... 49
4.4 Indian Public Sector- Performance ........................................................................................................ 50
4.5 Financing Development ......................................................................................................................... 51
4.6 Equity and Social Justice ....................................................................................................................... 53
4.7 Meaning and Concept of Cottage and Small Scale Industries................................................................ 54
4.8 Cottage and Small Scale Industries - The Underlying differences......................................................... 56
Summary...................................................................................................................................................... 57
References.................................................................................................................................................... 57
Self Assessment............................................................................................................................................ 59
III
Chapter V..................................................................................................................................................... 61
India: Foreign Trade Policy....................................................................................................................... 61
Aim............................................................................................................................................................... 61
Objectives..................................................................................................................................................... 61
5.1 Introduction............................................................................................................................................. 62
5.2 Regional and Bilateral Trade Agreements.............................................................................................. 62
5.3 World Bank Involvement........................................................................................................................ 62
5.4 World Bank Reports................................................................................................................................ 62
5.5 The IMF, World Bank and WTO ........................................................................................................... 63
5.6 How the IMF, World Bank and WTO Work Together?.......................................................................... 64
5.7 WTO, IMF and World Bank are Undemocratic . .................................................................................. 65
5.8 Structural Adjustment Programs (SAPs) .............................................................................................. 65
5.9 WTO Trade Agreements ........................................................................................................................ 66
5.10 Sharing the World’s Resources and Decommissioning the IMF, World Bank .................................... 67
5.11 A Means to Improve International Trade.............................................................................................. 69
5.12 How Sharing Would Affect the Global Economy?............................................................................... 69
5.12.1 Aid and Development ......................................................................................................... 69
5.12.2 International Trade . ............................................................................................................. 69
5.12.3 International Finance ........................................................................................................... 70
Summary...................................................................................................................................................... 71
References.................................................................................................................................................... 71
Self Assessment............................................................................................................................................ 72
Chapter VI................................................................................................................................................... 74
Financial System in India: Structure and Evolution............................................................................... 74
Aim............................................................................................................................................................... 74
Objectives..................................................................................................................................................... 74
6.1 Introduction............................................................................................................................................. 75
6.2 Evolution of the Financial Environment................................................................................................. 75
6.3 Financial Intermediation: Pattern and Institutions.................................................................................. 77
6.4 Financial Institutions............................................................................................................................... 78
6.4.1 Commercial banks.................................................................................................................. 78
6.4.2 Other financial institutions...................................................................................................... 78
6.5 Structure and Evolution of Financial Markets........................................................................................ 79
6.5.1 Money Market......................................................................................................................... 80
6.5.2 Credit market.......................................................................................................................... 82
6.5.3 Capital Market........................................................................................................................ 83
6.6 Government Securities Market............................................................................................................... 84
6.7 Foreign Exchange Market....................................................................................................................... 85
Summary...................................................................................................................................................... 87
References.................................................................................................................................................... 87
Self Assessment............................................................................................................................................ 88
Chapter VII................................................................................................................................................. 90
Changing Role of Government.................................................................................................................. 90
Aim............................................................................................................................................................... 90
Objectives..................................................................................................................................................... 90
7.1 Introduction . .......................................................................................................................................... 91
7.2 Role of Government in Capitalist Economies ....................................................................................... 92
7.2.1 Unrealistic Assumptions......................................................................................................... 92
IV
7.2.2 Lacunae in Performance ........................................................................................................ 93
7.3 Pitfalls of Communism .......................................................................................................................... 94
7.3.1 Good produced not in line with consumer’s preferences ...................................................... 94
7.3.2 Difficulties in training martial balancing . ............................................................................. 94
7.3.3 Outdated technologies ........................................................................................................... 95
7.4 Indian Experience .................................................................................................................................. 95
7.5 Emerging Consensus on the Changed Role of Government . ................................................................ 96
Summary...................................................................................................................................................... 97
References.................................................................................................................................................... 97
Self Assessment............................................................................................................................................ 98
Chapter VIII.............................................................................................................................................. 100

Structural Dimensions of Indian Economy............................................................................................ 100
Aim............................................................................................................................................................. 100
Objectives................................................................................................................................................... 100
Learning outcome....................................................................................................................................... 100
8.1 Introduction........................................................................................................................................... 101
8.2 Economic Growth and Development.................................................................................................... 101
8.2.1 Economic Growth................................................................................................................. 101
8.2.2 Economic Development........................................................................................................ 102
8.3 Indian Economic Growth Experience................................................................................................... 104
8.3.1 Growth Rate of NNP and NNP Per Capita........................................................................... 104
8.3.2 Income and Per Capita Rate.................................................................................................. 104
8.4 Basic Structural Changes in the Economy............................................................................................ 105
8.5 India’s Saving and Investment: Trends and Components..................................................................... 106
8.5.1 Savings Rate......................................................................................................................... 106
8.5.2 Financial-Asset Structure of the Household Sector.............................................................. 106
8.5.3 Gross Domestic Capital Formation....................................................................................... 107
8.6 India’s Monetary and Price Trends....................................................................................................... 107
8.6.1 Money Supply....................................................................................................................... 107
8.6.2 Growth Rate: Principal Factors............................................................................................. 108
8.7 Other Structural Dimensions................................................................................................................. 109
8.8 Demographic Trends and Structure...................................................................................................... 109
Summary.....................................................................................................................................................111
References...................................................................................................................................................111
Recommended Reading.............................................................................................................................111
Self Assessment...........................................................................................................................................112
V
List of Figures
Fig. 1.1 Elements of non – economic environment........................................................................................ 4
Fig. 1.2 Macro-environment........................................................................................................................... 6
Fig. 1.3 Factors affecting economic environment.......................................................................................... 7
Fig. 6.1 Structure of Indian financial system................................................................................................ 75
Fig. 8.2 M1, M2, M3 Money Supply Components..................................................................................... 108
VI
List of Tables
Table 2.1 Parallel economy estimates in developed countries...................................................................... 27
Table 2.2 Estimates of parallel economy in developing countries period: 1990-93..................................... 28
Table 3.1 Comparison between fiscal policy and monetary policy.............................................................. 41
VII
Abbreviations
APR - Annual Review of Performance
CSIR - Council of Scientific and Industrial Research
ECAFE - Economic Commission of Asia and the Far East
FDI - Foreign Direct Investment
FTA - Foreign technology agreements
GATS - The General Agreement on Trade in Services
GATT - General Agreement on Tariffs and Trade
GDP - Gross Domestic Product
IFIs - International Financial Institutions
MIS - Management Information Systems
MOU - Memorandum of Understanding
NMITLI - New Millennium Indian Technology Leadership Initiative
SWOT - Strengths, Weaknesses, Opportunities and Threats
TFYP - Tenth Five Year Plan
TKDL - Traditional Knowledge Digital Library
TNA - Training Need Analysis
TRIMS - Trade Related Investment Measures
WTO - World Trade Organisation
VIII
Chapter I
Economic and Non-Economic Environment
Aim
The aim of this chapter is to:
• explain various components of economic environment
• elucidate microenvironment and microenvironment
• explicate the various elements of non-economic environment
Objectives
The objectives of this chapter are to:
• define economic planning
• enlist the objectives of the study of economic environment
• explicate important economic policies
Learning outcome
At the end of this chapter, you will be able to:
• define the tenth and eleventh five year plan
• identify the factors affecting economic environment
• understand tenth and eleventh five year plan
1
1.1 Introduction
Economic environment broadly covers the aspects relating to nature of the economy, anatomy of the economy,
functioning of the economy, economic progress and programmes, economic policy statements and proposals,
economic controls and regulations, economic legislations, economic problems and prospects and to understand all
these, we should invariably discuss the concept of economic system.
1.2 Objectives of the Study of Economic Environment

The main objectives of economic environment study are as follows:
• Power functioning of an economy
• Knowledge of new opportunities and resources
• Study of environmental factors
• Removal of obstacles and challenges
• Optimum use of environment
• Minimising ill-effects
The survival and success of each and every business enterprise depend fully on its economic environment. The main
factors that affect the economic environment are:
• Economic conditions: The economic conditions of a nation refer to a set of economic factors that have great
influence on business organisations and their operations. These include gross domestic product, per capita
income, markets for goods and services, availability of capital, foreign exchange reserve, growth of foreign
trade, strength of capital market, etc. All these help in improving the pace of economic growth
• Economic policies: All business activities and operations are directly influenced by the economic policies framed
by the government from time to time. The government keeps on changing these policies from time to time in view
of the developments taking place in the economic scenario, political expediency and the changing requirement.
Every business firm has to function strictly within the policy framework and respond to the changes therein.
The important economic policies are as follows:
Industrial policy: The Industrial policy of the government covers all those principles, policies, rules,
regulations and procedures, which direct and control the industrial enterprises of the country and shape the
pattern of industrial development
Fiscal policy: It includes government policy in respect of public expenditure, taxation and public debt.
Monetary policy: It includes all those activities and interventions that aim at smooth supply of credit to the
business and a boost to trade and industry
Foreign investment policy: This policy aims at regulating the inflow of foreign investment in various sectors
for speeding up industrial development and take advantage of the modern technology.
Export-Import policy (Exim policy): It aims at increasing exports and bridge the gap between expert and
import. Through this policy, the government announces various duties/levies. The focus now-a-days lies
on removing barriers and controls and lowering the custom duties
The world economy is primarily governed by three types of economic systems, viz:
• Capitalist economy
• Socialist economy and
• Mixed economy
1.3 Non-Economic Environment

The various elements of non-economic environment are as follows:
• Social environment: The social environment of business includes social factors like customs, traditions, values,
beliefs, poverty, literacy, life expectancy rate etc. The social structure and the values that a society cherishes
have a considerable influence on the functioning of business firms. For example, during festive seasons there
2
is an increase in the demand for new clothes, sweets, fruits, flower, etc. Due to increase in literacy rate the
consumers are becoming more conscious of the quality of the products. Due to change in family composition,
more nuclear families with single child concepts have come up. This increases the demand for the different
types of household goods. It may be noted that the consumption patterns, the dressing and living styles of people
belonging to different social structures and culture vary significantly
• Political environment: This includes the political system, the government policies and attitude towards the
business community and the unionism. All these aspects have a bearing on the strategies adopted by the business
firms. The stability of the government also influences business and related activities to a great extent. It sends
a signal of strength, confidence to various interest groups and investors. Further, ideology of the political party
also influences the business organisation and its operations. You may be aware that Coca-Cola, a cold drink
widely used even now, had to wind up operations in India in late seventies. Again the trade union activities also
influence the operation of business enterprises. Most of the labour unions in India are affiliated to various political
parties. Strikes, lockouts and labour disputes etc. also adversely affect the business operations. However, with the
competitive business environment, trade unions are now showing great maturity and started contributing positively
to the success of the business organisation and its operations through workers participation in management
• Legal environment: This refers to set of laws, regulations, which influence the business organisations and their
operations. Every business organisation has to obey, and work within the framework of the law. The important
legislations that concern the business enterprises include:
Companies Act, 1956
Foreign Exchange Management Act, 1999
The Factories Act, 1948
Industrial Disputes Act, 1972
Payment of Gratuity Act, 1972
Industries (Development and Regulation) Act, 1951
Prevention of Food Adulteration Act, 1954
Essential Commodities Act, 2002
The Standards of Weights and Measures Act, 1956
Monopolies and Restrictive Trade Practices Act, 1969
Trade Marks Act, 1999
Bureau of Indian Standards Act, 1986
Consumer Protection Act, 1986
Environment Protection Act
Competition Act, 2002
Besides, the above legislations, the following are also form part of the legal environment of business.
Provisions of the Constitution: The provisions of the Articles of the Indian Constitution, particularly directive
principles, rights and duties of citizens, legislative powers of the central and state government also influence the
operation of business enterprises.
3
P olitical Factors
E conomic Factors
S ociocultural Factors
T echnological Factors
Fig. 1.1 Elements of non – economic environment

(Source: http://www.ppm.net/wp-content/uploads/2009/05/pest.jpg)
Judicial decisions: The judiciary has to ensure that the legislature and the government function in the interest of
the public and act within the boundaries of the constitution. The various judgments given by the court in different
matters relating to trade and industry also influence the business activities.
1.4 Technological Environment

Technological environment include the methods, techniques and approaches adopted for production of goods and
services and its distribution. The varying technological environments of different countries affect the designing of
products. For example, in USA and many other countries electrical appliances are designed for 110 volts. But when
these are made for India, they have to be of 220 volts. In the modern competitive age, the pace of technological
changes is very fast. Hence, in order to survive and grow in the market, a business has to adopt the technological
changes from time to time. It may be noted that scientific research for improvement and innovation in products and
services is a regular activity in most of the big industrial organisations. Infact, no firm can afford to persist with the
outdated technologies, now-a-days.
1.5 Demographic Environment

This refers to the size, density, distribution and growth rate of population. All these factors have a direct bearing on
the demand for various goods and services. For example, a country where the population rate is high and children
constitute a large section of population will have more demand for baby products. Similarly, the demand of the
people living in cities and towns are different than the people of rural areas. The high rise of population indicates
the easy availability of labour. These encourage the business enterprises to use labour intensive techniques of
production. Moreover, availability of skill labour in certain areas motivates the firms to set up their units in such
area. For example, the business units from America, Canada, Australia, Germany, and UK are coming to India due
to easy availability of skilled manpower. Thus, a firm that keeps a watch on the changes on the demographic front
and reads them accurately will find opportunities knocking at its doorsteps.
1.6 Natural Environment

The natural environment includes geographical and ecological factors that influence the business operations. These
factors include the availability of natural resources, weather and climatic condition, location aspect, topographical
factors, etc. Business is greatly influenced by the nature of natural environment. For example, sugar factories are
set up only at those places where sugarcane can be grown. It is always considered better to establish manufacturing
unit near the sources of input. Further, government’s policies to maintain ecological balance, conservation of natural
resources etc. put additional responsibility on the business sector.
4
1.7 External Environment
It is now unquestionably accepted that the prospects of a business depend not only on its resources but also on the
environment. An analysis of Strengths, Weaknesses, Opportunities and Threats (SWOT) is very much essential
for the business policy formulation. The external environment consists of a micro-environment and a macro-
environment.
1.7.1 Micro-environment
The micro-environment consists of the factors in the company’s immediate environment that affects the performance
of the company. It is quite obvious that the micro-environment factors are more intimately linked with, the company
than the macro factors. These include the suppliers, marketing intermediaries, competitors, customers and the
public:
• Suppliers: An important force in the micro environment of a company is the suppliers i.e., those who supply
the inputs to the company. The importance of reliable source/sources of supply to the smooth functioning of
the business. Uncertainty regarding the supply often compels companies to maintain high inventories causing
cost increases. When compared to Japan with our country
• Marketing intermediaries: The immediate environment of a company may consist of a number of marketing
intermediaries which are “firms that and the company in promoting, selling and distributing its goods to final
buyers”. The marketing intermediaries include middlemen such as agents and merchants who “help the company
find customers or close sales with them”. Marketing intermediaries are vital links between the company and the
final consumers. A dislocation or disturbance of this link or a wrong choice of the link may cost the company
very heavily
• Publics: A company may encounter certain publics in its environment. “A public is any group that has an actual or
potential interest in or impact on an organisation’s ability to achieve its interests”. Media publics, citizen’s action
publics and local publics are some examples. Many companies are also affected by local publics. Environmental
pollution is an issue often taken up by a number of local publics. Actions by local publics on this issue have
caused some companies to suspend operations and or take pollution abatement measures
• Customers: As it is often exhorted, the major task of a business is to create and sustain customers. A business
exists only because of its customers. Monitoring the customer sensitivity is therefore a pre requisite for the
business success. The choice of the customer segments should be made by considering a number of factors
including the relative profitability, dependability and stability of demand, growth prospects and the extent of
competition
• Competitors: A firm’s competitors include not only the firms which market the same or similar products but
also all those who compete for the discretionary income of the consumers. The competition amongst these
products may be described as ‘desire competition’ as the primary task here is to influence the basic desire of
the consumer. Such desire competition is generally very high in countries characterised by limited disposable
income and many unsatisfied desires. If the consumer decides to spend his discretionary income on recreation
he will still be confronted with a number of alternatives to choose. “The competition among such alternatives
which satisfy a particular category of desire is called generic competition”
1.7.2 Macro-environment
Macro environment consist large societal forces that affects all the factors in the company’s macro-environment
– namely, the demographic, economic, natural, technological, political and cultural forces. Macro environment is
again divided into two environments. They are:
• Economic environment
• Non-Economic environment
5
TECHNOLOGY
LEGAL MACRO
MICRO
& ENVIRONMENT ECONOMY
POLITICAL
SOCIAL & NATURAL

DEMOGRAPHIC ENVIRONMENT
Fig. 1.2 Macro-environment
1.8 Economic Environment

Economic environment broadly covers the aspects relating to nature of the economy, anatomy of the economy,
functioning of the economy, economic progress and programmes, economic policy statements and proposals,
economic controls and regulations, economic legislations, economic problems and prospects and to understand all
these, we should invariably discuss the concept of economic system. Economic environment of business refers to
the broad characteristics of the economic system in which a business firm operates. An economic system defines
the institutional frame work of environment. Once we are fully conversant with the different aspects of economic
systems, they provide us an overall view about the economic environment under which the business unit has to
function.
1.8.1 Various Components of Economic Environment

At present economic environment is a complex phenomenon. It deals with government policies optical, mainly
marketing, household sector and foreign sector. The components of economic environment are as follows:
• Economic conditions
• Economic systems
• Economic policies
• International economic environment
• Economic legislation
All these components are closely related. Although, these are different, but even then they are mutually dependent
and go on charging. Hence, economic environment is a wide and dynamic concept.
1.9 Non-Economic Environmental Factors

Non-economic environmental factors refers to social, political, legal, technological and cultural factors. Let us
discuss briefly about those factors which itself influence the decisions of a business enterprise.
6
Factors affecting Economic Environment
Internal External
Economic Non-economic
National Human Physical

Resources Resources
Social
Social and Technology
cultural system Dev Political
Political Govt
system Policies Legal
Mktg Capital and Technology

Conditions Money
Economic International Education

Laws Condition
Historical
Transport and Entrepreneurial
communication and Innovation
Ethical
Education
System Population International
Cultural
Ecological
Fig. 1.3 Factors affecting economic environment
1.9.1 Socio-cultural Environment

Business must have a social purpose and business concerns must discharge social responsibility, social obligations
and social commitment without which business cannot enjoy social sanction. The following aspects are:
• Social institutions and system: The caste system, the joint family system, the child marriage etc. may be cited
as illustrations under this head
• Social values and attitudes: These are changing very fast in almost all the nations including India. The influence
of western values of individualism has its bearing impact on the Indian population. The role of Indian women is
not confined only to house hold duties. On the other hand, she has been competing equally with her counterpart
in all the fields similarly/ choosing a particular profession at present is not based on community or caste as it
was
• Education and culture: Under this, we may refer to the attitude towards education need for business education,
educational match with skill requirements of industry, business culture etc
• Role and responsibility of government: The role of government especially in a democracy is very significant
in order to bridge the gap between the aspirations and achievements of the society. The government has a very
responsible function of maintaining social order and harmony to protect the interests of the majority
• Social groups and movements: In a society individuals have groups basing on caste, creed, religion, language,
trade and profession, etc., which may have direct business interests consumerism, trade-unionism, co-operative
movement, shareholders association, and Bank Depositors Association may be mentioned as examples under
this head
7
• Social problems and prospects: The excessive population growth rate in a country like India is a definite potential
source of danger, as it results in growing. Unemployment and poverty, poor housing and incidence of social
tensions. That is the reason why the business enterprise must consider the problems while they take business
decisions
1.9.2 Political-Legal Environment

In the present world, business of any type and size is influenced by government policies, programmes and legislations.
The following aspects help us to understand more about the political-legal environment:
• The form of government: Irrespective of the economy, government intervention in business activity all over the
world is an existence in one form or the other. Therefore, the form and structure of government is very significant.
Democratic government, Federal Form of Government etc. may be cited as examples
• Ideology of the ruling party: This factor influences much on the management, ownership structure and size of
business. If the ruling party has the rightist ideology, it usually formulates pro-business policies on the other hand if
it is inclined towards leftist ideology, it will adopt measures like nationalisation and excessive centralisation
• Strength of opposition: In the democratic nations, the opposition has to play a significant role. The strength of
the opposition to a greater extent depends on whether or not opposition parties are invited or divided. Though,
there may likely be ideological differences among different opposition parties. They must be united a judge the
every more of the ruling party critically. If the opposition is fair, firm and consistent, it can initiate constructive
criticism of the ruling party’s policies affecting business. As a result, the government cannot act irresponsibility
with regard to the business sector
• Bureaucracy: In order to run the government administration without any break, bureaucracy has a pivotal role
to assume. It is meant to keep the continuity in government policy operations in connection with business
and non-business sectors. In a system which is influenced more by government controls and regulations with
regard to business, bureaucracy is very powerful in enforcing government rules and regulations, systems and
procedures, licenses and restrictions
• Political stability: This is another factor which governs business operations. Business flourishes in an economy
which is politically stable. As we observed, whenever the nation becomes politically unstable, the flow of
foreign capital and enterprise is adversely affected and this sends wrong signals to the business both national
and multi-national
• Plans and programmes of the government: The Government formulates and executes a variety of policies and
programmes. If the government frequently change its policies on industries, money, fiscal and other economic
matters, it adversely affects the business sector. On the other hand, if government policies are stable, the business
unit can plan their activities accordingly
1.10 Economic Planning

The concept of economic planning attracted the attention of most of developing countries since its first experiment
made by then Soviet Union in 1928. Since then it was adopted by number of countries in various forms. For having
enough understanding of the concept, it is felt essential to study its basic doctrine.
Definition of economic planning

It is rather difficult to give a concise definition of economic planning with a fair degree of precision and acceptability
to one and all. Hence, different economists have defined economic planning in a variety of ways by keeping in
mind the goals to be achieved and the techniques for achieving them. Apart from stating that planning is a method,
a technique or a means to an end, the end being the realisation of clearly set targets, we discuss the number of
definitions which in their totality convey the full meaning and content of economic planning.
Mrs. Barbara Wootton defines it as, “Economic planning is a system in which the market mechanism is deliberately
manipulated with the object of producing a pattern other than which would have resulted from its own spontaneous
activity”.
8
Herman Levy defines it as, “Economic planning means securing a better balance between demand and supply by
conscious and thoughtful control either of production or distribution”.
Dr. Dalton says, “Economic planning in the widest sense is the deliberate direction by persons in charge of large
resources of economic activity towards chosen end.”
Lewis Lorwin defines a planned economy “as a scheme of economic organisation in which individual and separate
plants, enterprises and industries are treated as coordinate units of one single system for purpose of utilising all
available resources to achieve for maximum satisfaction of the people’s needs within a given time”.
According to the National Planning Commission of India, “Planning under a democratic system may be defined
as the technical co-ordination, by disinterested experts, of consumption, production, investment, trade and income
distribution, in accordance with social objectives set by bodies’ representative of the nation. Such planning is not
only to be considered from the point of view of economics and the raising of the standard of living but must include
cultural and spiritual and the human side of life”.
Thus, planning comprises of the following essential features:

• Predetermined and well defied objectives or goals
• Deliberate control and direction of the economy by a central authority (e.g., the state) for economic planning
• Optimum utilisation of natural resources and capital which may be scarce; and labour that may be abundant
• The objectives are to be achieved within a given interval of time –5 years, 7 years, etc
• The performance of the economic function of increasing production, maximising employment and controlling
population growth so that production outstrips population growth
1.11 Need for Planning in Underdeveloped Countries

Planning is beneficial for both the developed and underdeveloped countries- for the developed countries to maintain
or accelerate growth already achieved and for underdeveloped countries to overcome poverty and to raise the standard
of living. Unless the underdeveloped countries wake up and follow the planning, they will be left far behind in the
race of economic well-being. The following arguments reveal an urgent need of planning in underdeveloped and
developing countries:
• Remove the poverty and inequalities: The economic vicious circle of poverty arising due to low income, low
savings and high propensity to consume, and further lower investment and low capital formation, low productivity,
low income and poverty must be broken and it can be done only by planning. Planning is like a shot in the arm
which enables a sick person to overcome his sickness. Planning alone can create more jobs and remove the wide
spread unemployment and disguised unemployment which is a common feature of underdeveloped countries.
It is the sovereign remedy for raising national and per capita income, for reducing inequities in income and
wealth, for increasing employment opportunities and for achieving as all round rapid economic development.
It is commonly said that the pendulum has swung too wide in favour of planning that is cannot swing back
against planning
• Development of agriculture and industrial sector: Planning alone can transform an agricultural and primary
producing economy into more balanced economy with heavy, medium and light industries. Agriculture and
industry stimulate production in each other by creating demand for their products. Development of agriculture
is also essential to supply the raw material to the industrial sector. Economic planning held in designing the
plans of agricultural and industrial sectors of developing economies
• Development of infrastructure: Planning alone can help an underdeveloped economy to build up its infrastructure–
irrigation and power, transport and communication and schools and hospitals. The establishment of these social
economic overheads is essential for an all-round harmonious and integrated development
9
• To increase the rate of economic development: One of the principle objectives of the planning in underdeveloped
countries is to increase the rate of economic development. In the words D.R.Gadgil, “Planning for economic
development implies external direction or regulation of economic activity by the planning authority which in
most cases identify with the government of state.” It means planning increases the rate of capital formation
by raising the levels of income, saving and investment. A planned economy can revolutionise the economy by
providing financial institutions and by mobilising savings and investments in the rural areas. Planning alone
can remove the imbalance in foreign trade which is generally unfavourable to the underdeveloped countries
that are the exporters of primary produce and imports of produced goods
• To improve and strengthen market mechanism: The rationale for planning arises in such countries to improve
and strengthen the market mechanism. The market mechanism works imperfectly in underdeveloped countries
because of the ignorance and unfamiliarity with it. A large part of the economy comprises the non-monetised
sector. The product, factor, money and capital markets are not organised properly. The market mechanism is
required to be perfected in underdeveloped countries through planning
• Balanced development of the economy: In the absence of sufficient enterprise and initiative, the planning authority
is the only institution for planning balanced development in the economy. For rapid economic development,
underdeveloped countries require the development of the agricultural and industrial sectors, the establishment
of social and economic overheads, and the expansion of the domestic and foreign trade sectors in a harmonious
way. All this requires simultaneous investment in different sectors which is only possible underdevelopment
planning
• Development of money and capital markets: Money and Capital market are underdeveloped countries are primary
stage. This factor acts as an obstacle to the growth of industries and trade. The planning authority which can
control and regulate the domestic and foreign trade in the best interests of the economy
1.12 The Structure of the Planning Commission of India

In the post-Independence era (i.e., after 1947), the Planning Commission was set up in India, drawing from the
social premises of the Directive Principles of State Policy which directed that: “The State shall strive to promote
the welfare of people by securing and protecting as effectively as it may, a social order, in which justice - social,
economic and political - shall inform all institutions of national life.” And further that: “The State shall, in particular,
direct its policy towards securing -
• That the citizens, men and women equally, have the right to an adequate means of livelihood
• That the ownership and control of the material resources of the community are so distributed as best to sub
serve the common good
• That the operation of the economic system does not result in the concentration of wealth and means of production
to the common detriment”
From this, the following functions were assigned to the Planning Commission:
• To make an assessment of the material, capital and human resources of the country, and to augment those
resources that are found to be deficient
• To formulate a Plan for the most effective and balanced utilisation of the country’s resource after determining
the priorities
• To indicate the factors those tend to retard economic development, and determine the conditions which should
be established for the Plan’s successful execution
• To determine the nature of machinery this will be necessary for securing successful implementation of each
stage of the Plan in all its aspects
• To appraise from time to time the progress achieved in the execution of each stage of the Plan and recommend
for adjustments of policy and measures that such appraisal may show to be necessary
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Organisation
The composition of the Commission has undergone a lot of change since its inception. With the Prime Minister as
the ex-officio Chairman, the committee has a nominated Deputy Chairman, who is given the rank of a full Cabinet
Minister. Mr. Montek Singh Ahluwalia is presently the Deputy Chairman of the Commission. Cabinet Ministers with
certain important portfolios act as part-time members of the Commission, while the full-time members as experts
of various fields like Economics, Industry, Science and General Administration. The Commission works through
its various divisions, which are of three kinds:
• General Planning Divisions
• Programme Administration Divisions
• The majority of experts in the Commission are economists, making the Commission the biggest employer of
the Indian Economic Services
1.12.1 Functions
The functions of the Planning Commission are as follows:
• Assessment of resources of the country
• Formulation of Five-Year Plans for effective use of these resources
• Determination of priorities, and allocation of resources for the Plans
• Determination of requisite machinery for successful implementation of the Plans
• Periodical appraisal of the progress of the Plan
• To formulate plans for the most effective and balanced utilisation of country’s resources.
• To indicate the factors which are hampering economic development?
• To determine the machinery as it will be necessary for the successful implementation of each stage of plan
1.12.2 Functional Area

The functional areas of the Planning Commission are as follows:
• Agriculture Division
• Backward Classes Division
• Communication and Information Division
• Development Policy Division
• Education Division
• Environment and Forest Division
• Financial Resources Division
• Health, Nutrition and Family Welfare Division
• Housing, Urban Development and Water Supply Division
• Industry and Minerals Division
• International Economic Division
1.13 Objectives of Planning Commission

The Planning Commission was set up by a Resolution of the Government of India in March 1950 in pursuance of
declared objectives of the Government to promote a rapid rise in the standard of living of the people by efficient
exploitation of the resources of the country, increasing production and offering opportunities to all for employment in
the service of the community. The Planning Commission was charged with the responsibility of making assessment
of all resources of the country, augmenting deficient resources, formulating plans for the most effective and balanced
utilisation of resources and determining priorities. Pt. Jawaharlal Nehru was the first Chairman of the Planning
Commission.
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Constitution
In the context of the formulation of Eleventh Five Year Plan (2007-2012), the following sector wise Working Groups/
Steering Committees/Task Force have been set up by Planning Commission, to make recommendations on various
policy matters.
• Agriculture
• Backward Classes
• Communication and Information
• Development Policy
• Education
• Environment and Forests
• Financial Resources
• Health and Family Welfare
• Housing and Urban Development
• Industry and Minerals
• Labour, Employment and Manpower
• Multi Level Planning
• Power and Energy, Energy Policy and Rural Energy
• Programme Evaluation Organisation
• Rural Development
• Social Justice and Women Empowerment
• Science and Technology
• State Plans
• Tourism
• Transport
• Village and Small Enterprises
• Voluntary Action Cell
• Water Resources
• Women and Child Development
• International Economics
1.14 Tenth Five Year Plan

Council of Scientific and Industrial Research has established a network of national laboratories/institutes in various
parts of the country to undertake research in diverse fields of science and technology with emphasis on applied
research and utilisation of results thereof. There are, at present, 38 research establishments including five regional
research laboratories. Some of the establishments have set up experimental, survey field stations to further their
research activities and 39 such stations attached to 16 laboratories are functioning at present.
The guiding principle for CSIR during the Tenth Five Year Plan (TFYP) is inherent in its mission, i.e., to provide
scientific industrial R&D that maximises the economic, environmental and societal benefits for the people of India.
CSIR activities and programmes in the TFYP were operated through following six schemes of which five were
continuing from Ninth Plan and one scheme namely ICT Infrastructure & Renovation & Refurbishment (IRR)
introduced as a new scheme in the Plan:
• National Laboratorties
• National S&T Human Resource Development
• Intellectual Property and Technology Management
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• R&D Management Support
• New Millennium Indian Technology Leadership Initiative (NMITLI), and
• ICT Infrastructure Renovation & Refurbishment
• Among these schemes, National Laboratories under which major R&D programmes/projects have been
undertaken was the major scheme accounting for more than 75% of CSIR Plan funds.
1.14.1 Approach, Strategy and Policy Reforms during the Tenth Five Year Plan
The activities and the role performed by CSIR were in conformity with the then prevailing economic, social,
industrial, and R&D environment conditions nationally and internationally. The national target of GDP growth of
8% in Tenth Five Year Plan required organisations to re-examine their strategies and adopt innovative approach.
CSIR, as a dynamic responsive organisation in the past, quickly responded to the need. The CSIR plans were drawn
up based on the careful assessment of the needs and the opportunities, development of core competencies and R&D
facilities.
The rationale for drawing programmes were based on the premise that pre-competitive research being public goods,
need to be largely financed through public funding. In the selection of the programmes the guiding principles were
based on:
• High levels of novelty and innovativeness
• Global competitive positioning in science and / or technology
• Potential industrial, economic, strategic, societal benefits that could be captured and accrue to the Indian
economy
As CSIR has a well knit network of laboratories across multi disciplines, a conscious decision was taken to implement
programmes in network mode through establishing synergy within the vast, often niche, and competencies available
with the laboratories. The knowledge networking within and across CSIR laboratories was affected through
identification of network programmes and projects. The network projects, thus evolved, for the Tenth Five Year
Plan period consisted of:
• Target oriented core network R&D projects, and
• Building of capabilities and facilities
1.14.2 Overview of Performance during the Tenth Five Year Plan

CSIR has made significant contributions during the first four years of TFYP in a wide spectrum of activities, which
span from creation of public goods, private goods, social goods and strategic goods. While maiden flight of SARAS
was a landmark in CSIR’s contributions to herald the civil aviation industry in the country, the discovery of a new
molecule, as a potential drug for cure of deadly disease of tuberculosis, CSIR’s instant response to alleviation of
hardships of Tsunami’s victims were a few of the major contributions in other spheres.
CSIR lead the Team India initiative for setting up the first ever Traditional Knowledge Digital Library (TKDL) to
provide a search interface to retrieval of traditional knowledge information on international patent classification (IPC)
and keywords in multiple languages. Database has been created on traditional medicinal formulations comprising
13 million A4 size pages of data on transcribed 62,000 formulations in Ayurveda, 60,000 formulations in Unani,
and 1300 formulations in Siddha. TKDL has been receiving wide international coverage.
As a socially conscious organisation CSIR continued its effort to provide the S&T needed for the masses. During
the plan, it promoted employment generation on one hand and developed diverse technologies to add to the quality
of life on the other hand. These technologies include: ceramic membrane based removal of arsenic and iron from
contaminated ground water; pehsticide removal unit for producing potable water, free from organic pollutants; setting
up of Reverse Osmosis (RO) based desalination plants in villages; hand operated microfiltration units (with 3 litre
/minutes discharge rate) capable of providing bacteria and virus free water; Ultra Filtration (UF) membrane based
technology requiring no electricity and chemicals to remove germs, cysts, spores, parasites, bacteria, Cryptosporidium,
endotoxin etc. low sodium salt from bitterns in place of pure sodium chloride; which is being recommended to
patients suffering from hypertension; etc. CSIR response to Tsunami victims had shown its scientific and technical
skills to mitigate the hardship of those survived.
13
The initiatives taken by various CSIR laboratories could provide food, drinking water and shelter to the
survivors.
1.14.3 Achievements during the Tenth Five Year Plan

Some of the contributions from under the scheme during the Tenth Five year Plan are as follows:
• During the Plan the Central Management Support has established Human Resource Development Centre for
organising and conducting of induction, orientation, and refresher and skill up-gradation training programmes
for different categories of CSIR staff
• The Centre, thus, conducted one-day interactive familiarisation programs in 32 laboratories including CSIR
Headquarters for familiarisation of new format for Annual Review of Performance (APR) for Group IV
scientists
• Improvement in quality and transparency in working, the Centre organised awareness-cum-implementation
programme on ISO 9001: 2000 QMS certification for HOD’s, senior scientists, administration and finance
personnel from Headquarters and laboratories
• Development of Management Information Systems (MIS) for its various HR activities, Training Need Analysis
(TNA), Creation of focused HRD groups in labs. Computer Based Training (e-training) etc
• A new organ called the Performance Appraisal Boards (PABs) was introduced to critically review the performance
of each laboratory once in every three years
• During the Tenth Plan, CSIR’s international programmes had a clear focus on joint collaborative projects rather
than on exchange programmes, as was the case in previous plans
• The Unit for R&D in Information Products created to catalyse and mobilise packaging of information products
based on CSIR databases
1.15 Approach and Strategy for the Eleventh Five Year Plan
India’s centralised planning process is governed by seven cardinal policy objectives: growth; social justice and
equity; modernisation; self-reliance; food; productivity and employment.
These would continue to be the guiding principles for the Eleventh Plan (2007-12) which commences from
1st April, 2007. A very large part of our planning is concerned with fiscal aspects and physical targets. It must,
however, be recognised that it is the human and natural resources, scientific methods and technologies which are
the fundamental elements in the creation of wealth for higher productivity, increased efficiency and completely
new ways of doing things. The Eleventh Plan, therefore, would place emphasis on these components which have
received inadequate attention in the past. Eleventh Plan would be the vehicle that would position the country to be a
super power- economically, strategically and scientifically. For the Eleventh Five Year Plan the Government of India
is envisaging the economy to grow at an annual growth rate of 8.5%%. This implies that Agricultural Sector will
have to grow at a rate of 3.9%, industry at 9.9%, services at 9.4%, and exports at 16%, while keeping the imports
at a level of 12.1%.
The implicit growth of manufacturing sector which is a subset of industry is targeted for 12%. The above growth
rates interwoven with each other, of course, would depend upon many factors. Some of these factors are internal to
the Indian economy and some are influenced by the external environment. The growth in the agricultural productivity
can be sustained on a long term basis only through continuous technological progress and these calls for well
structured strategies for research & development. Industrial sector has gained a lot over the past decade or so due
to liberalisation and is gradually integrating with the world economy. Some of the sub-sectors like automobiles,
pharmaceuticals, biotechnology products, specialty chemicals, and textiles have acquired unprecedented level of
global competitiveness and need to be supported to maintain the present edge. The Eleventh Plan is also placing
special emphasis on infrastructure and skill development, the two crucial and critical catalysts for growth.
The services sector is currently the fastest growing sector of economy accounting for about 54% of GDP. It is
estimated that this sector has the potential for creating 40 million jobs and generating additional $ 200 billion annual
income by 2020. In the Eleventh Plan, the government is placing special focus on this sector so that its potential to
create employment as growth parameter is fully realised.
14
Eleventh five year plan programmes and activities
The bold and the daring approach proposed for the XI Plan by the Planning Commission to achieve new vistas of
growth, is expected to provide enough opportunities to convert growth potential of 8.5% into reality. This however
calls for a total departure from the past practices in developmental planning and implementation, by working out
new management strategies involving coordination and stronger linkages for more effective implementation.
The first five following schemes would be the continuing schemes with new programmes/projects/tasks and activities,
the sixth scheme would be the new scheme:
• National Laboratories
• National S&T Human Resource Development
• Intellectual Property & Technology Management
• R&D Management Support
• New Millennium Indian Technology Leadership Initiative and
• Setting up of a Translational Research Institute
1.16 Comparison between Tenth and Eleventh Five Year Plan

The main objectives of the tenth five-year plan were:
• Reduction of poverty ratio by 5 percentage points by 2007
• Providing gainful and high-quality employment at least to the addition to the labour force
• All children in India in school by 2003; all children to complete 5 years of schooling by 2007
• Reduction in gender gaps in literacy and wage rates by at least 50% by 2007
• Reduction in the decadal rate of population growth between 2001 and 2011 to 16.2%
• Increase in Literacy Rates to 75 per cent within the Tenth Plan period (2002 to 2007)
• Reduction of Infant mortality rate (IMR) to 45 per 1000 live births by 2007 and to 28 by 2012
• Reduction of Maternal Mortality Ratio (MMR) to 2 per 1000 live births by 2007 and to 1 by 2012
• Increase in forest and tree cover to 25 per cent by 2007 and 33 per cent by 2012
• All villages to have sustained access to potable drinking water within the Plan period
• Cleaning of all major polluted rivers by 2007 and other notified stretches by 2012
• Economic Growth further accelerated during this period and crosses over 8% by 2006
The main objectives of the eleventh plan were:

Income and Poverty
• Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to double per
capita income by 2016-17
• Increase agricultural GDP growth rate to 4% per year to ensure a broader spread of benefits
• Create 70 million new work opportunities
• Reduce educated unemployment to below 5%
• Raise real wage rate of unskilled workers by 20 percent
• Reduce the headcount ratio of consumption poverty by 10 percentage points
Education
• Reduce dropout rates of children from elementary school from 52.2% in 2003-04 to 20% by 2011-12
• Develop minimum standards of educational attainment in elementary school, and by regular testing monitor
effectiveness of education to ensure quality
• Increase literacy rate for persons of age 7 years or above to 85%
• Lower gender gap in literacy to 10 percentage points
• Increase the percentage of each cohort going to higher education from the present 10% to 15% by the end of
the plan
15
Health
• Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per 1000 live births
• Reduce Total Fertility Rate to 2.1
• Provide clean drinking water for all by 2009 and ensure that there are no slip-backs
• Reduce malnutrition among children of age group 0-3 to half its present level
• Reduce anemia among women and girls by 50% by the end of the plan
Women and Children

• Raise the sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by 2016-17
• Ensure that at least 33 percent of the direct and indirect beneficiaries of all government schemes are women
and girl children
• Ensure that all children enjoy a safe childhood, without any compulsion to work
Infrastructure
• Ensure electricity connection to all villages and BPL households by 2009 and round-the-clock power
• Ensure all-weather road connection to all habitation with population 1000 and above (500 in hilly and tribal
areas) by 2009, and ensure coverage of all significant habitation by 2015
• Connect every village by telephone by November 2007 and provide broadband connectivity to all villages by
2012
• Provide homestead sites to all by 2012 and step up the pace of house construction for rural poor to cover all
the poor by 2016-17
Environment
• Increase forest and tree cover by 5 percentage points
• Attain WHO standards of air quality in all major cities by 2011-12
• Treat all urban waste water by 2011-12 to clean river waters
• Increase energy efficiency by 20 percentage points by 2016-17
Types of Data of Tenth Plan

• Contains no section on the unorganised sector or home-based workers
• Laid down a three-fold strategy for empowering women
• No reference to best practices
• Contains a specific chapter on Women titled ‘Women and Child.’
• Only includes data from the Census of India
Types of Data of Eleventh Plan

Types of Data: Includes a section on the unorganised sector and home-based workers and female concentrations
in both.
• Uses a five-fold strategy to empower women: specific locations of women are identified, and specific issues
highlighted
• Inclusion of Best Practice boxes throughout the document
• Has renamed the chapter ‘Women’s Agency and Child Rights’ and includes a gender perspective across
sectors
• Includes data from the Census, UN bodies, academics and well-known civil society organisations
16
Summary
• The survival and success of each and every business enterprise depend fully on its economic environment.
• The world economy is primarily governed by three types of economic systems.
• The external environment consists of a micro environment and a macro environment.
• The micro environment consists of the factors in the company’s immediate environment that affects the
performance of the company.
• Macro environment consists larger societal forces that affect all the factors in the company’s macroenvironment
namely, the demographic, economic, natural, technological, political and cultural forces.
• Non-economic environmental factors refer to social, political, legal, technological and cultural factors.
• The concept of economic planning attracted the attention of most of developing countries since its first experiment
made by then Soviet Union in 1928.
• Planning is beneficial for both the developed and underdeveloped countries for the developed countries to
maintain or accelerate growth already achieved and for underdeveloped countries to overcome poverty and to
raise the standard of living.
References
• Ramachandran, K.S., 2007. Economic Environment of India:Lesson from Past and for the Future, Northern
Book Centre.
• Callan, S. J. & Thomas, J.M., 2009. Environmental Economics and Management: Theory, Policy and Applications,
Cengage Learning.
• Economic Growth and Environment [Pdf] Available at: <https://www.gov.uk/government/uploads/system/
uploads/attachment_data/file/69195/pb13390-economic-growth-100305.pdf > [Accessed 11 July 2013].
• Global Economic Environment [Pdf] Available at: <www.economics.gov.nl.ca/E2012/GlobalEconomicEnvironment.
pdf‎> [Accessed 11 July 2013].
• 2012. The Economic Environment [Video online] Available at: <https://www.youtube.com/watch?
v=EWhRy4MaUeA‎> [Accessed 11 July 2013].
• 2011. Economic Environment [Video online] Available at: <https://www.youtube.com/watch?v=BEipiii-DlE‎>
[Accessed 11 July 2013].
Recommended Reading
• Smith, A., Richards, M., Heale, G. & Meer, N. V., 2008. Economic Environment Level 3, Pearson Education
South Africa (Pvt.Ltd).
• Pailwar, V. K., 2008. Economic Environment of Business, PHI Learning Private Limited.
• Raj, R., 2008.Economic Environment of Business and Environmental Management, 1st ed., Nirali Prakashan.
17
Self Assessment
1. ________ includes government policy in respect of public expenditure, taxation and public debt.
a. Industrial policy
b. Fiscal policy
c. Monetary policy
d. Foreign investment policy
2. _________ environment include the methods, techniques and approaches adopted for production of goods and
services and its distribution.
a. Technological
b. Natural
c. Demographic
d. External
3. Which of the following statements is false?

a. Technological environment include the methods, techniques and approaches adopted for production of goods
and services and its distribution.
b. Demographic environment refers to the size, density, distribution and growth rate of population.
c. The natural environment includes geographical and ecological factors that influence the business
operations.
d. The political environment of business includes social factors like customs, traditions, values, beliefs, poverty,
literacy, life expectancy rate etc.
4. Match the following

1. Suppliers A. An important force in the micro environment of a company.
B. Include middlemen such as agents and merchants who “help the
2.Marketing Intermediaries
company find customers or close sales with them”.
C. These are changing very fast in almost all the nations including
3.Social Values and Attitudes
India.
4.Social Institutions and D. The caste system, the joint family system, the child marriage etc
System: may be cited as illustrations under this head.
a. A.1-B, 2-C, 3-D, 4-A
b. B.1-A, 2-B, 3-C, 4-D
c. C.1-C, 2-D, 3-A, 4-B
d. D.1-D, 2-A, 3-C, 4-B
5. _____________ aims at regulating the inflow of foreign investment in various sectors for speeding up industrial
development and take advantage of the modern technology.
a. Industrial policy
b. Fiscal policy
c. Monetary policy
d. Foreign investment policy
18
6. Who defined “Economic planning means securing a better balance between demand and supply by conscious
and thoughtful control either of production or distribution”?
a. Barbara Wootton
b. Herman Levy
c. Dr. Dalton
d. Lewis Lorwin
7. The implicit growth of manufacturing sector which is a subset of industry is targeted for _____.
a. 8%
b. 10%
c. 12%
d. 14%
8. The services sector is currently the fastest growing sector of economy accounting for about ____ of GDP.
a. 12%
b. 24%
c. 32%
d. 54%
9. Which of the following statements is true?

a. The implicit growth of manufacturing sector which is a subset of industry is targeted for 12%.
b. The explicit growth of manufacturing sector which is a subset of industry is targeted for 14%.
c. The implicit growth of manufacturing sector which is a subset of industry is targeted for 18%.
d. The implicit growth of manufacturing sector which is a subset of industry is targeted for 22%.
10. ______ is another factor which governs business operations.

a. Bureaucracy
b. Political Stability
c. Plans and Programmes of the Government
d. Strength of Opposition
19
Chapter II
Problems of Indian Economy
Aim
• explain the current population of India
• elucidate demographic trends in India
• explicate the effect of population growth on Indian economic development
Objectives
• explain poverty
• enlist the causes of rapid growth of population
• explicate causes of poverty
Learning outcome
• describe balance of payments
• identify the types of unemployment
• understand parallel economy
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2.1 Introduction
India is a complex land. On one aspect analysing the metropolitan cities of India one draws it to be a developing
nation with upgraded lifestyle and trade efficiency but the others aspect explains a completely different and a factual
story that majority of Indian’s are still rooted to villages making it an agricultural and rural nation. India has faced
the worst consequences of such overpopulation in terms of poverty, malnourishment and illiteracy.
2.2 Current Population of India

After two centuries of coherent British colonial rule, India attained independence and became a sovereign secular
nation on August 15, 1947.The Republic of India is spread over a vast area of 3,287,590 square kilometres making it
marginally more than one-third the size of the United States. With a unique distinction of being rich and diversified
in its geographical presentation, religion and culture, India is a multilingual and multiethnic society. World’s major
religions such as Hinduism and Buddhism have their roots of origin here. It is often referred to as an amalgamation
of many countries tied together by a common destiny and the biggest yet strong and successful democracy. While it’s
an emerging economic power but majority of life remains rooted to the rural areas. India has a vast population and
is the 2nd country to cross the 1 billion population figure. Population of India is a big problem of Indian economic
growth.
To access the detailed overview of population in India and its implications on the socio economic strata of the country
and ways to combat such immense enhancement in population over the decades let’s get down to the categorised
form of state of India firstly, as a British empowered colony and secondly, as a sovereign.
2.3 Population of India: Pre-Independence Era

India’s rapid rise of population was originated in the third decade of the 19th century which drew immense concern.
Until 1920, India’s population was growing at snail pace owing to heavy loss of life due to famines, wars and
epidemics.
According to census reports decline in population of the country within its present geographical boundaries took place
between 1911 and 1921 by 0.8 million due to high mortality inflicted by the influenza pandemic of 1918-1919.The
population steadily increased since 1921 because of scientific advancement and technical know how for epidemic
and famine control and sanitation measures undertaken by the provincial governments. For the first time since the
initiation of the systematic census in 1881, India’s population increased slightly by more than 10% in a decade with
the 1931 census enumerating a population of 279.0 million. The interest and action from social reformers to combat
this population growth Land its adverse effect on women health is significant in character.
2.4 Population: Post Independence Period

When India attained independence on the dawn of august 15.1947, it faced a series of challenges in every aspect of
a state-societal matrix, socio economic complications and defence. As a result of partition 8 million refugees had
come into the country from what was now Pakistan. The people had to be found satisfactory standards of living
education and employment thus this migration was a surplus population input to India.
India’s population in 1947 was large, almost 345 million the citizens of the vast land inhibited lingual, cultural
and ethical difference and practiced different professions and ate different food. At the time of independence vast
majority of population dwelled in rural areas with a marginal percentage of people residing in cities. Clearly, the
new nation had to lift its masses out of poverty by increasing the productivity of agriculture and initiating setup of
new industries.
Since independence, the population of India has more than tripled. Since 1950, India’s total fertility rate was 6
(children/woman) approx. Since 1952, India has made efforts to control its population growth. It was of prime
necessity as check on population growth will enhance the country economic condition and will be a promoting step
towards the eradication of poverty. In 1983, the goal of the country’s national health policy was to have a decremented
value of total fertility rate of 2.1 by the year 2000 which proved to be hypothetical. During late 1980s, a goal of two
children/couple by 2000 was declared but too ambitious to be achieved.
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India’s population crossed the 1 billion mark in 2000. In 2000, India established a new National Population Policy
(NPP) to stem the growth of the country population having one of the primary aims to reduce the total fertility rate
to 2.1 by 2010, But still unachieved it remains as high as 2.8.also set another goal of two-child family which led to
unwanted results of increased abortion of female fetuses and preferences to male child. Many states joined in the
program but few states like Haryana, Himachal Pradesh and Madhya Pradesh have withdrew because of cries from
many segments of society.
All figures with respect to population are large in India: 2.7 million annual births; 8.7 million annual deaths and 1.5
million infant deaths. Population growth in India was viewed as a problem very early in 1947 but after numerous
population policies and measures still the aims couldn’t be achieved and above all there has been immense
enhancement in the population over the decades. In the most populated states Bihar and Uttar Pradesh, fertility
still remains above four children per woman and is declining slowly but these states having the quarter of India’s
population have a defining role to play for the reduction of population by control on fertility rates. An additional
important aspect to India’s population policy is imbalance of the sex ratio at birth. The widespread strong preference
of a male child over a female has resulted in abortion of female fetuses.
Population refers to total number of people residing in a place. Growth in population is considered to be favourable
in certain countries like Australia because:
• It provides work force to produce
• It provides markets for the products produced
• It may promote innovative ideas
• It may promote division of labour and specialisation
Growth in population is not desirable for countries like India because:

• There may not be adequate jobs to absorb all additional people
• They put pressure on means of subsistence
• They put pressure on social overheads (hospitals, roads, schools, etc.)
• They may result in increased consumption and reduced savings and hence slow down capital formation
• They may increase dependency.
2.5 Present scenario: The Facts

The present scenario is discussed as below:
• India with 1.22 billion people is the second most populated country in the world .India represents apparently
17.30% of the world’s population. With population growth rate flying at 1.58% it’s predicted to have more than
1.53 billion people by end of 2030
• More than 50% of India’s current population is below the age of 25.About 72% population lives in village while
the rest dwells in towns or urban agglomerations
• The birth rate per 100 people per year is 22.22 births/1000 populations
• While, Death rate per 1000 individuals per year is 6.4 deaths/1000 populations
• Fertility rate is 2.72born/woman
• Infant mortality rate is 30.15 deaths/1000 live births
• India has the largest illiterate population of the world
2.6 Implication of Growing Population in India

India’s high count on population results in increasingly impoverished and sub standards for growing segments of
the Indian populace. In the United Nations human development index in 2007, India ranked 126th which takes into
account social educational and other human living aspects. Population growth bearing a direct impact on economy
is a controversial debate
22
2.7 How to Combat Population Growth India?
Rapid reduction in population growth can be achieved through public awareness and emancipation of women through
imparting knowledge and education to woman and people residing in the rural sectors of India. By meeting all felt
needs for contraception and reducing the infant and maternal mortality and mortality so that desired reduction in
fertility level is achieved.
2.8 Demographic Trends in India

Following are the demographic trends in India:
Size of Population
The Size of Population is determined in terms of number of person. The population has risen from 23.84 crores
in 1901 to 102.27 crores in 2001. Now, it is 111 crores (2005-06).India’s Population ranks 2nd in the World after
China. India has about 2.4% of the World’s area and Less than 1.2% of the World’s Income but accommodates about
16.7% of the World’s Population. Every sixth person in the World is an Indian.
Birth rate and Death rate

Birth Rate refers to number of birth per thousand of Population. Death Rate refers to number of Deaths per thousand
of population. Birth Rate has declined from 39.9 in 1951 to 25.4 in 2001 and 23.8 in 2005.Death Rate has declined
from 27.4 in 1951 to 8.4 in 2001 and 7.6 in 2005.
Density of population
Density of population refers to the number of persons per square kilometre. It has increased from 117 in 1951 to
274 in 1991 and 324 in 2001.Density of Population is not same for all the states. Kerala, West Bengal, Bihar and
U.P. have Density higher than the Average Density. Andhra Pradesh, Himachal Pradesh, Gujarat, Madhya Pradesh,
Maharashtra, Rajasthan, Orissa, etc. have lower Density than the Average Density. West Bengal is the most densely
populated State in the country with 904 persons living per sq. km. followed by Bihar with 880.Industrially well
developed areas has higher density.
Sex ratio
Sex ratio refers to the number of females per 1000 males.Sex ratio has increased from 927 in 1991 to 933 in 2001.
Kerala has the favourable sex ratio of 945 in 2001 which has decreased from 976 in 1991 and 984 in 1971.
Life-expectancy at birth
Life expectancy refers to the mean expectation of life at birth. If death rate is high/death occurs at an early age; life
expectancy will be low and vice-versa. Life expectancy has increased from 32.1 years in 1951 to 59.3 in 1991 and
63.8 in 2001.
Literacy ratio
Literacy ratio refers to numbers of Literates as a Percentage of Total Population. Literacy Rate has increased from
16.7 persons in 1951 to 43.6 in 1981 and 65.38 in 2001.Literacy is higher among Urban Population than Rural
Population. Literacy Rates are different among the States. Kerala has the highest Literacy Rate of 90% followed by
Goa with 82%, 77% in Maharashtra and Himachal Pradesh, 73% in Tamil Nadu, etc.
2.9 Causes of Rapid Growth of Population

Population generally increases because of:
• High birth rate
• Relatively lower death rate
• Immigration is more than emigration
In India, population has mainly increased because of high birth rate and relatively low death rate.
23
Causes of High Birth Rate

Following are the causes of high birth rate:
• Pre-dominance of Agrarian Economy
• Slow Process of Urbanisation
• High Incidence of Poverty
• Early Marriage of Women
• Universal Marriage of Women
• Role of Religion
• Joint Family System
• Illiteracy, Ignorance and Belief in Fate
• Limited Spread of Family Planning
Causes of Decline in Death Rate

Causes of decline in death rate are mentioned as below:
• Control of Epidemics like Plague, Small Pox, Malaria, etc
• Control of Famines
• Improved Medical Facilities
• Spread of Maternity Homes
• Impact of Social Reforms
• Impact of Economic Development (Improved Standard of Living, Improved Hygiene and Sanitation, etc.)
2.10 Effect of Population Growth on Indian Economic Development

India is passing through the stage of population explosion which is a transitory phase according to the Theory of
Demographic Transition.
The consequences of population growth on Indian Economic Development:

• Growth of national income
• Food supply
• Unproductive consumers
• Problem of unemployment
• Capital formation
• Ecological degradation
Measures to solve population problem

• Spread of education
• Increase in female wage employment
• Provision of old age pension and social security
• Reduction in infant mortality
• Raising the marriage age
• Family planning
• Urbanisation
• Removing economic reasons for preferring large families
• Introducing incentives for people with small families
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2.11 Poverty
Poverty is divided into:
• Relative poverty
• Absolute poverty
Relative poverty
Relative Poverty refers to the income or asset position of one class or group of people in comparison with the other
classes or groups, or of one individual vis-a-vis the others. The essential point here is that poverty of one is relative
to the richness of the other. For example, an average middle class person is poor when compared to the upper middle
class person, who in turn, may be poorer than the richer person and so on.
Absolute poverty
It is associated with a minimum level of living or minimum consumption requirements of food, clothing, housing,
health, etc. All those people who fail to secure income or assets to have access to even these minimum consumption
requirements are classified as ‘Poor’.
2.11.1 Poverty in India

The latest National Sample Survey 2004-05 shows that a percentage of people living below Poverty Line have
reduced from 26% in 1999-2000 to about 22% in 2004-05.The Tenth Plan had set a target of Reduction in Poverty
Ratio to 19.3% by 2007 and 11% by 2012. The targets for Rural and Urban Poverty in 2007 were 21.1% and 15.1%
respectively.
Causes of poverty
• Under developed Nature of the Indian Economy
• Inequalities in income and assets distribution cause additional income from development to be cornered by a
few rich people
• Rapidly growing population is a major cause of low per capita income and poverty in India
• Large scale unemployment causes lowering of the Levels of Living of People
• Inflation has reduced purchasing power of money. This has reduced real income and thus people can buy less
and consume less with giving Income. This has added to poverty
• Rural character of India’s economy has also its bearing on rural poverty
• Sociological reasons to have contributed to underdevelopment and poverty in India
Measures to reduce poverty

• Agriculture and other rural vocations should be rapidly developed so as to eradicate rural poverty
• Village and Small industries should be developed to create greater employment both in rural and urban areas
• Programmes should be implemented that directly target the poor and help them increase their Income and
Consumption
• Income Inequalities should be reduced:
Labour legislation should ensure better Wages
Goods consumed by the poor should not be taxed
Goods required by the poor must be subsidised
Free health care and education should be provided to the poor
Persons belonging to poor families must be provided employment
• Rapid growth of population must be controlled and population growth rate brought down through family
planning, education, incentives, etc.
25
2.12 Unemployment
Unemployment refers to the situation where the persons who are able to work and willing to work, fail to secure
work or activity which gives them income or means of livelihood. Those who are fit to work but do not want to
work and hence do not actively seek work are not included among the unemployed persons.
2.12.1 Types of unemployment

Following are the types of unemployment:
• Voluntary unemployment
• Frictional unemployment
• Casual unemployment
• Seasonal unemployment
• Structural unemployment
• Technological unemployment
• Cyclical unemployment
• Chronic unemployment
• Disguised unemployment
Voluntary unemployment: People who are unwilling to work at the prevailing wage rate and people who get a
continuous flow of income from their property or other sources and need not to work, such people are voluntarily
unemployed. Voluntarily unemployment is a national waste of human energy, but it is not a serious economic
problem.
Frictional unemployment: A temporary phenomenon which results from workers which are temporarily out of work
while changing Jobs or are suspended due to strikes or lockouts. Frictional unemployment is due to difficulties in
getting workers and vacancies together. For example, Big industries units and polluting industries have been moved
out of the large towns and cities like Delhi.
Casual unemployment: In Industries, such as construction, catering or agriculture, where workers are employed
on a day to day basis, there are chances of casual unemployment occurring due to short-term contracts, which are
terminable any time.
Seasonal unemployment: Industries and occupations such as agriculture, the catering trade in holiday resorts,
where production activities are seasonal in nature offer employment only for a certain period of time in a year.
People engaged in such type of work or activities may remain unemployed during the off-season which is termed
as seasonal unemployment.
Structural unemployment: Unemployment which arises due to change in the pattern of demand leading to changes
in the structure of production in the economy is termed as structural unemployment. Example use of synthetic
rubber is bound to reduce demand for natural rubber and lead to unemployment in rubber plantation. The only way
to remove such unemployment is to retrain the unemployed in new vocations so that they learn new technologies
and are thus absorbed in the expanding economic sectors
Technological unemployment: Due to introduction of new machinery, improvement in methods of production,

labour-saving devices, etc., some workers tend to be replaced by machines. Their unemployment is termed as
technological unemployment.
Cyclical unemployment: Associated with the cyclical fluctuations in economic activity, especially in the recessionary
depressionary phases of trade cycle. mostly found in capitalist countries like the USA and Western European nations,
etc. the solution for cyclical unemployment lies in measures for increasing total expenditure in economy, thereby
pushing up the level of effective demand.
26
Chronic unemployment: When employment tends to be a long-term feature of a country, it is called chronic
unemployment. Underdeveloped countries suffer from chronic unemployment on account of the vicious circle of
poverty, lack of developed resources and their under utilisation, high population growth, low capital formation,
etc.
Disguised unemployment: Refers to a position where people may be working and apparently employed, yet their
contribution to output may be zero. Hence, they seem to be employed, but technically they are unemployed because
their marginal productivity is zero.
2.13 Parallel Economy

Parallel economy means functioning of an unsanctioned sector in the economy whose objectives run parallel and in
contradiction with the objectives of official or sanctioned or legitimate sector in the same economy. This is variously
referred to as ‘unaccounted economy’, ‘illegal economy’, ‘subterranean economy’, or ‘unsanctioned economy’.
According to the D.K.Rangnekar, “If the ‘Parallel economy’ poses a serious threat to stability and growth of the
official economy, surely it stems from the fact that the magnitude of ‘black money’ is large and rigged deals are
growing in volume and complexity at an alarming rate. Apart from the wide ramifications of the ‘parallel economy’,
one might also be alive to the fact that ‘black incomes’ are accentuating the inequalities in income and wealth and
breeding a new class of ‘black’ rich in a society which is already harshly stratified.”
Illegal economy is tax evaded economy. It is possible to convert illegal economy or black money into white money
and vice versa. For example, when a person manages to get the receipt from the shopkeeper by paying the sales
tax for a commodity but does not purchase it actually, he generates black money as reimbursement is made to him
against the receipt. The money not actually paid is the black money in such a case.
In such case, the shopkeeper sells the same commodity to another person without giving him any receipt for it. On
the other hand, if a person purchases something (say, a scooter, or a VCR, etc.) and plays `. 15,000 for it out of white
money but gets a receipt of only `. 10,000, the balance of `. 5,000 becomes black money for the seller.
In this case, the white money becomes the black money. The parallel economy has political, commercial, legal,
industrial, social and ethical aspects. There are wide confrontations between the objectives of the legitimate and
illegitimate sectors under parallel economy. D.R.Pendse argued that there are two possible sources of black money.
Firstly, it may originate from illegitimate source of income arising out of illegal gratification such as payment of
‘Selami or Pagri’ or income from smuggling, bribery etc. Secondly, it may originate from legitimate and legal sources
of income but concealed from tax authorities out of tax evasion.
The basic objectives of this paper are to analyse the causes of parallel economy, its impact on the economy and
various initiatives of Indian government for solving this problem.
International experience
Parallel economy or black economy is existing in both developed and developing countries. There is an abundance
of literature available upon measurement techniques and about estimates of parallel economy. A variety of methods
have been used and the different methods appear to generate widely divergent estimates. This is summarised in
Table 2.1.
Country Parallel Economy (as % of GDP)

Greece, Italy, Spain, Portugal and Belgium 24 - 30%
Sweden, Norway, Denmark, Ireland, France,
13 - 23%
The Netherlands, Germany and Great Britain
Japan, USA, Austria and Switzerland 8 - 10%
Table 2.1 Parallel economy estimates in developed countries

(Source: http://www.crisil.com/youngthoughtleader/winners/topic4_Jyoti_Agarwal_IIm_CAL.PDF)
27
Table below shows that parallel economy exists in various developed countries all though their various initiatives
have been taking governments. The estimates of parallel economy in the context of some of the developing countries
are presented in table below
Parallel Economy
Country
(as % of GDP)
Africa
Nigeria and Egypt 68 - 76%
Tunisia and Morocco 39 - 49%
Central and South America
Guatemala, Mexico, Peru and Panama 40 - 60%
Chile, Costa Rica, Venezuela, Brazil, Paraguay and
25 - 35%
Colombia
Asia
Thailand 70%
Philippines, Sri- Lanka, Malaysia and South Korea 38 - 50%
Hong Kong and Singapore 13%
Table 2.2 Estimates of parallel economy in developing countries period: 1990-93

(Source: http://www.crisil.com/youngthoughtleader/winners/topic4_Jyoti_Agarwal_IIm_CAL.PDF)
Indian experience
Various attempts have been made to assess the black money in India from time to time. Major few of them are as
presented here:
Kaldor’s estimate: Although the Taxation Enquiry Commission had examined the structure of Indian Taxation, a
review by Prof. Nicholas Kaldor was desired by the Government in late 1955 “in view of the larger dimensions
assumed by the problems of resources for the plan since the commission reported (Important Events 1946-61)”.
Prof. N. Kaldor in his report on Indian Tax Reform estimated the non-national income:
• Wages and salaries
• Income of self-employed
• Profit, interest and rent
After making the rough adjustments, according to Wanchoo Committee, “the estimated income on which tax has been
(black income) would probably be `. 700 crores and `. 1000 crores for the years 1961-62 and 1965-66 respectively.
Projecting this estimate further to 1968-69 on the basis of percentage increase in national income from 1961-62 to
1968-69, the income on which tax was evaded for 1968-69, the income on which tax was evaded for 1968-69 can
be estimated at a figure of `. 1800 crores” (Datt and Sundharam, 2004, 378-379)
Wanchoo committee’s estimate: Shri K.N.Wanchoo, retired Chief Justice of the Supreme Court of India, as chairman
explained what the term black money meant in its final report submitted in December, 1971. This committee estimated
non-salary income for 1961-62 of amounting `. 2686 crores and non-salary income actually assessed to tax as `.
1875 crores, thus, tax escaped for `. 811 crores. Therefore, in 1961-62, black money was of amounting `.700 crores
which rose to `. 1000 crores in 1965-66 and further `. 1400 crores in 1969-70. Very lately it was accounted to be
4.4 percent of GNP (Dhar, 2003,719).
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Rangnekar’s estimate: D.K. Rangnakar as a member of the Wanchoo Committee submitted his report in 1982 (India
Today, 2005). According to Rangnekar, tax evaded income for 1961-62 was the order of `. 1,150 crores, as compared
to the DTEC estimate of `.850 crores. For 1965-66, it was `. 2,300 crores, as against `. 1,216 crores estimated by
DTEC. The projections of black money for 1968-69 and 1969-70 were `. 2,833 crores and `. 3,080 crores respectively
(Datt and Sundharam, 2004, 378).
Chopra’s estimate: A Committee under O.P. Chopra was formed in 1982 for measuring black money in India (India
Today, 2005). O.P.Chopra prepared a series of estimates of black income where it increased from `. 916 crores (6.1
percent of GDP) in 1961-62 to `. 8098 crores (10.5 percent of GDP) in1976-77 (Dhar, 2003). The study showed
that a buoyant economy offers more opportunities for unaccounted income. During periods of recession, it may
be difficult for producers to exact unaccounted money. Chopra also corroborates the hypothesis that tax evasion
is more likely the higher the rate of tax. His findings also support the hypothesis that increase in prices leads to an
increase in unaccounted income. Further, he found that funds are diverted to agriculture to convert unaccounted
(black) income into legal (white) income (Datt and Sundharam, 2004, 379).
Gupta’s estimate: Government of India formed a committee under Poonam Gupta and Sanjeev Gupta in 1981 for
calculating black money in India. They used Feige’s method of transaction income ratio to estimate black money
in a country. They used average of three years viz. 1949-50, 1950-51 and 1951-52 as the bench mark for estimating
black money for the year of 1967-68 to 1978-79.
They estimated that it was 19.8% of GDP at market price. The black money increased for `. 3034 crores in 1967-68
to `. 46867 crores in 1978-79. The main findings of studies on black money were:
• A buoyant economy offers more opportunities for unaccounted income
• The ratio of unaccounted income to assessable non-salary income has gone up after 1973-74
• Increase in prices leads to an increase in black money
• Funds are diverted to agriculture to convert black money into white money
• One per cent increase in overall taxes leads to more than 3 percent increase in the black
• economy relation to the official economy (Lekhi, 2003, 192)
The National Institute of Public Finance and Policy estimated that in 1985 amount of black money in India was nearly
`. 1,00,000 crore, which is approximately 20 percent of the national income. In 1996, the estimated black money
was believed to be more than `. 4, 00,000 crore (The Hindustan Times, January 20, 1997).Most of India’s black
money - estimated to be about US$1 trillion (Dh3.67tn) - is believed to be parked in bank accounts in Switzerland.
According to the Swiss Bankers Association, Swiss law and tax agreements prohibit third countries from general
searches for possible tax evaders, or “name-fishing” .The Indian government hopes that situation will change after
its tax treaty with the country is revised (Chopra, 2010).
Impact of Black Income on the Indian Economy

Generation of black income and thereby establishment of parallel economy has been creating the following serious
impacts on the social and economic system of the country.
• Black income has been causing underestimation of GDP in India as an enormous volume of income is diverted
to this unaccounted sector resulting in growing continuation of parallel economy of the country
• The direct effect of black income is the loss of revenue to the state exchequer as a tax evasion. Black money
has resulted in the diversion of resources for the purchase of real estate and luxury housing. Black money has
resulted in transfer of funds from India to foreign countries through clandestine channels (Dhar, 2003, 721)
• The availability of black incomes with businessmen and capitalists and the consequent inequalities of income
place a large amount of funds at their disposal
• A part of the black incomes is held in cash and as a result there is an abundance of liquidity which becomes
available through the addition of savings held in the form of cash, bullion, gold, silver, etc
• Money evaded by illegitimate way is spent in undesirable and vulgar manner. Virtues like hard work and honesty
are underestimated. Thus the existence of parallel economy has totally distorted and disrupted the planning of
the economy of the country
29
2.14 Balance of Payments (BoP)

The balance of payments is the record of a country’s transactions with the rest of the world. It consists of three main
parts: the current account, the capital account, and official reserves settlement balance. The sum of the three main
parts sum to zero. All transactions must be recorded somewhere. The key is where.
Letting CAt be the current account, KOt the capital account, and ORTt the official reserves settlement balance, the
Balance of Payments can simply be written as:
CAt + KOt + ORTt = 0. (1.1)
If the sum of the three accounts is equal to zero it is hard to speak of a balance of payments deficit. When people
speak of a Balance of Payments deficit they are referring to the sum of the current and capital account. If these are
in deficit, a surplus is required in official settlements. From (1.1) we can see that ORTt = CAt + KOt. The difference
is made up by the loss of foreign reserves, often gold.
This may not be sustainable. So while technically the Balance of Payments is always in balance, when we speak
of a Balance of Payments deficit we automatically react to this by thinking of the sum of the current and capital
account.
The basic idea behind Balance of Payments accounting is straightforward: any transaction that gives rise to a receipt
from the rest of the world is recorded as a credit, while any transaction that gives rise to a payment is a debit in the
Balance of Payments. One simple way to think about the Balance of Payments is that if you need dollars to pay for the
transaction it is a credit. If you need foreign currency it is a debit item. The question is where are they allocated.
2.14.1 A Simple Three-Item Model of the Balance of Payments

It is useful to start with a simple three-item model. The key point to remember in this example is that when people
buy goods across countries they have to pay for it somehow. Suppose that our economy has net exports of goods
and services to ROW equal to 100, and assume that these are paid for in the following way:
80 come from imports of financial assets in excess of exports, and 20 comes from gold. That is, the surplus in
trade is paid for in part by accumulating foreign assets, and in part by accumulating gold. Our simple Balance of
Payments looks like:
Category Net Exports

Goods and Services 100
Financial Claims -80
Gold -20
Total 0
What does it mean to have negative net exports of financial claims? Suppose that domestic residents issue an IOU
to foreigners. Foreigners would be crediting us now in exchange for payments in the future. With these credits we
could buy goods and services in the foreign country. In our example, foreigners are issuing more credits to us then
we are to them; hence, there are negative net exports of financial assets. Notice further, that if foreigners were not
able to borrow from us, and if their sales of goods and services (i.e., our imports from them) were less than our sales
to them, they would have to pay the difference somehow. All is left in our simple model is to transfer some other
asset; gold. The key point of our simple example is that the sum of the three components equal zero. It does not
matter exactly how they balance out, but it is critical that the sums do. Notice that in this example, we are selling
more goods and services to the rest of the world than we are purchasing. This excess must be paid for somehow.
The three categories of our simple example correspond to the three main parts of the Balance of Payments. The
CAB refers to the balance on net exports of goods and services, including net interest income on foreign assets and
unilateral transfers. The second category corresponds to the balance on the capital account, and the third category
corresponds to net imports of international reserves.
Our simple example abstracts from the double entry aspects of the Balance of Payments, focussing only on the net
flows. But it is enough to capture the general principles.
30
Current account: The current account is the measure of the economy trade in goods and services with the rest of
the world, including unilateral transfers. A good way to think of it is precisely as current items. Hence, it included
investment income, tourism, payments to military personnel, as well as exports and imports. What is excluded from
the current account is trade in assets. This is what makes up the capital account balance? In the current account
visible and invisibles are typically distinguished. The former refers to merchandise which can be seen and touched;
the latter to tourism and other flows of professional services which create remissions, but no tangible good.
Interest and investment income is an especially important item. It is important to note that the payments for the
services of capital, investment income, appear in the current account. The purchase of the good itself appears in
the capital account. For example, the profits from a factory in Canada would be in the current account, while the
investment to build the factory shows up in the capital account. The current account balance also corresponds, as we
have already seen, the net acquisition of assets by the economy. If the CA > 0 it means that the economy has received
more in receipts than we have made payments. Hence, the difference must have been acquired by the economy. This
can happen in two ways either through a surplus in the capital account or in official reserves.
Capital account balance: The capital account balance refers to all inter-national asset transactions, excluding the
ones made by the monetary authorities. When US residents purchase German bonds that represents an outflow in the
capital accounts. A German resident’s purchase of US assets would represent a capital inflow. If the capital account
balance is in surplus it means that there is a net inflow of resources.
The capital account contains three main types of flows. First, there is direct foreign investment; for example, the
factory built in Canada. Second, there is long-term portfolio investment, which would include purchases of securities
and long-term bank loans. Of course, purchases of securities are somewhat arbitrary one can speculate on 10 year
bonds just as easily as on 3-month T bills. Short term capital flows are the third item, and refer to purchases of
securities with maturities less than one year. Because of the ambiguity over flows, the US now breaks down portfolio
investment into bank related and securities rather than short-term and long-term. But other countries still stick to
the maturity distinction.
31
Summary
• India has faced the worst consequences of such overpopulation in terms of poverty, malnourishment and
illiteracy.
• India’s rapid rise of population was originated in the third decade of the 19th century which drew immense
concern.
• Population refers to total number of people residing in a place.
• India with 1.22 billion people is the second most populated country in the world. India represents apparently
17.30% of the world’s population.
• Rapid reduction in population growth can be achieved through public awareness and emancipation of women
through imparting knowledge and education to woman and people residing in the rural sectors of India.
• In India, population has mainly increased because of high birth rate and relatively low death rate.
• Relative poverty refers to the income or asset position of one class or group of people in comparison with the
other classes or groups, or of one individual vis-a-vis the others.
• Absolute poverty is associated with a minimum level of living or minimum consumption requirements of food,
clothing, housing, health, etc.
• Unemployment refers to the situation where the persons who are able to work and willing to work, fail to secure
work or activity which gives them income or means of livelihood.
• Parallel economy means functioning of an unsanctioned sector in the economy whose objectives run parallel
and in contradiction with the objectives of official or sanctioned or legitimate sector in the same economy.
• The balance of payments is the record of a country’s transactions with the rest of the world. It consists of three
main parts: the current account, the capital account, and official reserves settlement balance.
• The current account is the measure of the economy trade in goods and services with the rest of the world,
including unilateral transfers.
• The capital account balance refers to all inter-national asset transactions, excluding the ones made by the
monetary authorities.
References
• Jain, T. R, Trehan, M. & Trehan, R., 2010.Indian Economy, Revised ed., V.K. Publications.
• Singh, R., 2011. Indian Economy, 3rd ed., Tata McGraw Hill Education Private Limited.
• Current Economic Scenario [Pdf] Available at: <164.100.47.134/intranet/Currenteconomicscenario.pdf >
• Outlook for the Indian Economy [Pdf] Available at: <www.icra.in/Files/ticker/ICRA%20Macro%20and%20
Policy.pdf‎> [Accessed 11 July 2013].
• 2011. Indian Economy: The Road Ahead [Video online] Available at: <https://www.youtube.com/watch?
v=BqyGaT0RCt0‎> [Accessed 11 July 2013].
• 2012. The Economy of India [Video online] Available at: <https://www.youtube.com/watch?v=mwBrsP61U9I‎>
Recommended Reading
• Kapila, R. & Kapila U., 2004. Indian Economy, Academic Foundation.
• Gupta, K.R. & Gupta, J.R., Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.
• Jain, T.R., Trehan, M., Trehan, R. & Uppal, R., 2010. Indian Economy, V.K.Publications.
32
Self Assessment
1. India attained independence and became a sovereign secular nation on ___________.
a. 26 January 1950
b. 26 August 1950
c. 15 August 1947
d. 26 January 1947
2. In Which year India crossed the 1 billion population mark?

a. 2000
b. 1991
c. 1996
d. 1980
3. Which of the following is not an important part of Balance of Payment?

a. Current account
b. Capital account
c. Official reserves settlement balance
d. Recurring account
4. Which of the following is defined as the measure of the economy trade in goods and services with the rest of
the world, including unilateral transfers?
a. Current account
b. Capital account
5. Which of the following refers to all inter-national asset transactions, excluding the ones made by the monetary
authorities?
a. Current account
b. Capital account
6. When employment tends to be a long-term feature of a country, it is called _________________.

a. Structural unemployment
b. Technological unemployment
c. Cyclical unemployment
d. Chronic unemployment
7. Which of the following refers to a position where people may be working and apparently employed, yet their
contribution to output may be zero?
a. Structural unemployment
b. Technological unemployment
c. Disguised unemployment
d. Seasonal unemployment
33
8. ____________ has reduced Purchasing Power of Money.

a. Unemployment
b. Inflation
c. Poverty
d. Population
9. What do you mean by density of population?

a. Number of Persons per square kilometer.
b. Number of Persons per thousand kilometers.
c. Number of Persons per square meter.
d. Number of Persons per square feet.
10. In which year India has started making efforts to control its population growth?
a. 1950
b. 1947
c. 1952
d. 1964
34
Chapter III
Economic Policies
Aim
• explain economic policies
• elucidate the objectives of policy
• explicate fiscal policy
Objectives
• explain monetory policy
• enlist the objectives of fiscal policy
• explicate objective of monetory policy
Learning outcome
• describe instruments of monetary policy
• compare fiscal and monetary policy
• understand foreign investment policy
35
3.1 Introduction
A particular objective of this chapter is to provide the total perspective in which some of the recent initiatives in
India’s economic policy need to be viewed. These initiatives, usually characterised by the catchall phrase “economic
liberalisation”, have been the special focus of international attention directed at India. They are certainly important,
but they must be seen as once element of the total economic policy package, addressed especially at improving
performance in the industrial sector. Economic policy must also deal with many other aspects of performance
where the key issues do not relate to economic liberalisation. It is also important to distinguish the Indian policy
initiatives form the classical “liberalisation packages” which are ardently advocated in many quarters. There are
important differences in approach and perhaps also in underlying philosophy and these differences are brought out
in this chapter.
3.2 Objective of Policy

Both performance and policy are in some sense best judged in terms of the objectives of development policy, the
more so in an economy in which objectives have been consciously set in successive national plans. The broad
objectives which have guided India’s development strategy are listed below. Some of them are obviously common
to all developing countries, but others are not so, at least not to the same extent.
• Achievement of a high rate of economic growth leading to a sustained improvement in the levels of living of
the population. This is obviously a common objective of all developing countries
• Reduction in inequalities and more especially an accelerated effort to remove poverty at a pace faster than would
be achieved solely through the normal growth process
• Development of a mixed economy with a strong public sector, especially in key areas of the economy. The
creation of a public sector could be viewed as an instrument for achieving broader objectives of growth with
equity, but India’s development strategy has accorded such special importance to the public sector that t could
properly be described as an independent objective of policy. The creation of a public sector was viewed not
merely as an instrument to achieve other objectives. There was a more basic and widely shared socio-political
commitment to the creation of a mixed economy, in which the state has a substantial direct control over important
production sectors
• Achievement of a high order of “self-reliance” has been an important independent objective. The term itself is
used in tow senses. In one sense, self-reliance has meant that development must be financed as far as possible
from domestic savings, avoiding excessive dependence upon external assistance. Self-reliance has also meant
a conscious effort at developing a broad domestic production base and an indigenous technological capacity,
both of which were felt to be essential requirements for building a strong industrialised economy
• Promotion of balanced regional development, with a narrowing of economic difference across regions. This has
tended to be viewed not just as matter of promoting economic growth but also more specifically as a matter of
regional balance in the degree of industrialisation
• Finally, these social and economic objectives were to be pursued in the framework of a constitutional
democracy
These broad objectives have been evident from the very early stages of Planning in India. Over time they have
taken more concrete shape as distinct objectives. It is evident that some of these objectives involve a potential
conflict or trade-off with growth, at least in the short term. The possibility of such trade-offs in the short run was
always consciously recognised, though of course it is always relevant to ask whether in practice the trade-off was
optimised.
How has the economy performed in terms of these objectives? A summary assessment is offered in the following
sections, focusing especially on recent performance and identifying some key aspects of policy and future priorities
as they emerge from recent experience.
36
3.3 Growth Performance
The rate of growth of the economy is the most commonly used measure of overall performance and it is appropriate
to begin with this indicator. Up to about the mid-seventies, India’s trend growth rate of G.D.P ignoring yearly
fluctuations seemed firmly anchored at about 3.5 percent per year, unforgettably characterised by the late professor
Raj Krishna as “the Hindu rate of growth”. There is clear evidence that the economy broke through this constraint
sometime in the mid-seventies. The growth rate over the past ten years or so averages about 4.5 percent and this
is an average over a period in which growth was accelerating. The underlying growth rate of the economy in the
mid-eighties is nearer 5 percent per year. This is not high compared with growth rates achieved in earlier decades
by the better-performing developing countries. Some countries have achieved annual growth rates as high as 10
percent over sustained periods, and many have grown at rates between 6 percent and 7 percent in the sixties and
early seventies. But this comparison is not wholly fair in assessing recent economic performance in India.
An obvious point which has to be noted is that India is a relatively large economy and also among the group of
low-income countries of the developing world. The size of the economy ensures that a process of averaging must
be at work. India’s “growth potential” cannot therefore be presumed to be equal to the fastest-growing developing
countries, but closer to the average. More important, India’s recent performance should not be assessed by comparing
it with growth rates achieved by developing countries in an earlier period when the international environment was
especially conducive to rapid growth. The growth potential of the developing world as a whole has slowed down
since the mid-seventies, and when due allowance is made for this factor, India’s recent growth performance and
current growth prospects appear in a much better light.
In the period up to the mid-seventies India’s growth rate of around 3.5 percent per year was much lower than the
average of about 6.0 percent achieved by the developing countries as a whole. In the past ten years, however, India’s
growth rate has accelerated, while growth rates in most of the developing world have decelerated. India’s growth
rage in the period 1981-86 was almost 5 percent, when all developing countries taken together grew by only 2.5
percent. Admittedly the low growth of developing countries as a group was partly due to negative growth rates in
the oil-exporting countries, but even if these countries are excluded, the category of non-oil-developing countries
shows a growth of only 3.5 percent per year in this period. In fact, India’s growth performance in the eighties is
exceeded only be some of the fast-growing East Asian economies and China.
This raises the question whether the acceleration in growth is a temporary phenomenon or indicative of a more
basic improvement in the economy’s growth potential. The theme explored in this chapter is that India had indeed
experienced a permanent acceleration in growth, accompanied by an increase in its underlying growth potential.
A degree of structural maturity has been achieved in both agriculture and industry, which not only has laid the
foundation for sustained growth at 5 percent but also holds out the prospect of higher growth in future. The elements
of this transformation and the policy framework in which it took place are discussed in the subsequent sections of
this chapter.
The governments of all countries are expected to promote the economic growth and economic welfare to improve
the standard of living of the citizens. Governments are also expected to maintain law and order and ensure security
of the country. Economic growth is generally measured in terms of GDP (Gross Domestic Product). GDP is the
total value of goods and services produced in a country. An increasing GDP indicates increasing economic activity,
which in turn generates more income. When employment and income of the citizens increases, their standard of
living also increases. The policies that governments pursue to encourage economic growth and welfare are called
economic policies. These policies can be broadly classified into:
• Fiscal policy
• Monetary policy
37
3.4 Fiscal Policy

This policy seeks to promote the economic growth and to offset fluctuations in employment and income through
proactive management of public expenditure, investments, taxation, and borrowings. The sources of funds of the
government are tax receipts and borrowings. The major expenditures of the government are salary and administrative
expenses on maintaining the government machinery for tax collection, law and order, and defence of the country.
Payment of interest and repayments of the existing borrowings are major outflows in case of governments that have
been spending more than their tax income or running deficit budgets. Progressive governments, therefore, try to
limit the preceding outflows and invest the surplus in augmenting infrastructure and other facilitators of economic
growth.
The governments also try to directly influence the growth of certain regions, industries, or vulnerable sections of
citizens by providing incentives in the form of tax concessions and subsidies. In addition, governments also enlarge
the welfare initiatives like health care and education. Governments draft relevant policies and implement them
through various ministries. However, these policies are coordinated by the Finance ministry, which is responsible for
raising resources and allocating the required resources to the various ministries. The policies formulated by various
ministries and coordinated by the Finance ministry through the budgeting process are called Fiscal policies.
3.4.1 Objectives of Fiscal Policy

The objectives of fiscal policy are not specified, they may differ from country to country. Following are the main
objectives of fiscal policy in the developing countries.
• Desirable levels of prices: The desirable level of prices can be achieved with the change in rate of taxes. Higher
taxes are imposed on luxury goods and lower on consumer goods
• Desirable level of employment: The desirable level of employment is the level of full employment, which can
be obtained with the increase in constructional and developmental, works in the country
• Desirable level of income distribution: Higher income taxes are imposed on rich people so that there may be
equal distribution of wealth in the country
• Desirable level of consumption: Desirable level of consumption is achieved by imposing higher duties on foreign
products and less duties on national product, so that domestic industries may be developed
3.4.2 Fiscal Policy Tools

The legislative and executive branches of government control fiscal policy. In the United States, this is the President’s
administration (mainly the Treasury Secretary) and the Congress that passes laws. Policy-makers use fiscal tools to
manipulate demand in the economy. For example:
• Taxes: If demand is low, the government can decrease taxes. This increases disposable income, thereby stimulating
demand
• Spending: If inflation is high, the government can reduce its spending thereby removing itself from competing
for resources in the market (both goods and services). This is a contractionary policy that would lower prices.
Conversely, when there is a recession and aggregate demand is flagging, increased government spending in
infrastructure projects would lead to higher demand and employment
Both tools affect the fiscal position of the government i.e., the budget deficit goes up whether the government
increases spending or lowers taxes. This deficit is financed by debt; the government borrows money to cover the
shortfall in its budget.
3.5 Monetary Policy

Prices of goods and services are influenced primarily by factors of demand and supply. These keep fluctuating on a
constant basis. The changes in price level are measured by the government by average prices of a basket of goods
and services both at the wholesale level and individual consumer level. Price indicators are known as Wholesale
Price Index and Consumer Price Index.
38
Wild fluctuations in prices can be very disruptive as it will affect the fortunes of industries and, therefore, impact
the life of those engaged by the industries. It is the responsibility of the government to ensure reasonable stability
of prices. Similarly, ensuring stability of exchange rate of the country vis-a-vis the international currencies such as
US dollar and Euro is also essential to ensure orderly growth of industries. Fluctuations in exchange rates can cause
fluctuation in the general price level, which in turn could destabilise the economy. Hence, an important goal of the
government is to ensure reasonable stability of exchange rate of the currency of the country.
The policies pursued for managing liquidity, interest rates, and prices are together known as the monetary policy.
This policy is shaped and administered by the Reserve Bank of India [RBI]. RBI announces policy stance every 6
months. The policy statements of RBI cover more than liquidity and interest management. It covers all functions of
RBI, such as, monetary management, regulation of banking system, exchange rate management, and their role as
bankers to the government, namely, managing the finances and borrowing programmes of the government.
3.5.1 Objectives of Monetary Policy

The basic objectives of the monetary policy are to influence price level and investments, which determine economic
growth. This policy seeks to achieve these objectives by proactive management of:
• Price level
• Money supply
• Interest rates
• Foreign exchange rate
Relevance of price level

A gradual increase in price level has positive influence on sentiments. However, runaway increase in prices or
inflation has damaging influence on both investors and savers. Strident increase in prices increases uncertainty and
generates a sense of insecurity both among the savers and investors. Therefore, one of the important objectives of
the monetary policy is to limit increase in price level to acceptable levels also known as inflation targeting. What is
the acceptable level depends on the situation prevailing in the country. The RBI and the government seem to have
accepted an increase of up to 5% in a year in price level as acceptable.
Relevance of money supply

One of the factors that influences price level and is under the control of RBI is money supply. The measures of
money supply are:
• M1: Currency with public and demand deposits with banks and RBI, both available for immediate spending.
• M2: M1 plus savings deposits with banks
• M3: M2 plus fixed deposits with banks
• M4: M3 plus total deposits with post offices
The government influences money supply or liquidity in the following manner:

• Government spending and investments increase money supply
• Collection of taxes and borrowings from the market reduce money supply till it is spent or invested.
• Deficit financing leads to an increase in money supply because deficits exceed expenditure funded by borrowing
from RBI
Relevance of interest rate

If funds are available at affordable interest rates, it leads to higher investments on personal as well as business
front. The increased availability of retail credit at affordable rates leading to growth of automobile, housing and
consumer goods industry in India is a good example of relevance of interest rates. Higher investments lead to higher
employment and income, which in turn fuels demand and encourages further investments.
39
Increasing interest rate dampen demand for money for investments from individuals and business. Decline in
inventory build up and investments lead to lower employment and lower income. Higher interest may also divert
funds from consumption to savings leading to reduction in demand. This further leads to reduction in price level,
and in turn dampens business sentiments and fresh investments.
Relevance of Foreign Exchange Rate

If rupee becomes cheaper (more rupees per dollar), then Indian goods will become cheaper abroad which will lead to
increase in exports. Investment in export-oriented industries will increase. Conversely, imports will become costlier
and import dependent industries will be affected. Other industries, which are consumers of the import dependent
industry, will also be impacted negatively. In an import dependent economy like India, which depends on oil imports,
trade deficit will increase resulting in further reduction in competitiveness.
India has always had a trade deficit, but the imbalance in trade is being made good by inward remittances from
Indians abroad and investment flows such as Foreign Direct Investment [FDI] and Foreign Institutional Investor
[FII]. Exchange rates impact prices, interest rates, and economic growth. Therefore, smoothening exchange rate
fluctuations and managing its range and direction of movement is an important element of the monetary policy.
3.6 Instruments of the Monetary Policy

The instruments at the disposal of the RBI for managing money supply, interest rates and exchange rates are:
3.6.1 Liquidity Management

• Cash Reserve Ratio: Banks reserve liquidity through their power to create credit. Presently in India, banks are
required to maintain the following reserves:
Cash Reserve ratio: 8.25% of demand and time deposits (w.e.f. 24.05.2008)
Statutory Liquidity ratio: 25% of demand and time deposits
Just as additional cash inflows enable the banking system to create credit, any increase in CRR will require the
banking system to contract credit by a large amount
SLR (Statutory Liquidity ratio) is a requirement peculiar to India. In addition to ensuring that banks can fall
back on the readily saleable government deposits in the event of a run on the bank, it was a prescription to divert
bank deposits to meet government investment expenditure
• Open Market Operations: Banks as well as other financial institutions, such as insurance companies, mutual funds
and corporate with surplus cash are big investors in government securities. When RBI wishes to inject liquidity
into the market, it has another option of buying government securities. When RBI offers to buy the securities
at a rate that is better than the rate prevailing in the market, some of the investors can sell their holdings and
the cash inflow would lead to credit creation of a large magnitude. Similarly, when RBI sells government
securities at a higher rate than market rate, RBI absorbs funds and the banking system contracts credit
by a large magnitude to reduce liquidity. This is known as open market operation
• Managing Credit Expansion: CRR and OMO reduce liquidity in the system and reduce the ability of banks to
create credit. RBI also controls sector specific expansion of credit by specifying maximum amounts that can be
lent, minimum margins to be maintained and higher risk weights. When RBI feels that banks have overextended
themselves to certain sectors, the flow of credit to certain sectors is leading to an imbalanced growth of the
economy or it wants to control the price of certain commodities by preventing hoarding by wholesalers with
borrowed funds, RBI makes sector specific or commodity specific interventions
3.6.2 Interest Rate Management

Repo rate: Repo rate or repurchase rate is a swap deal involving the immediate sale of securities and simultaneous
purchase of those securities at a future date, at a designated price. It could also be an overnight deal with sale taking
place on day one and repurchase on day two. The repurchase price is adjusted for the interest payable for the use
of funds for the period of contract. Reverse repo involves the immediate purchase and future sale of those same
securities. RBI uses repo and reverse repo to control liquidity on a day-to-day basis.
40
• Bank rate: RBI provides refinance to banks against funds deployed by banks in specified sectors such as export
finance portfolio of the banks. In the past, the bank rate used to be the primary interest rate tool of RBI. But
over a period of time the repo rate has presently emerged as the primary interest rate tool and bank rate has lost
much of its relevance. Changes in the bank rate are a signal to the market regarding the direction in which the
RBI would like interest rates to move
• Rates paid on government securities: RBI, as a banker to the government, helps government to borrow from
the market by selling their securities. RBI also determines the timing, size, and rate paid on the issues. Rates
offered by RBI on government securities are both a reflection of the market and also an indicator to the market
on the direction of interest rate movements
3.6.3 Foreign Exchange Management

• Tweaking the basket of currencies: The exchange rate of rupee is calculated by RBI based on the exchange
rates of basket of currencies of countries with which India has significant trade transactions. RBI maintains
confidentiality about the weightage given to each currency in the basket and when RBI wishes to manage the
extent of volatility in the exchange rate of rupee, RBI adjusts the weightages properly
• Market intervention: Large balance of payment surpluses and build up of Forex reserves are bound to strengthen
the rupee in the exchange market. This market force cannot be counted by RBI for long periods of time. However,
by intervening in the market by offering to buy any amount of foreign currency at a particular rate, RBI can
prevent the sudden strengthening of rupee. RBI seeks to smoothen the movement of rates in either direction so
than importers and exporters have time to adjust to the changing exchange rate scenario and are not caught by
surprise by violent rate movements, which could cripple them
3.7 Difference between Fiscal Policy and Monetary Policy

Difference between fiscal policy and monetary policy is discussed as below:
Fiscal Policy Monetary Policy
Manipulating the level of aggregate Manipulating the supply of money to

demand in the economy to achieve influence outcomes like economic growth,
Principle:
economic objectives of price stability, inflation, exchange rates with other currencies
full employment, and economic growth. and unemployment.
Monetary policy is the process by which the

Fiscal policy is the use of government monetary authority of a country controls the
Definition: expenditure and revenue collection to supply of money, often targeting a rate of interest
influence the economy. to attain a set of objectives oriented towards the
growth and stability of the economy.
Interest rates; reserve requirements; currency

Policy
Taxes; amount of government spending peg; discount window; quantitative easing;
Tools:
open market operations; signalling
Policy- Government (e.g. U.S. Congress, Treasury

Central Bank (e.g., U.S. Federal Reserve)
maker: Secretary)
Table 3.1 Comparison between fiscal policy and monetary policy
3.7.1 Foreign Investment Policy

A particularly striking feature of India’s foreign investment regime since the 1990s has been that it encourages the
adoption of foreign technology by domestic firms while at the same time opening up these industry sectors to foreign
investors. So liberalisation consists of two distinct components:
41
Foreign direct investment (FDI), defined by the International Monetary Fund as a foreign firm taking at least a 10%
stake in a domestic firm. Foreign technology agreements (FTA), more ‘arm’s length’ transactions in which a foreign
firm enters into partnership with a domestic firm. The relative importance of the two components can be gauged by
the fact that in the post-reform period (between August 1991 and January 2005 in this study), the number of FDI
projects approved by the Indian government was nearly 19,000 and the number of FTAs approved was just over
7,600.Unlike in many East Asian countries, Indian policy-makers have resisted the temptation to offer subsidies to
foreign investors (at least until very recently). Instead, they have pursued a two-pronged strategy of inviting FDI
from foreign firms as well as encouraging FTAs by domestic firms.
Previous research has shown that increasing FDI leads to greater competition in industries where firms compete
with each other at a single stage of the production process. The effect of increased competitive pressure is to lower
the mark-ups that domestic firms are able to charge, thereby reducing their measured productivity. This is typically
not outweighed by any productivity benefits to domestic firms from observing and copying the techniques used by
foreign firms – what are known as ‘technology spillovers’. For firms in these industries to gain significantly from
technology spillovers, they need to be technologically advanced or close to the ‘technology frontier’.
But in vertically integrated industries (where firms operate at more than one stage of the production process),
previous research suggests that the effect of FDI on productivity is positive. This implies that both domestic and
foreign firms benefit from technology spillovers.
Chawla’s research finds that liberalisation of the foreign investment regime in India has significantly improved
the performance of manufacturing firms. This is surprising as the sample mainly consists of firms that compete
at a single stage of production. What seems to have happened is that the policy of encouraging FTAs has had an
effect equivalent to technology spillovers, moving domestic firms closer to the technology frontier, albeit through
different means. Since the industries studied were simultaneously subjected to both FDI and FTA liberalisation, it
is not easy to distinguish between the effects of two policies. To do this, the research looks in detail at the motor
vehicle industry. It finds that in this sector at least, the two elements of the foreign investment regime have been
complementary in their positive impact on firms’ productivity.
India’s experiences are often compared with China’s, and while the latter has attracted greater FDI inflows than the
former since the early 1990s, India has attracted greater portfolio investment and the ratio of market capitalisation
of its listed firms to GDP has been higher. What’s more, Indian firms now invest so much abroad that FDI outflows
almost match FDI inflows. The fact that India’s foreign investment liberalisation treats foreign technology and direct
investment as inseparable is important here. Such a policy is bound to have effects beyond the simple enumeration
of FDI inflow figures. At least one important implication of this policy is its positive effect on the productivity of
manufacturing firms. Arunish Chawla is an occasional research.
New dimensions of Foreign Investment Policy

One of the new dimensions of foreign investment policy is investment in infrastructure. The contours of this policy
have been dictated by three main factors. First, India’s infrastructural needs are huge. The quantum of infrastructural
gaps and the resource requirements has been estimated by the India Infrastructure Report (1996). Second, the public
sector is no longer in a position to meet the requirement all by itself. Third, India needs to have latest technologies
in order to have modem infrastructural facilities. Technological up gradation in the rest of the economy can be
facilitated only with modernisation of infrastructure. Accordingly, private sector participation (domestic as well
as foreign) has been a key element of the policy for infrastructure development. It has taken some years to evolve
definitive policy framework and has not been without hitches, which arose out of lack of necessary understanding
of the principles that guide private investment in infrastructure. However, the policy that has finally evolved is a
mix of international trend in foreign participation in infrastructure and the country’s long-term perspective.
The policy permits:

• 100 per cent foreign investment in power, roads and highways, construction of airports and ports and
• 49 per cent foreign equity in telecom
42
There is lack of clarity, or rather indecisiveness, about foreign investment in the railways and civil aviation. In the
case of railways, it is not clear whether foreign investment is welcome or not, and if welcome, what is the permissible
extent of foreign equity. This sector has also managed to escape any kind of debate. But the civil aviation sector has
been a controversial one. Foreign equity participation up to 40 per cent, subject to approval, is what the government
may be willing to consider, but so far it has not been possible to establish it as a matter of general policy. On the
whole, it can be said that though the government welcomes foreign investment in infrastructure, the policy is rather
sectoral than general in character.
Investment in financial sector is another new dimension of foreign investment policy. Like infrastructure, this sector
was also closed to the private sector, but has been subjected to gradual reform since 1991. So far, there is nothing
that can be called a comprehensive foreign investment policy for financial sector, but three distinct policy changes
have been undertaken. First, the foreign banks are given liberal permission to open subsidiaries and expand branches,
besides wider avenues in the area of banking operations. Second, foreign non-banking financial companies (NBFCs)
have been allowed to start operations in India, mostly in joint ventures with the Indian NBFCs, though there is lack
of clarity as to the extent of foreign equity participation. The interest is primarily on capital adequacy and protection
of investors’ money, rather than equity. Third, the FIIs are allowed to invest in the equities of listed Indian companies
to the extent of 30 per cent. These are the broad aspects of foreign investment policy in the financial sector. The
question of foreign investment in the insurance sector has been a subject of considerable debate, but lack of necessary
political support has been a major obstacle to reform. The doors are closed even to the domestic private sector.
43
Summary
• A particular objective of this chapter is to provide the total perspective in which some of the recent initiatives
in India’s economic policy need to be viewed.
• Both performance and policy are in some sense best judged in terms of the objectives of development policy,
the more so in an economy in which objectives have been consciously set in successive national plans.
• The rate of growth of the economy is the most commonly used measure of overall performance and it is
appropriate to begin with this indicator.
• Fiscal policy seeks to promote the economic growth and to offset fluctuations in employment and income through
proactive management of public expenditure, investments, taxation, and borrowings.
• The legislative and executive branches of government control fiscal policy.
• Prices of goods and services are influenced primarily by factors of demand and supply. These keep fluctuating
on a constant basis.
• The basic objectives of the monetary policy are to influence price level and investments, which determine
economic growth.
• Repo Rate or repurchase rate is a swap deal involving the immediate sale of securities and simultaneous purchase
of those securities at a future date, at a designated price.
• RBI provides refinance to banks against funds deployed by banks in specified sectors such as export finance
portfolio of the banks.
• Foreign direct investment (FDI), defined by the International Monetary Fund as a foreign firm taking at least a
10% stake in a domestic firm.
• One of the new dimensions of foreign investment policy is investment in infrastructure.
References
• Coeure, B. & Jacquet, P., 2010. Economic Policy:Theory and Practice, Oxford University Press.
• Dixit, A.K., 1996.The Making of Economic Policy:A Tansaction-Cost Politics Perspective, The MIT Press.
• Economic Policy Reforms 2013 [Pdf] Available at: <http://www.oecd.org/inclusive-growth/Economic%20
Policy%20Reforms%202013%20Going%20for%20Growth.pdf> [Accessed 11 July 2013].
• Economic Policy Reforms 2013 [Pdf] Available at: < arhiv.mm.gov.si/vlada/temp/OECD2012.pdf‎> [Accessed
11 July 2013].
• 2011. Indian Economy: The Road Ahead [Video online] Available at: <https://www.youtube.com/watch?v=
BqyGaT0RCt0‎> [Accessed 11 July 2013].
Recommended Reading
• Sterner, T., 1996. Economic Policies for Sustainable Development, Kluwer Academic Publishers.
• Acocella, N., Economic Policy in the Age of Globalisation, Cambridge University Press.
• Krueger, A.O., Economic Policy Reforms and the Indian Economy, The University of Chicago Press,
Chicago.
44
Self Assessment
1. What do you mean by GDP?
a. It is the total value of goods and services produced in a country.
b. It is the total value of goods and services produced in the whole world.
c. It is the total volume of goods and services produced in a country.
d. It is the total volume of goods and services produced in the world.
2. The policies that governments pursue to encourage economic growth and welfare are called _____________.
a. social policies
b. economic policies
c. financial policies
d. employment policies
3. Which of the following is a swap deal involving the immediate sale of securities and simultaneous purchase of
those securities at a future date, at a designated price?
a. Repo Rate
b. Bank Rate
c. Interest Rate
d. Rates paid on government securities.
4. RBI announces policy stance every ___ months.

a. 3
b. 6
c. 12
d. 9
5. Which of the following policy seeks to promote the economic growth and to offset fluctuations in employment
and income through proactive management of public expenditure, investments, taxation, and borrowings?
a. Fiscal policy
b. Monetary policy
c. Social policy
d. Financial policy
6. What do you mean by inflation targeting?

a. Limit increase in GDP.
b. Increase in price level of goods.
c. Limit increase in price level.
d. Increase in GDP.
45
7. Which of the following is one of the factors that influences price level and is under the control of RBI?
a. Relevance of Money supply.
b. Relevance of Interest rate.
c. Relevance of Foreign Exchange Rate.
d. Relevance of Liquidity management.
8. Banks reserve liquidity through their _____ to create credit.

a. Capacity
b. Power
c. Profit
d. Balance
9. Which of the following do not falls under liquidity management?

a. Repo rate
b. Cash Reserve Ratio
c. Managing Credit Expansion
d. Open Market Operations
10. Investment in __________ sector is another new dimension of foreign investment policy.
a. technology
b. financial
c. telecom
d. housing
46
Chapter IV
Industrial Development and Industrial Policy
Aim
• explain industrial performance
• elucidate problems related to industrial growth
• explicate Indian Public Sector- Performance
Objectives
• explain the concept of cottage and small scale industries
• enlist the industrial and trade policies
• explicate privatisation
Learning outcome
• describe liberalisation
• compare cottage and small scale industries
• understand financing development
47
4.1 Industrial Performance and Policies

Rapid industrialisation has long been viewed as the key to sustained growth and modernisation of the economy.
However, industrial policies were not framed solely by the immediate requirements of growth maximisation. They
were also influenced by active government intervention in pursuit of some of the other developmental objectives
listed earlier in this chapter.
The results present a mixed picture. In some respects the industrial sector can be said to have achieved the objectives
set for it. A substantial public sector presence has been created, laying the foundations for a mixed economy. A high
degree of “self reliance” has been achieved in the sense that a highly diversified industrial base has been created,
catering to the domestic needs of the economy in a very wide variety of products. The entrepreneurial base of the
economy has also been widened greatly, with the emergence of a number of new large and medium-scale industrial
houses and a profusion of small-scale entrepreneurs. Finally, industrial has spread into regions where industry
did not exist earlier and into which it probably would not have gone for many more years but for government
intervention.
4.2 Problems Related to Industrial Growth (A Critical Analysis)

Against these achievements there are some obvious shortcomings. Industrial growth has not been as rapid as was
expected. After a promising early period in the fifties and early sixties, industrial growth slowed down considerably,
and from 1964-65 to 1975-76 the index of industrial production showed a growth rate of only 4 percent per year
and value added in industry grew at 3.5 percent per year. There is evidence of a gradual acceleration after the mid-
seventies, through with considerable year-to-year fluctuations. In the most recent period 1981-82 to 1986-87, the
index of industrial production (using the new index base 1980-81=100) shows an average growth rate of around 7
percent per year while value added growth is about 6 percent. This is definitely an improvement on past performance,
but it still falls short of what is needed to take the economy beyond the current 5 percent growth of GDP. For the
future, India should be aiming at an industrial growth rate of around 9 percent to 10 percent, with value added in
the industrial sector growing at 8 percent to 9 percent.
Another major shortcoming in India’s industrial sector is its lack of international competitiveness and consequent
poor export performance. Export performance is obviously important in a situation in which the continued growth
and modernisation of the economy requires a substantial inflow of imported capital goods and other inputs into
production. The industrial sector, which absorbs a large percentage of total resources available to the economy, must
be able to earn the foreign exchange it needs from exports. This has not yet happened to the extent needed, and one
of the major constraints is clearly lack of competitiveness in terms of both cost and quality.
These shortcomings of slow industrial growth and a high-cost uncompetitive industrial sector have been widely
recognised in India and have led to critical reexamination of the industrial policy structure to see what corrective
steps are necessary. The blame for slow industrial growth cannot, of course, be laid on policy alone. For example, it
could be argued that the key to faster industrial growth lies in a more rapid pace of expansion in agriculture which
would provide the stimulus for faster growth in industry. While this is undoubtedly true, a consensus has also
emerged that the system of regulatory control that has evolved over time is not conducive to industrial efficiency
and dynamism.
A number of official reports and academic studies have documented that problems created by a control system
consisting of detailed, often multiple, regulation and scrutiny. This system has operated in a manner which hampered
the ability of industrial units to take rational investment decisions, limited their ability to modernise existing capacities
and even discouraged expansion of production beyond licensed capacity. It has also restricted competition which
would have been a spur to improved quality and lower cost. Much of the problem arises because of the multiplicity
of objectives to which industrial policy has been tailored, each involving an intervention which has an economic
cost.
The catalogue of criticisms of the industrial policy is well-known. The original rationale for industrial licensing
was to direct private investment into desired areas and also to avoid wasteful over investment. In practice, strict
licensing often had the effect of limiting expansion by efficient units or entry by potential new units on the ground
48
that adequate capacity had already been licensed. Inefficient producers were therefore effectively shielded from
domestic competition. The objective of limiting concentration of economic power led to especially strict scrutiny
and regulation of the expansion or investment plans of larger houses, with a view to ensuring that their activities
were restricted to high-priority, technically more difficult industries. Consideration of maintaining regional balance
often led to fragmentation of capacity, with a consequent loss of economies of sale. There was a tendency to license
a larger number of small units spread over many States, where a single economic-scale plant would have been more
efficient.
These and other sources of inefficiency undoubtedly contributed to the emergence of a high-cost industrial structure
which slowed growth and reduced export competitiveness. Such a structure would obviously not have been sustainable
in a more open economy, which allows competition from imports, but the trade policy permitted very little room
for import competition. The objective of self-reliance should have meant self-reliance with efficiency. In practice,
however, domestic production was protected from external competition with little regard to domestic resource
costs. Protection, which should have been viewed as giving initial support for infant industries, which would in time
outgrow the need for it, typically continued as an indefinite crutch, supporting industries whose costs of production
were far out of line with international prices.
4.3 Policy Initiatives Taken

These problems prompted the establishment of various official committees in the early eighties to examine the structure
of industrial and trade policies and make recommendations for change. On the basis of their recommendations a
series of policy initiatives were taken in 1985 and 1986. The most important of these were the following:
• The coverage of industrial licensing was reduced by relicensing twenty-five industries and eighty-two
pharmaceutical products
• Where licensing remained in operation, procedures were simplified and industrial licensing was much more
liberally operated. Furthermore, greater flexibility was provided to producers to expand capacity within existing
licensed capacity. Provisions for allowing automatic expansion in licensed capacity, which existed earlier,
were liberalised. For a number of products, licenses were “broad banded” so as to cover similar products, thus
allowing flexibility in varying the product mix
• The minimum size of assets beyond which a unit is declared a “large house” and subjected to especially rigorous
scrutiny in licensing was increased from `. 200 million to `. 1,000 million
• Twenty-seven industries were added to the list of industries for which large houses are exempted from the
special scrutiny normally required
• A list of industries was notifies where economies of scale are important, and for these industries minimum
economic scales of plant were specified. Existing units below these sizes will be allowed to expand freely up
to the minimum economic size, and new units will be licensed only for these of higher sizes
• A number of items were earlier reserved for production in the small-scale sector, defined in terms of units with
investment in plant and machinery below `. 35 lakhs. In many cases, this investment limit was too low for
efficient production of the reserved items. The list of reserved items has been reviewed, and a number of items
have been deleted, or in some cases redefined, to enable larger-scale investment to be made for the production
of a large number of items
• In the area of trade policy, the Government accepted the principle of shifting from quantitative controls to tariff
controls. Implementation, however, was left to be determined in the light of practical possibilities. Some tariff
adjustments have indeed been made along these lines
• No major change was made in the degree of import liberalisation in 1985 and 1986, but it was reaffirmed that the
liberalisation that had earlier taken place over the first half of the eighties would stay in place. The affirmation
that import policy would not be reversed was an important signal in a situation where the balance of payments
was beginning to show strain
• A major step was taken towards rationalisation of the indirect tax system in 1986 by introducing a modified
value-added tax, covering a wide range of commodities. The system provides for adjustment of the duties paid
on inputs against the tax due on output. Although tax rates on outputs were simultaneously raised to avoid
any net reduction in effective taxation in the initial stages, it was nevertheless an important reform. The total
49
burden of excise taxation on a commodity is now more apparent since earlier-stage duties are adjusted against
the tax. This paves the way for restructuring of indirect taxation in the future. The Government has indicated
that restructuring of indirect taxes will be attempted industry by industry
• Steps have also been taken to rationalise the structure of customs duties. The range of variation of tariffs for
capital goods has been reduces. Tariffs were raised on a number of items earlier allowed at 55 percent duty and
lowered on others where the tariff was 101 percent, and all these items now face a uniform duty of 85 percent
(inclusive of a 15 percent countervailing duty which offsets the 15 percent domestic excise duty on capital
goods). In addition, the customs duty structure for components and raw materials has been both lowered, and
rationalised, for selected sectors. It has also been indicated that such restructuring will continue to be made
sector by sector
• Finally, a number of measures were taken to improve the competitive position of exporters. The procedures for
giving exporters access to imports at international prices were further improved in several ways and direct tax
incentives for income from exports were strengthened. Some of these measures are applicable to all exporters,
but others were aimed at particular export sectors. The customs duties on capital goods for certain industries
deemed to have export potential (gems and jewelery, garments, leather, etc.) were reduced to 35 percent in an
effort to bring the cost of production in these industries more in line with world prices
It is too early to evaluate quantitatively the effect of the 1985 and 1986 measures on actual industrial performance.
However, there is no doubt that they have contributed to a spurt of investment proposals in these years. The volume
of industrial licenses approved in 1985 and 1986 increased very substantially and there was also a large increase in
industrial investment proposals in the relicensed category as measured by the number of registrations. Moreover,
because of the more liberal approach to technological modernisation and import of capital goods for this purpose,
the more recent investment proposals embody better technology than has been allowed in the past. Many of them
also represent plant sizes which are nearer to economic levels of scale. The full impact of this investment boom and
the associated qualitative improvements should be evident in the next few years when the capacities to be created
by these investments come on-stream.
4.4 Indian Public Sector- Performance

An important determinant of industrial performance in India is the performance of the public sector. The creation
of a large public sector presence in the Indian economy was one of the explicit objectives of India’s development
strategy and the success in achieving this objective is evident. Public sector output today accounts for about 45
percent of the output of the organised industrial sector and 30 percent of total industrial output. Its alone ensures
that an overall acceleration of industrial growth would require an improvement in public sector performance. This
is all the more so since the public sector occupies a dominant position in key infrastructure industries such as power
generation, coal, steel and crude oil production, and performance in these areas is crucial to the general level of
industrial efficiency.
There can be no doubt that very considerable improvement is needed in public sector performance. The logic of
undertaking large investments to create a public sector with a commanding presence implies that it will generate
the necessary surpluses to be able to replace capital and finance investment for future growth. The record in this
respect has been disappointing. There are heartening examples of very good performance by individual enterprises,
but, equally, there are many cased of large and chronic loss makers. The overall generation of resources from this
sector is well below the level assumed in the Plan. If the resources contributed by the oil sector are excluded, the
performance of the other public sector organisations appears in a much poorer light.
There is no easy solution to the problem of improving public sector performance. Many of the public sector enterprises
suffer from earlier noneconomic decisions, which are not always the fault of management. No simple formula will
overcome these problems. Many are heavily overmanned, and it is not easy to lay off surplus labor. Some suffer
from wrong technology choices or product mix decisions made earlier which impose a continuing burden on the
enterprise. In some cases, public sector projects become unviable even before they commence production because
capital costs are allowed to escalate to unreasonable levels on account of delays in implementation, usually because
the unit was short of funds at the early stages. Still other loss-making enterprises in the public sector are actually
former private sector units which had become financially unviable and were taken over by the Government only to
protect employment. Each of these pathologies obviously calls for its own solution.
50
However, a consensus is emerging on one important issue, and that is the need to give management autonomy to
public sector enterprises as a key requirement for efficient functioning. There is no inherent reason why a public
sector corporation should be inefficient, if it is run like a corporation. In particular, it must not be subjected to
continuous interference from the Government or bureaucracy who demoralises public sector management and dilutes
accountability. Government should set out the corporate objectives of the enterprise and top management must be
given the full degree of autonomy needed to achieve these corporate objectives. With this autonomy there must
also be accountability. The performance of top management must be judged in terms of the achievement of agreed
objectives. The Sengupta committee, which examined the functioning of public sector enterprises and submitted
its report in 1985, had recommended that the objective of ensuring autonomy and accountability could be achieved
by introducing a Memorandum of Understanding (MOU) which would be jointly agreed between the Government
and the top management of the enterprises each year. The MOU would set out the objectives according to which
the management performance would be judged and it would also specify actions expected by the public sector
enterprise from the Government. As an experiment, the system of MOUs is being implemented for six major public
sector enterprises beginning in 1987.
It is important to note that the “privatisation” which is often recommended as the answer to public sector inefficiency
is not on the agenda. Proponents of privatisation obviously regard the public sector as inherently inefficient. No such
assumption underlies the policy reform being attempted in India. On the contrary, the basic approach is that a public
sector enterprise can be as efficient as any other corporate sector unit can be made to approximate the relationship
between shareholders and a corporation.
The policy initiatives described above for improving industrial performance involve a considerable measure of
deregulation and therefore may be called economic liberalisation but they obviously differ in important respects
from the usual liberalisation packages often prescribed for developing countries and also undertaken in some cases
(though with varying success). The familiar liberalisation package focuses heavily on foreign trade liberalisation and
rationalisation of protection. The usual formula is to recommend a first stage consisting of a switch from quantitative
to tariff controls, followed by a phased reduction in both the variation in degrees of protection across sectors and
also the average level of protection. The whole process is usually expected to be underpinned by exchange rate
depreciation. Often it includes a conscious policy of privatisation of the public sector to overcome problems of public
sector inefficiency. The differences in the Indian case are evident. Indian policy reform has focused much more on
domestic industrial liberalisation rather than foreign trade liberalisation. There is considerable internal deregulation
aimed at strengthening the more efficient domestic firms and encouraging them to invest and expand. This is expected
to inject much more competition into the system, creating incentives for reducing costs. The internal liberalisation
has been accompanied by a policy of maintaining a sufficiently open access to imports to permit modernisation and
technological upgrading in Indian Industry, which again will reduce costs and promote international competition. As
far as foreign trade liberalisation is concerned, a broad direction has been given about the desirability of switching
from quantitative controls to tariffs, but the movement in this area is limited and certainly does not include imports
of final consumer goods. However, significant tariff rationalisation measures have been implemented in several
sectors. Finally, there is no question of privatisation of the public sector. The focus is on management and institutional
reform of the public sector to improve its efficiency.
An important feature of the process of policy reform under way in India is that it is gradualist. The system is being
subjected too much stronger pressures for efficiency and modernisation, but at a controlled pace. The rationale for
this gradualist approach lies in the perception that the system should be subjected to pressure commensurate with
its ability to respond. Pressures beyond this point are only disruptive.
4.5 Financing Development

An important aspect of performance, which has a direct bearing on the longer-term growth potential of the economy,
is the ability to mobilise resources for investment. India’s recent performance in this dimension is commendable.
The rate of gross domestic investment in the economy, which increased only marginally from 17 percent in 1960-
61 to 18 percent in 1970-71, then increased sharply thereafter to reach 24.7 percent in 1980-81. It has stayed at that
level in the eighties. This investment rate is not high compared with rates achieved in the more rapidly growing
middle-income countries, but it is much higher than the rates achieved in all the other low-income countries except
51
China. What is more, the high rate of investment is being financed almost entirely from higher domestic savings,
testifyi9ng to the success of self-reliance in this sense of the term. The gross domestic savings rate, which was 17
percent in 1970-71, had increased to 23 percent by 1985-86.
There is certainly need and scope for further increased the rate of savings and thereby also the rate of investment.
But the levels already achieved, and their evident sustainability, reflect on important structural transformation in the
economy in terms of its resource mobilisation capability. Even if the investment rate is only maintained at around
24-35 percent, it should be possible not only to maintain the present 5 percent growth rate, but perhaps even to
achieve some further acceleration. This is because all available evidence suggests that the incremental capital-output
ratio is higher in India than in other countries. These points to the scope for increased efficiency in resource use,
a possibility which is confirmed by recent studies of total factor productivity such as Ahluwalia and Goldar which
show slower growth in these indices of industrial productivity in India compared with other developing countries.
An important feature of the increase in the aggregate savings rate is that it has occurred entirely because of the
rapid growth in private household savings as a percent of GDP. The ratios of private corporate sector savings and
public sector savings to GDP have remained more or less constant at 2 percent and 3 percent of GDP respectively,
while private sector savings increased from 12 percent of GDP in 1970-71 to 18 percent of GDP in 1985-86. This
rapid growth reflects the cumulative impact of a conscious policy of giving strong incentives for private household
savings, especially in the form of financial assets. Following nationalisation of the Indian commercial banks in 1969
(foreign banks were not nationalised) there was a massive expansion of the banking system spreading bank branches
to all parts of the country, including also rural areas. The spread of bank branches definitely helped to mobilise
private savings for investment in the organised sector. Interest rate policy was also geared to encourage household
savings and for the past ten years or so, rates paid on term deposits with banks and other government-sponsored
small savings schemes have yielded positive real rates of return for savers, especially for maturities of three years
and above. More recently positive real rates of return have been available even for shorter maturities.
This favorable interest rate policy was reinforced by fiscal incentives for savings built into the direct tax structure
which provide deductions from taxable income of the interest earned on a wide range of financial instruments.
For certain types of long-term savings instruments, a deduction is aloes allowed for a part of the amount invested.
These incentives, which have been steadily strengthened and expanded in the past ten years, have had the effect of
raising the effective pretax return on eligible financial investments. They certainly encouraged the flow of savings
into these investments and on the whole probably also stimulated total savings.
The institutional mechanisms for mobilising household savings for productive investment have been further
strengthened in the eighties by the remarkable development of the domestic capital market. Until about 1980 the
volume of funds sought to be raised directly from the capital market through equity and bonds was only about `.
500 crores per year. By 1986-87 this had increased more than tenfold.
This is an impressive rate of expansion by any standard and is indicative of a structural transformation taking place in
an important area, which would have very important implications for mobilising capital and allocating it efficiently.
The process is as yet far from complete. The capital market remains thin and vulnerable to manipulation. It lacks
adequate depth in terms of the existence of large numbers of active participants, including institutional investors. It
is also inadequately regulated in terms of rules for full disclosure and restrictions on trading malpractices, including,
in particular, insider trading. These limitations are fully recognised and a number of initiatives have been taken to
overcome these problems. The Unit Trust of India, until now the only mutual fund operating in India, and hitherto a
conservative income-oriented operation at that, floated a second fund aimed at capital appreciation. The State Bank
of India is to float a second mutual fund to complete with the Unit Trust. The term lending financial institutions,
which up to now have played only a limited role in the capital market, have been more active in it in the past two
years. The 1986 and 1987 budgets liberalised the treatment of long-term capital gains on sale of shares so that the
maximum tax on capital gains on shares is only 20 percent for shares held for more than one year. The Government
also proposes to set up a National Securities and Exchange Board which will serve as an agency supervising the
functioning of the stock markets and setting clear rules on issues such as disclosure, insider trading, etc, to protect
the investor. It will also serve as a forum for the development and implementation of ideas aimed at developing a
healthy capital market.
52
In the area of resource mobilisation therefore, the economy has shown a reasonably good performance with important
structural changes taking place which have strengthened its capability to mobilise and allocate resources efficiently.
The principal weak area has been the generation of investable surpluses forms the public sector. This weakness
has been widely recognised and it is to be hoped that the various measures being taken to improve public sector
performance will correct this problem.
4.6 Equity and Social Justice

Considerations of equity and social justice have been extremely important in India’s development objectives and
policies and any evaluation of performance must include these dimensions also. This is not an easy task because
of the multidimensional nature of the equity and social justice objective. The concern with income inequality and
the need to increase incomes and levels of living for the poorest sections of the population is the most commonly
discussed aspect of this objective. However, there are several other dimensions also, which call of distinct policy
interventions. These include provision of basic or “minimum needs” for the build of the population (not just the
poor) relating to health, education, drinking water and sanitation, removal of social disparities arising from caste,
providing equality of opportunity at various levels of education to promote vertical mobility, and reduction in regional
disparity, avoiding concentration of economic power within the private sector.
A major problem in assessing performance in reducing inequality is the lack of reliable time series data on the
distribution of income. The only robust conclusions which can be asserted are that the distribution of income in
India, as measured by the usual indicators of inequality, is among the more equal in the developing world. There is
also no evidence of any increase in income inequality over time. Data on the distribution of consumption are more
readily available and these show a decline up to the mid-seventies followed by a period in which there is year-to-
year fluctuation but no trend.
Success in reducing poverty is in many respects more important than trends in relative inequality, and this subject
has been extensively investigated in the Indian literature, especially in the context of rural poverty, which is the
bulk of the problem. A broad consensus is emerging. Studies have shown that up to about the mid-seventies the
percentage of the rural population living below the poverty line has fluctuated over time, but without any underlying
trend. The percentage appears to have increased in years of poor agricultural performance (allowing for appropriate
lags) and to have declined in response to good agricultural performance. It has also been argued that the behavior
of prices and inflation has an important impact on the extent of poverty with rising prices being associated with an
accentuation of poverty.
Although a clear trend does not emerge from the available data up to the mid-seventies, the more recent performance
is more encouraging. There was perceptible drop in the late seventies in the percentage of population living below
the poverty line and this appears to have continued into the eighties. The Planning Commission has estimated that
the percentage of the rural population in poverty declined by 10 percent points in the Sixth Five-Year Plan period
(1980-85) from 47 percent to 37 percent.
The pattern of no trend up to the mid-seventies followed by an improvement can be attributed to two factors. One
is probably the acceleration in agricultural and nonagricultural growth which took place from the mid-seventies
onward. In the earlier period, overall growth, and especially agricultural growth, was so low that after allowing
for population growth, there was only a very modest growth in per capita incomes. Per capita income in the rural
areas probably grew at no more than 0.5 percent per year up to the mid-seventies. With per capita incomes growing
so slowly it is not surprising that rural poverty was not much reduced. In the second period, growth in rural per
capita incomes was definitely higher. If more rapid growth in nonagricultural income earned by rural households
is allowed for, the growth in per capita incomes in rural areas in the more recent period could well be in the range
of 1.5 percent or so. These growth rates are still only modest, but they represent a definite improvement on the
earlier pattern. The regional pattern of growth in the eighties also indicates a shift which would have helped reduce
poverty. There is acceleration in growth in some old the very areas where poverty has been most concentrated, e.g.,
Uttar Pradesh and Bihar.
53
These developments suggest that the twin strategy of relying on accelerated growth, especially in agriculture, together
with special programs aimed at directly helping households below the poverty line, can produce significant results
in a reasonable period of time. The Planning Commission has estimated that the percentage of the population below
the poverty line will have declined to 25 percent by 1989-90. The next decade should see a further sharp decline if
not virtual eliminated in poverty as measured by the standard that has been used thus far.
As noted above, progress in other dimensions of equity and social justice is not so easily documented because of lack
of data. But there is no doubt that there has been commensurate growth in most of the other indicators of minimum
needs and living standards also. Perhaps the most important recent initiative in this area is the announcement of a New
Education Policy aimed at upgrading the quality of education at all levels and accelerating the spread of education.
A beginning in implementing this policy is being made in 1987-88 with a massive increase of almost 120 percent
in Central Government expenditure on educational programmes. The special focus on education, including adult
education, has direst relevance not only for productivity of the labor force but also for equity and poverty removal.
Industry, with present levels of the rate of investment or modest improvements therein. The policy initiatives being
taken in the industrial sector will help to bring about this outcome.
4.7 Meaning and Concept of Cottage and Small Scale Industries

Cottage and small scale industries are defined in terms of investment in plant and machinery under section II B of
Industries (Development and Regulation) Act 1951. The limit is revised from time to time to offset the impact of
inflation and to meet the technological needs.
Cottage industry is the one which is run by an individual with the help of his family members with very little
capital. Most of the cottage industries do not use power. According to the Fiscal Commission (1949-50) “cottage
industry is an industry which is run either as whole- time or part-time occupation with the full or partial help of the
members of the family”. These industries are mostly run by the artisans in their own homes. The use of power and
machines in these industries are very limited. The products produced in cottage industries are usually to satisfy the
local demands. Number of hired-labour in this sector is very limited and the capital investment is also small. They
are mostly located in villages and rural areas.
According to the Economic Commission of Asia and the Far East(ECAFE) “cottage industries are those industries
which are run fully or partially with the help of family members”1. In the words of Dharand Lydall2 “cottage industries
are mainly traditional industries which produce traditional goods with the traditional techniques”. Examples of cottage
industries are khadi industry, handicrafts, handlooms, cane and bamboo base industries, pottery, blacksmith etc.
In India, the first official criterion for small scale industry dates back to the second Five Year Plan when it was
defined in terms of gross investment in land, building, plant and machinery and the strength of the labour force. In
1955 Small Scale Industries Board defined small scale industry as “A unit employing less than 50 persons, if using
power and less than 100 persons without the use of power and with capital assets not exceeding rupees five lakhs”3.
The Ministry of Commerce and Industries modified the above definition in 1960 on the recommendation of the Small
Scale Industries Board. According to it “small industries will include all industrial units with a capital investment of
not more than rupees five lakhs, irrespective of the number of persons employed”4. Thus, this revision has enlarged
the scope of employment opportunities in small scale sector, but the investment ceiling remains unchanged.
In 1972, the Government of India constituted Committee for drafting legislation for small-scale industries, which
suggested that the small-scale industries might be classified into the following three categories.
• Tiny Industry: Tiny units are those in which the investments in fixed assets are less than `. 1 lakh or `. 4000/-
per worker and the annual turn-over does not exceed `. 5 lakh
• Small Industry: Small industry is one in which capital investment in fixed assets does not exceed `. 7.5 lakh
irrespective of the number of persons employed
• Ancillary Industry: An ancillary unit is the one rendering services and supplying or proposing to render 50
percent of its production or total services, as the case may be, to other units for production of other articles.
Moreover, such a unit should not be owned or controlled by any undertaking. The limit for investment in fixed
assets of such an industry is fixed at `. 10 lakh
54
The Industrial Policy of 1980, announced on July, 23 has revised the ceiling limits of investment in plant and
machinery for small-scale industries. According to the Industrial Policy resolution of 1980, the investment limit
in small scale industries has been increased with a view to develop these industries. In case of small ancillary
industries, the limit has been revised from `. 15 lakh to `. 25 lakh and for tiny industries it has been raised to `. 12
lakh from `. 1 lakh.
In March 1985, the Government has again revised the investment limit of small scale undertakings to `. 35 lakh. As
per the Industrial Policy Resolution of 1990, the investment limit in plant and machinery for small scale industries
has been raised to `. 60lakh and correspondingly for ancillary units from `. 45 lakh to `.75 lakh. In 1997, on the
recommendation of Abid Hussain Committee, the Government has raised the investment limit in plant and machinery
for small units and ancillaries from `. 60/75 lakh to `. 3 crore and that for tiny units from `.5 lakh to `. 25 lakh. In
2000, the Union Government has reduced the investment limit in plant and machinery for small scale units from `.
3 crore to `.1 crore. However, the investment ceilings for tiny industries remain unchanged to `. 25 lakh.
In accordance with the provision of Micro, Small and Medium Enterprise Development (MSMED) Act, 2006. The
micro, small and medium enterprises are classified into two classes-
• Manufacturing Enterprises - The enterprise engaged in the manufacture or production of goods pertaining to
any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951. The
manufacturing enterprises are defined in terms of investment in plant and machinery
• Service Sector - The enterprises engaged in producing or rendering of services and are defined in terms of
investment in plant and machinery. The limit for investment in plant and machinery for manufacturing and
service enterprises are given in table 3.1& table 3.2
INVESTMENT LIMIT IN MANUFACTURING SECTOR
Enterprises Investment in plant and machinery

Micro - enterprises Does not exceed twenty five lakh rupess
More than twenty five lakh rupees but does not exceed
Small- enterprises
five crore rupees.
More than five crore rupees but does not exceed ten
Medium - enterprises
crore rupees.
(Source: Micro, Small and Medium Enterprises Development (MSMED) Act, 2006)
The definition of small scale industries has undergone changes over the years in terms of investment limits to boost
up the development of this sector.
55
CHANGES IN THE DEFINITION OF SMALL SCALE INDUSTRIES IN TERMS OF INVESTMENT LIMITS
Investment limits in
Sr. No Year Additional Conditions
plants and machinery
Less than 50/100 persons
1 1955 Up to `. 5 lakhs
with/without power
2 1960 Up to `. 5 lakhs No conditions
3 1966 Up to `. 7.5 lakhs No conditions
8 1997 Up to `. 3 crores No conditions
Source: Complied from various Acts and Notifications
4.8 Cottage and Small Scale Industries - The Underlying differences.

The Fiscal Commission remarks over the distinction of cottage and small scale industry is that “Cottage industries are
normally associated with agriculture in rural areas and provide part-time employment to the agricultural labourers,
while small scale industries are established in urban and sub-urban areas and provide full time employment to the
labourers”.
The main difference as mentioned in First Five Year Plan (1951-56) between cottage and small scale industries
are:
• Cottage industries are mainly located in villages although they are scattered all over the country while small-
scale industries are mostly located in urban and suburban areas
• Cottage industry normally do not employ hired-labour as these units are primarily run by the members of the
family at their own premises while small-scale industries produce goods with partially or wholly mechanised
equipment employing outside labourers. Negligible or no capital is invested in cottage industries and production
is done by hand with simple tools
• A small scale industrial unit employ wage earning labour and production is done by the use of modern techniques
which involves capital investments
• Small-scale industrial units use modern sophisticated machines run by power while in cottage industries the
production is done by hand without the use of power
• The products of cottage industries usually meet local demands and supply ancillary goods to small-scale industries
while the products of small-scale industries meet the demands for a larger area
• Small scale industries are located as separated establishment but cottage industries are located in the homes of
the artisans
• Traditional goods like khadi, mattress, shoes, candle, cane and bamboo products are produced in cottage industries
while small-scale industries produces many modern goods like radio, television, mixer-grinder etc
56
Summary
• Rapid industrialisation has long been viewed as the key to sustained growth and modernisation of the
economy.
• In the most recent period 1981-82 to 1986-87, the index of industrial production (using the new index base
1980-81=100) shows an average growth rate of around 7 percent per year while value added growth is about
6 percent.
• The industrial sector, which absorbs a large percentage of total resources available to the economy, must be able
to earn the foreign exchange it needs from exports.
• The original rationale for industrial licensing was to direct private investment into desired areas and also to
avoid wasteful over investment.
• An important determinant of industrial performance in India is the performance of the public sector.
• Public sector output today accounts for about 45 percent of the output of the organised industrial sector and 30
percent of total industrial output.
• It is important to note that the “privatisation” which is often recommended as the answer to public sector
inefficiency is not on the agenda.
• An important feature of the process of policy reform under way in India is that it is gradualist.
• The rate of gross domestic investment in the economy, which increased only marginally from 17 percent in
1960-61 to 18 percent in 1970-71, then increased sharply thereafter to reach 24.7 percent in 1980-81.
• An important feature of the increase in the aggregate savings rate is that it has occurred entirely because of the
rapid growth in private household savings as a percent of GDP.
• A major problem in assessing performance in reducing inequality is the lack of reliable time series data on the
distribution of income.
• Progress in other dimensions of equity and social justice is not so easily documented because of lack of data.
• Cottage and small scale industries are defined in terms of investment in plant and machinery under section II
B of Industries (Development and Regulation) Act 1951.
• According to the Fiscal, Commission (1949-50) “cottage industry is an industry which is run either as whole-
time or part-time occupation with the full or partial help of the members of the family”.
• The Fiscal Commission remarks over the distinction of cottage and small scale industry is that “Cottage industries
are normally associated with agriculture in rural areas and provide part-time employment to the agricultural
labourers, while small scale industries are established in urban and sub-urban areas and provide full time
employment to the labourers”.
References
• Callan, S. J. & Thomas, J. M., 2009. Environmental Economics and Management: Theory, Policy and
Applications, Cengage Learning.
• Kiado, A., 1979. Industrial Development and Industrial Policy.
• Industrial Policy-2013 [Pdf] Available at: <http://www.midcindia.org/Lists/Policies%20Circulars%20and%20
Notification/Attachments/88/Industrial%20Policy%20of%20Maharashtra%202013.pdf> [Accessed 11 July
2013].
• Industrial Policy of Maharashtra 2013-Highlights [Pdf] Available at: <http://www.midcindia.org/Lists/
Policies%20Circulars%20and%20Notification/Attachments/87/Industrial%20Policy%20of%20Maharashtra%20
2013%20-%20Highlights.pdf‎> [Accessed 11 July 2013].
• 2013. What is Industrial Policy [Video online] Available at: <https://www.youtube.com/watch?v=BqyGaT0RCt0‎>
• 2013.What hope for Industrial Policy [Video online] Available at: <https://www.youtube.com/watch?v=
veIpUWF6bd8‎> [Accessed 11 July 2013].
57
Recommended Reading
• Bianchi, P. & Laboy, S., 2011. Industrial Policy after the Crisis:Seizing the Future., Edward Elgar Publishing
Limited.
• Bianchi, P., 2006. International Handbook on Industrial Policy, Edward Elgar Publishing Limited.
• Pathak, B., 2007. Industrial Policy of India: Changing Facets, Deep and Deep Publications Pvt. Ltd.
58
Self Assessment
1. Rapid ______________ has long been viewed as the key to sustained growth and modernization of the
economy.
a. Globalisation
b. Glocalisation
c. Industrialisation
d. Civilisation
2. India should be aiming at an industrial growth rate of around _______ percent.

a. 9-10
b. 7-8
c. 5-6
d. 8-9
3. Which of the following industry is the one which is run by an individual with the help of his family members
with very little capital?
a. Oil
b. Cottage
c. Cement
d. Telecom
4. What does ECAFE stands for?

a. Economic Conditions of Asia and Far East
b. Economic Conditions of Africa and Far East
c. Economic Commission of Africa and Far East
d. Economic Commission of Asia and Far East
5. The Industrial Policy of _______, has announced revised the ceiling limits of investment in plant and machinery
for small-scale industries.
a. 1960
b. 1970
c. 1980
d. 1990
59
6. Match the following

A. . More than five lakh rupees but should not
1. Small Enterprises
exceed five crore rupees
2. Micro Enterprises0 Micro Enterprises B. Does not exceed twenty five lakh rupees
C. More than five crore rupees but should not
3. Medium Enterprises0 Medium Enterprises
exceed ten crore rupees.
4. Government of India constituted Committee0Government of India constituted Committee
for drafting legislation for small-scale D. 1972
industries
a. A-1,B-2,C-3,D-4
b. A-2,B-3,C-4,D-1
c. A-3,B-1,C-2,D-4
d. A-1,B-3,C-2,D-4

a. The products of cottage industries usually meet local demands and supply ancillary goods to small-scale
industries while the products of small-scale industries meet the demands for a larger area.
b. Cottage industry is the one which is run by an individual with the help of his family members with very
little capital. Most of the cottage industries do not use power.
c. The Planning Commission has estimated that the percentage of the population below the poverty line will
have declined to 25 percent by 1989-90.
d. The performance of top management must not be judged in terms of the achievement of agreed
objectives.
8. When was the nationalisation of Indian Commercial Banks done?

a. 1959
b. 1979
c. 1969
d. 1999
9. In March ______, the Government has again revised the investment limit of small scale undertakings to `. 35
lakh.
a. 1985
b. 1981
c. 1983
d. 1984
10. The cottage industries are mainly located in which part of the country?
a. Urban
b. Sub-urban
c. Villages
d. Metropolitian cities
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Chapter V
India: Foreign Trade Policy
Aim
• explain Regional and Bilateral Trade Agreements
• elucidate World Bank Involvement
• explicate IMF and World Bank Corporate Links
Objectives
• explain WTO
• enlist World Bank Reports
• explicate IMF
Learning outcome
• describe WTO Trade Agreements
• identify Structural Adjustment Programs
• understand the role of UN
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5.1 Introduction
Although India has steadily opened up its economy, its tariffs continue to be high when compared with other countries,
and its investment norms are still restrictive. This leads some to see India as a ‘rapid globalizer’ while others still
see it as a ‘highly protectionist’ economy.
Till the early 1990s, India was a closed economy: average tariffs exceeded 200 percent, quantitative restrictions on
imports were extensive, and there were stringent restrictions on foreign investment. The country began to cautiously
reform in the 1990s, liberalising only under conditions of extreme necessity. Since that time, trade reforms have
produced remarkable results. India’s trade to GDP ratio has increased from 15 percent to 35 percent of GDP between
1990 and 2005, and the economy is now among the fastest growing in the world. Average non-agricultural tariffs
have fallen below 15 percent, quantitative restrictions on imports have been eliminated, and foreign investments
norms have been relaxed for a number of sectors.
India however retains its right to protect when need arises. Agricultural tariffs average between 30-40 percent,
anti-dumping measures have been liberally used to protect trade, and the country is among the few in the world
that continue to ban foreign investment in retail trade. Although this policy has been somewhat relaxed recently,
it remains considerably restrictive. Nonetheless, in recent years, the government’s stand on trade and investment
policy has displayed a marked shift from protecting ‘producers’ to benefiting ‘consumers’. This is reflected in its
Foreign Trade Policy for 2004/09 which states that, “For India to become a major player in world trade .we has also
to facilitate those imports which are required to stimulate our economy.” India is now aggressively pushing for a
more liberal global trade regime, especially in services. It has assumed a leadership role among developing nations
in global trade negotiations, and played a critical part in the Doha negotiations.
5.2 Regional and Bilateral Trade Agreements

India has recently signed trade agreements with its neighbors and is seeking new ones with the East Asian countries
and the United States. Its regional and bilateral trade agreements or variants of them are at different stages of
development:
• India-Sri Lanka Free Trade Agreement
• Trade Agreements with Bangladesh, Bhutan, Sri Lanka, Maldives, China, and South Korea
• India-Nepal Trade Treaty
• Comprehensive Economic Cooperation Agreement (CECA) with Singapore
• Framework Agreements with the Association of Southeast Asian Nations (ASEAN), Thailand and Chile
Preferential Trade Agreements with Afghanistan, Chile, and Mercosur (the latter is a trading zone between Brazil,
Argentina, Uruguay, and Paraguay).
5.3 World Bank Involvement

As a number of research institutions in the country provide the Government with good, just-in-time, and low-cost
analytical advice on trade-related issues, the World Bank has focused on providing analysis on specialised subjects
at the Government’s request.
In the last three years, the Bank has been working with the Ministry of Commerce in a participatory manner to help
the country develop an informed strategy for domestic reform and international negotiations. Given the sensitivity
of trade policy and negotiation issues, the Bank’s role has been confined to providing better information and analysis
than was previously available to India’s policymakers.
5.4 World Bank Reports

Over the last two years, the World Bank has completed two reports:
• Sustaining India’s Services Revolution: Access to Foreign Markets, Domestic Reforms and International
Negotiation: The study concludes that to sustain the dynamism of India’s services sector, the country must
address two critical challenges: externally, the problem of actual and potential protectionism; and domestically,
the persistence of restrictions on trade and investment, as well as weaknesses in the regulatory environment
• From Competition at Home to Competing Abroad: The Case of Horticulture in India: This study finds that the
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competitiveness of India’s horticulture sector depends critically on efficient logistics, domestic competition,
and the ability to comply with international health, safety and quality standards. The study is based on primary
surveys across fifteen Indian States
A third study, dealing with barriers to the movement of professionals is under preparation. The Bank has also held a
number of workshops and conferences with a view to providing different stakeholders with a forum to express their
views on trade-related issues. The WTO, IMF and World Bank have been major counterparts in the creation and
management of the modern world economy. Their activities are endorsed by economically dominant governments
and corporations who favour neoliberal policies and free-market solutions of debt-based finance and international
trade as the route to poverty reduction.
Together these institutions encourage economic structural adjustment, privatisation and market liberalisation in
emerging markets. Within the competitive global framework, developing countries are left with little choice other
than to comply with the neoliberal agenda. As a result these countries are often left with crippling debt and a fragile
economy. Meanwhile, foreign investors and multinational corporations gain control of a significant portion of the
world’s resources, finance, services, technology and knowledge. Whilst these multinationals report record profits,
around 50,000 people die each day from poverty.
In order to create balanced trade, stable international finance and effective development in poorer countries,
the regulation of the global economy must be returned to United Nations. The global public must, through their
governments, demand cooperative control over those resources which are essentials to life and should be shared
internationally according to human need - not corporate profit. Sharing resources can also reduce the level of
corporate controlled trade, debt accumulation and wasteful development projects. As the remit of the international
financial institutions is reduced, they can be progressively dismantled.
5.5 The IMF, World Bank and WTO

Created by the US and British Governments at The Bretton Woods Conference after World War II (1944 Hampshire,
USA), The International Monetary Fund (IMF) and The World Bank (WB) were designed to ensure economic and
corporate sustainability in countries affected by the war - mainly in Europe. The World Trade Organisation was
established more recently, in 1995, to replace the General Agreement on Tariffs and Trade (GATT). The WTO aims
to lower tariffs and non-tariff barriers in order to increase international trade.
Since the 1970’s the World Bank has steadily increased its original mandate of providing long term loans for
reconstruction, to funding multimillion dollar infrastructure projects in developing countries. It is the single
largest source of development finance in the world, lending for broad structural and economic changes, long-term
development and poverty reduction, building roads, dams, pipelines, extracting natural resources etc. It is an especially
important source of finance for very low income countries that are unable to acquire commercial loans. In this way
the World Bank has a direct effect on the lives of millions living in the majority world.
The IMF was created to maintain global monetary cooperation and stability by making loans to countries with balance
of payment problems, stabilising exchange rates and stimulating growth and employment. There have been many
changes in the global economy since then, such as the divorce of exchange rates from the stable ‘anchor’ of gold,
massive growth in the global economy and a dramatic increase in destabilising, speculative movements of capital
between nations. As a result the IMF has shifted its focus and now mainly intervenes in economically vulnerable
nations, particularly in the south.
The WTO fosters ‘free-trade’ between nations. It does this by liberalising markets, which means ‘opening them
up’ to global competition. This creates a free market where the unrestricted flow of goods and services can sharpen
competition, motivate innovation, create profit and breed success. Most of the world’s trading nations are members,
and as members they have to ratify WTO trade agreements within their governments. The WTO clearly states that
these rules, although binding on governments, are primarily for the benefit of the business community that produce,
import and export goods and services. In effect, the WTO overrides a government’s sovereign right to regulate its
economy, and places corporate interests first.
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5.6 How the IMF, World Bank and WTO Work Together?
The underlying theory that these International Financial Institutions (IFIs) propagate is that of ‘economic growth’
and ‘free-markets’ as the only means of generating wealth for development and poverty reduction. This neoliberal
ideology now dominates the global economy and has proven to be extremely profitable for corporations and financiers.
Meanwhile, these policies have increased levels of poverty and inequality in developing countries. Given their
financial insecurity, developing nations are left with little option but to participate and compete in the global economy
in the hope that they can increase their economic output (GDP). However, the competitive free-market is inherently
biased, and countries that enter the playing field with less wealth and undeveloped industries are handicapped.
Developing countries find themselves in a position where they do not have enough foreign currency reserves to
invest in growth-promoting policies as they may have spent their reserves on imports and debt repayments. They
might then lent money by the World Bank to finance large development projects in the hope that such projects (such
as extracting oil) will facilitate economic growth and have a knock-on effect on development. The World Bank
has significant connections with corporations (mainly in the US) who they contract for these lucrative projects.
Whilst these corporations earn huge benefits from these contracts, the country in question often finds itself with
an additional debt burden, a loss of control over key natural resources or services and a loss of revenue from these
resources as profits are repatriated abroad.
Faced with possible bankruptcy, which would ostracise them from other potential investors this, the country has
little choice but to turn to the IMF for a loan. The IMF clearly states that it is not a development bank and is not
concerned with poverty reduction. It is, however, closely allied with Wall Street bankers and the US Treasury, and
ensures that economic policies are implemented that benefit private investors and financial speculators in the free-
market. It lends to governments on the strict condition that they prioritise the repayment of the loan (over and above
domestic welfare needs). Countries must also agree to adjust domestic economic policies to ensure that their balance
of payment problems do not occur again. Once these conditions have been implemented and the loan approved,
the international investment community is informed. This reassures private investors of the country’s potential
profitability, and additional funds come flooding in.
With restrictions on the movement of capital relaxed, a period of destabilising financial speculation and capital
flight often results, further benefiting wealthy foreign investors and speculators whilst often bankrupting domestic
companies. This same IMF/World Bank enforced agenda has devastated many developing economies in East Asia
and Latin America over the past 20 years. The WTO’s trade agreements work alongside the IMF and World Bank
measures, ensuring all barriers to trade and domestic restrictions on how to manage foreign investment are lifted.
This enables foreign corporations to purchase and control everything from water, heath-care and education facilities
to agricultural technology and indigenous plants and knowledge. All in all, there is a huge migration of control and
financial resources away from local enterprises and industries that would otherwise benefit society and strengthen local
economies. Instead, these resources migrate to the large corporations whose major shareholders profit handsomely.
Foreign ownership of domestic resources, services and production compromises local initiative and industry, and
undermines the sovereign and democratic rights of local people and governments.
The combined effects of trade liberalisation and IMF/World Bank policies are insidious, devastating numerous aspects
of social and economic life in developing countries. It is clear that the ultimate beneficiaries of the IFIs’ policies
and actions are wealthy private investors, corporations and speculators. These small groups of private individuals
ultimately end up holding the reigns to the majority of the world’s natural resources, agriculture facilities, technology,
services, intellectual property and finance mechanisms. Their businesses are invariably based in the US and EU,
ensuring that the economic output, or GDP of their host countries remains high.
Revelling in their economic ‘profit’, G8 governments increasingly tow the corporate line, using their influence
within the IFIs to further the neoliberal ideology that appears to be prospering their nation. As a result, governments
have readily given away rights over public assets to corporations. They also continue (through the agency of the
IFIs) to denying the rights of developing countries to participate in the formation of international development
and finance strategies, multilateral trade agreements, or indeed their own domestic economic policies. In this way,
wealthy governments are guaranteeing their continued economic dominance within a competitive, market-based
global economy.
64
Whilst economic growth increases, the level of global inequality and marginalisation also increases. This phenomenon
is not restricted to developing countries, but is common place in wealthy nations. For example, in 2004 there were 5.4
million more Americans living in poverty than in 2000. Although the US is also one of the richest nations on earth,
with a GDP of 12.41 trillion dollars, about a fifth of global GDP, it has the largest inequality gap of any industrialised
nation. It also pursues neoliberal economic policies to a greater extent than other countries. This added much weight
to the significant body of evidence that suggests the pursuit of competitive economic growth for reducing extreme
poverty is largely ineffective and unable to reduce inequality.
5.7 WTO, IMF and World Bank are Undemocratic

Both the World Bank and IMF criticise recipient governments for their lack of transparency, widespread corruption
and undemocratic regimes, insisting on the reform of these aspects as a pre-condition to granting loans and debt
relief. However these same issues haunt the World Bank and IMF which are widely regarded as not transparent,
undemocratic and unaccountable. Corruption within these organisations is rife, and millions of dollars unaccounted
for both institutions are based in Washington USA, and are owned by their 184 member countries. The majority
(40%) of all votes are held by just 7 countries (the G7). The US holds the largest share at 18%, which grants them
the ability to veto policies that do not serve US interests. Votes are allocated according to financial strength (‘one
dollar one vote’), resulting in those financially powerful countries (and the commercial interests that influence them)
determining the monetary, economic and development architecture of the global economy. Thus the existing global
economic system places developing countries squarely at the mercy of G7 foreign interests.
The WTO is, constitutionally, a democratic organisation with an equal share of votes distributed to all member
nations regardless of their economic power. Yet the poorer nations still find themselves unable to exercise their
democratic rights in WTO global trade negotiations. The dominant economic powers- USA, Canada, the EU and
Japan (also known as the ‘Quad’ or ‘Quartet’) very clearly establish the agenda before a round of trade talks. The
Quad then invite a selected group of poorer nations to a ‘Green Room’ meeting where the key decisions are made
about which issues will be open to negotiation in the formal talks, and a declaration is drafted. During the formal
talks, nations can only agree with or block the predetermined proposals.
This structure effectively excludes the majority world from influencing the international trade agenda. Throughout
these negotiations, even within the green room talks, poorer nations (given their reliance upon international aid,
IMF and World Bank assistance) are at the behest of the Quad and are often unwilling to contest the declaration in
fear of economic or financial consequences. Overall, the global south’s ability to make trade work to their benefit
is severely compromised. The bias and disquiet of these negotiations is reflected by the frequent collapse of trade
talks in, the eventual submission by developing countries to further open their markets to the dominant nations and
the systematic inability of ‘quad’ nations to live up to their pledges to remove their own protectionist measures.
Without democratic representation within these bodies, and cooperation with the south, The WTO, IMF and World
Bank will remain unaccountable to the very people they claim to be assisting. In light of the failures of the WTO,
World Bank and IMF to address poverty and inequality, global protests continue to gain momentum, citizens and
nations are calling for a ‘ground up’ process of globalisation that is not controlled by, and for the benefit of, the
ruling elites.
5.8 Structural Adjustment Programs (SAPs)

When a developing country requires urgent financial assistance to avoid economic catastrophe, it usually turns to
the IMF. Although this assistance constitutes a crippling debt for the borrower, the IMF also insists on economic
reform as a condition to the loan. In effect the IMF takes this opportunity to render the struggling economy ‘free-
market friendly’. Prioritising debt repayment, market liberalisation and privatisation allow corporations and private
interests to capitalise on these reforms. The economic consequences for the developing country are often dire.
The IMF, working in conjunction with Wall Street bankers and the US Treasury, has effectively forced many emerging
economies to liberalise their financial markets. This happened to many countries in East Asia and Latin America in
the 1980’s and 90’s. Often this exposed them to massive financial speculation which in-turn devalued their currencies,
and created recession and financial crisis. Bolivia’s per capita income is less than it was 25 years ago, with 63%
of Bolivians living in poverty. Argentina is another well documented recent example, as is Thailand, South Korea,
Indonesia, the Philippians, Russia and Poland. In essence structural adjustments involve the following measures:
65
Reducing social spending, government budgets, programs and subsidies for basic goods: This allows a rapid
mobilisation of currency to repay the loans (debt). Meanwhile schools and hospitals are forced to introduce/increase
fees which in turn increase illiteracy rates, disease and death rates and perpetuate the poverty cycle.
Eliminating foreign ownership restrictions and increasing interest rates: These measures increase profitability for
foreign investors and enable corporations to take control of domestic resources. Meanwhile local producers and
businesses are destroyed, not being able to afford essential credit; unemployment goes up, and control of their
resources shifts to wealthy countries. Income is transferred out of the developing country further damaging its
people and economy.
Eliminating import tariffs and switching from subsistence farming to export economies: These measures benefit
foreign export markets and eliminate local competition. Low cost foreign goods including luxury items out-compete
domestic producers, putting them out of business. Food insecurity and malnutrition increases as production shifts
to cash crops for export and countries are forced into dependent relationships with northern suppliers. Increased
resource exploitation creates environmental degradation and pollution.
SAPs have recently been replaced by Poverty Reduction Strategy Papers (PRSPs) as part of an effort to address the
issue of ‘government ownership’ of structural adjustment policy, and to focus on strategies to relieve the debt of
Highly Indebted Poor Countries (HIPCs). Unfortunately little progress has been made; strategies are still broadly
imposed on governments and are still subject to conditions that increase income disparities
Not surprisingly, the neoliberal, open-market model preached by the IMF and Wold Bank was not the model adopted
by all existing economic powers during their industrialisation and development. Instead they protected their own
markets from foreign goods and investment and continue to do so, donating huge subsidies to domestic business.
Indeed, the US and EU remain, to this day, highly protected economies. The hypocrisy of liberalising emerging
markets is evidently in the self interest of economically dominant countries. Enforcing these policies on developing
countries is akin to economic imperialism.
5.9 WTO Trade Agreements

Since its creation, the WTO has promoted market access for corporations with trade agreements. These agreements
circumvent the democratic national rights of a country to determine domestic policies regarding trade, natural
resources and service provision. The General Agreement on Trade in Services (GATS) was agreed at the World
Trade Organisation (WTO) in 1994. Its aim is to remove any restrictions and internal government regulations in the
area of service delivery that can be+ considered “barriers to trade”. Such services include everything from marine
fishing to provisions for health and education. The agreement affectively abolishes a government’s sovereign right
to regulate, subsidise and provide essential national services on behalf of its citizens.
The WTO’s Trade Related agreement on International Property Rights (TRIPS), forces developing countries to
extend property rights to seeds and plant varieties. The agreement will even allow corporate property rights over
individual plant genes, thereby impacting on agricultural practices that two thirds of the worlds rely upon for their
livelihoods. It undermines thousands of years of indigenous control over local knowledge and production of food
and livestock. Six corporations now own 70% of patents on staple food crops, allowing them to set the market price
for them and block competition for 20 years.
Another serious infringement on democratic rights are the Trade Related Investment Measures (TRIMS) which
open domestic finance to corporate control, eliminating a country’s ability to shape their policies relating to foreign
investment and capital controls. The evidence suggests that market liberalisation and intellectual property rights
hinder development in poor countries and serve the economic interests of dominant countries. In 2000, an UNCTAD
confirmed this in a report which concluded that neoliberal trade measures primarily benefit corporate interests. Even
the European Commission doesn’t shy away from stating that trade agreements are primarily instruments for the
benefit of business.
66
Effectively, control over resources, services, policies and finance are granted to corporate interests through the
GATS, TRIPS and TRIMS framework. Meanwhile, developing countries continue to resist the imposition of WTO
agreements, and recently this resulted in the collapse of the Doha Round of trade talks (2006).
Corporate Lobbying at the WTO

Multilateral trade rules are agreed behind closed doors between the US, EU and major trade partners. 80% of
corporations reside in the US and EU, and through their lobbyists they enjoy privileged access to government policy
makers who partake in trade talks. Over 30,000 corporate lobbyists are based in Washington and Brussels, vastly
outnumbering the US Congress and European Commission staff that they lobby. The vast majority of lobby groups
represent business interests, who spend billions of dollars annually advocating their cause, typically market access
in emerging economies.
Many developing countries on the other hand do not have the resources to send enough, if any, representatives to
argue for fairer trade practices that would benefit their own economic development. In addition, these negotiations
are undemocratic, with the public denied access to or information about these discussions. The same is not true of
corporate lobby groups such as the European Services Forum (ESF) and many US corporations who can directly affect
and have access to Trade Committees. Unsurprisingly then, corporate interests form the basis of WTO agreements.
The corporate imperative is to have commercial access to all markets in all countries – whether goods, services
or intellectual property. Unsurprisingly, the vast majority of the world, whose basic human needs are not met, are
unlikely to ever have them met within the biased framework of the existing global economy.
IMF and World Bank Corporate Links

To qualify for World Bank loans and expertise a country must agree to implement Structural Adjustment Programs
(SAPs). These programs attract massive private investment into the country. Foreign direct investment now exceeds
$1 trillion per year for projects such as the privatisation of public utilities and the creation of banking systems. The
overall result is the marginalisation of government control over its own affairs and an increased flow of capital out
of the developing country to private investors and corporations, usually based in the north.
World Bank projects in Chad, Somalia, Rwanda, Mozambique Ghana, Brazil and the Philippines are well documented
as having a strong commercial bias. Generally they have provided corporate welfare at the expense of critical, non-
profitable development projects such as health and education. In recent years the IMF has been vociferously backed
by multinational corporate interests when applying for extra funding for expansion. This support was in response
to the IMF bailing out big banks and foreign investors which had made bad loans to developing countries. For
example, in 1995, the IMF gave almost $18 billion to Wall Street interests who stood to lose billions with the peso
devaluation. It also bailed out foreign investors in Russia with an $11 billion package and orchestrated a massive
bailout of the big banks that made bad loans to Asian countries in the 90’s.
The World Banks and IMF’s interrelationship, financial opportunism, corporate mandate and US backing is best
exemplified by their economic occupation of Iraq. Since the occupation began, Iraq’s entire economy has been
fashioned by the IMF and World Bank to suit (mainly US) foreign investors and corporate interests. The Paris
Club of creditors, through the IMF, quickly approved the cancellation of 80% of Iraq’s debts, approximately $39
billion. Using this as leverage, neoliberal structural changes were swiftly enacted including the privatisation of
assets and state owned enterprises. These undemocratic economic adjustments resulted in capital fight, huge levels
of unemployment and unaffordable increases in utility costs, sparking widespread protest.
5.10 Sharing the World’s Resources and Decommissioning the IMF, World Bank
An alternative model of economic and financial stability
The IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT - predecessor to the WTO) were
created at the end of the Second World War. Given the circumstances at the time, the US was in a strong position
to secure its economic dominance, and these three institutions were the means through which it could achieve this.
Alternative proposals to create a more balanced trade and finance system were rejected by the US at the Bretton
Woods conference, and Britain and Europe’s dependence on the US economy during and after the war meant the
US had its way.
67
One such alternative was John Maynard Keynes’ proposal for an ‘International Clearing Union’ (ICU). The ICU
was able to create monetary equilibrium between nations and prevent the accumulation of economic and political
power to creditor nations. Similarly, an International Trade Organisation was proposed as a mechanism to protect
against corporate dominance and ensure workers rights and employment. The GATT was adopted instead, and after
considerable corporate pressure, this was later replaced by the WTO which had the power to enforce undemocratically
decided trade rules upon member governments.
Since their inception, these organisations have indeed been very effective at securing economic strength for the
US. Their influence over the world economy and their ties with commercial interests has also grown. However,
as described in the above analysis, the past 20 years have provided ample evidence that the IMF, World Bank and
WTO impede poverty reduction and economic development in poor countries. It is clear that the global economy
needs to be urgently overhauled if poverty and inequality are ever to be resolved.
In a reformed world economy, commercial activity should be regulated by a democratic body to ensure that it benefits
the public good. Natural resources of common heritage and services that are essential to meet basic human needs
must not be allocated by corporations through existing trade structures. Guaranteed access to these resources is a
fundamental right according to the internationally adopted Universal Declaration of Human Rights. This right must
be exercised by the global public.
The Role of the UN

Given the corporate agenda of the WTO, World Bank and IMF, and their inherent bias since their creation, their
mandates must be transferred back to the United Nations. The UN system was originally intended to be the key
regulatory mechanism for the world economy, and the IMF, World Bank and GATT were originally intended to
function as part of this system. Sadly, funding for the UN agencies has been massively restricted in recent years,
mainly be the US. One of the reasons for this is the UN’s inherent emphasis on development friendly economics
an approach which is at odds with the US’ more hegemonic intentions. Funding has instead been lavished on the
international financial institutions (IFIs) which share the neoliberal ideology.
UN agencies such as the Economic and Social Council (ECOSOC), The UN Conference and Trade and Development
(UNCTAD) and the United Nations Development Program (UNDP) have the necessary knowledge, information and
experience to re-establish their regulatory hold on the global economy and render it more equitable. Importantly,
these UN agencies are naturally democratic and representative, unlike the IFIs.
Alongside restoring democratic control of the global economy to the UN, there must be a strengthening of the UN
in general. In order to render the UN democratic, the Security Council must be dissolved, and any rights to veto
decisions abolished. The General Assembly must take its place as a truly representative world body. The UN must
also be given greater financial power. This can be achieved through a number of possible mechanisms such as a
Tobin taxes, taxes on arms, taxes on pollution, or a combination of these.
Most importantly, the UN must adopt the principle of sharing in order to fulfil its humanitarian mandate and secure
basic human needs across the world. A new economic system based on sharing essential resources, such as land,
food, water and medicine needs to be urgently implemented to achieve this objective. We propose the creation of
a new UN agency, whose specific task would be to facilitate this process, the UN Council for Resource Sharing
(UNCRS). A system of sharing would exist alongside an overhauled market based economy that can continue to
produce and supply all ‘non essential’ resources.
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5.11 A Means to Improve International Trade
Sharing resources requires that the global public claim their communal ownership over essential goods and services.
In general, these will be all resources that are naturally occurring, such as land, water, oil and minerals, all produce
that is essential for life such as basic agricultural produce and energy, and essential services such as access to clean
water, healthcare and education.
One of the main reasons for sharing the world’s resources is to prevent unnecessary death from poverty, by
guaranteeing universal access to food, water, healthcare and other essential goods and services. The saving of some
50,000 lives each day in this way will hasten international development efforts and thereby have a positive impact
on the global economy. This will not only be the result of the investment in human capital that sharing creates, but
also by strengthening local industry. When countries are able to develop their own economies, they are better placed
to be active within the global economy.
Within this system of sharing, essential resources would be shared firstly as part of a United Nations Emergency
Redistribution Program (UNERP), designed to rapidly mobilise essential food, water and healthcare to people and
nations who are experiencing extreme poverty, malnutrition and unnecessary death. Thereafter, a more comprehensive
system of sharing can be implemented that can ensure basic human needs are always prioritised and met by the global
community. To achieve this, the UNCRS would create a Global Sharing Network (GSN) which could monitor the
ever changing levels of production and consumption of essential resources across the globe. The GSN would then
be able to coordinate an efficient global redistribution of these resources according to need. Resources would be
produced and consumed locally where ever possible, then shared regionally, and finally shared internationally.
5.12 How Sharing Would Affect the Global Economy?

Global public ownership and cooperative management of these resources will mean that they are no longer directly
involved in financial markets as commercial products. Excess production of essential resources would not be traded
or exchanged. They would instead be held in trust by the UNCRS, on behalf of the global public, and distributed
to where they are most urgently required. This will have a significant impact on existing systems of trade, finance
and development, and thereby directly affect the activity of the WTO, IMF and World Bank.
5.12.1 Aid and Development

Sharing essential resources in this way would replace all existing aid and development efforts. Redistributing
resources to alleviate poverty will replace the existing export oriented model of competitive economic growth for
poverty reduction. The majority of these resources must be transferred from where they are in excess in global north
to where they are most urgently required in the global south. Amongst other things, this will entail a significant
transfer of finance, food, technology and labour over a number of years in order to create a global economic and
social safety net.
Unlike existing development loans provided by the World Bank, sharing must not constitute a loan or incur a debt.
It would be necessary for the UNCRS to work closely in conjunction with existing UN development agencies and
international NGOs, to ensure that development occurs in an effective, sustainable and efficient manner. Over time,
the World Bank will be rendered largely redundant and any remaining development projects can be administered
through the United Nations Economic and Social Council (ECOSOC) and UN Development Program (UNDP). The
World Bank can then be progressively dismantled.
5.12.2 International Trade

A system of sharing would mean that the majority of commodities and goods that are currently traded would
instead be cooperatively owned and distributed by the global public through the UNCRS. Such resources would
include energy supplies and the provision of utilities such as water, essential agricultural produce required for food,
cotton for clothing, essential healthcare services, equipment and medication, essential knowledge and technology
and resources for providing education. As a result, international trade in commodities and their derivatives will be
significantly reduced, and confined to non essential goods.
69
Sharing will ensure that essential domestic needs are largely met at the local level, reducing dependency on foreign
imports of essential goods. As a consequence, there would be less need for developing countries to agree to prohibitive
trade agreements, whether multilateral or bilateral. This will free the population to develop their own industry and
economy enabling them to compete on an equal footing with wealthier nations in the global economy. Potentially,
when enough countries can effectively compete with the economic superpowers, a powerful incentive will be created
for these superpowers to adopt a more cooperative approach.
Agreements relating to remaining international trade should, where necessary, be democratically agreed through
the UN Conference on Trade and Development (UNCTAD). The remaining international trade, under the auspices
of UNCTAD, should utilise an inherently balanced mechanism similar to the International Clearing Union (ICU)
mentioned above. The combination of these factors will allow the WTO to be progressively dismantled over a
period of time.
5.12.3 International Finance

Sharing essential resources instead of trading them will mean that these resources are divorced from financial
markets. This will clearly have a significant impact upon these markets, dramatically reducing the amount of stock
and financial derivatives related to the stocks, which are traded. This in itself will help to reduce the global financial
instability that many economists and analysts believe will, sooner or later, result in an international financial crisis.
Sharing essentials will also mean that developing nations will require less foreign exchange in reserve as they will
be purchasing fewer goods from abroad. Balanced trading between nations (using an ICU type mechanism) and the
removal of debt burdens will also mean less chance of countries experiencing major balance of payment deficits.
The lack of foreign exchange is a key reason developing countries turn to the IMF for loans, which in turn leads to
crippling debt. Not only can sharing result in greater financial security for a developing country, it will also mean
that they are less likely to have to implement structural adjustments to their economy to render it acceptable to the
countries that follow neoliberal principles.
When there is a need for short term emergency foreign exchange loans, a new UN based Finance Organisation
could lend money and provide the necessary expertise in a pro-development manner without crippling interest rates
and without corporate or political influence. It would then be feasible for the IMF to be gradually dismantled; its
sizeable assets and gold reserves can be applied to the UNCRS and UN development projects. New agencies may be
required to undertake the decommissioning of the IFIs. Other measures which are essential if the global economy is
to be reformed and subjugated to the needs of the people include cancelling all debt owed by developing countries
and regulating the corporate environment.
70
Summary
• Although India has steadily opened up its economy, its tariffs continue to be high when compared with other
countries, and its investment norms are still restrictive.
• India has recently signed trade agreements with its neighbors and is seeking new ones with the East Asian
countries and the United States.
• The WTO, IMF and World Bank have been major counterparts in the creation and management of the modern
world economy.
• Agreement on Tariffs and Trade (GATT). The WTO aims to lower tariffs and non-tariff barriers in order to
increase international trade.
• The WTO’s trade agreements work alongside the IMF and World Bank measures, ensuring all barriers to trade
and domestic restrictions on how to manage foreign investment are lifted.
• Both the World Bank and IMF criticise recipient governments for their lack of transparency, widespread
corruption and undemocratic regimes, insisting on the reform of these aspects as a pre-condition to granting
loans and debt relief.
• The WTO is, constitutionally, a democratic organisation with an equal share of votes distributed to all member
nations regardless of their economic power.
• SAPs have recently been replaced by Poverty Reduction Strategy Papers (PRSPs) as part of an effort to address
the issue of ‘government ownership’ of structural adjustment policy, and to focus on strategies to relieve the
debt of Highly Indebted Poor Countries (HIPCs).
• The General Agreement on Trade in Services (GATS) was agreed at the World Trade Organisation (WTO) in
1994.
• In recent years the IMF has been vociferously backed by multinational corporate interests when applying for
extra funding for expansion.
• The IMF, the World Bank and the General Agreement on Tariffs and Trade (GATT - predecessor to the WTO)
were created at the end of the Second World War.
• Global public ownership and cooperative management of these resources will mean that they are no longer
directly involved in financial markets as commercial products.
• Balanced trading between nations (using an ICU type mechanism) and the removal of debt burdens will also
mean less chance of countries experiencing major balance of payment deficits.
• New agencies may be required to undertake the decommissioning of the IFIs.
References
• Mahajan, V. S., 1992. India’s foreign trade and balance of payments, Deep & Deep Publications.
• Prasad, P. C., 1977. Foreign Trade and Commerce in ancient India, Abhinav Publications.
• Foreign Trade Policy 2009 [Pdf] Available at: <http://pib.nic.in/archieve/foreigntradepolicy/foreigntradepolicy.
pdf> [Accessed 11 July 2013].
• Foreign Trade Policy [Pdf] Available at: <http://www.ieport.com/foreign_trade_policy_2009-2014/Foreign_
Trade_policy_2009-2014.htm‎> [Accessed 11 July 2013].
• 2010. India’s Foreign Policy [Video online] Available at: <https://www.youtube.com/watch?v=1JrviSFmUZo‎>
• 2013. Foreign trade policy [Video online] Available at: <https://www.youtube.com/watch?v=G9EcpZ18Dtg‎>
Recommended Reading
• Dr. Mustafa, A., 2010. Foreign Tarde Finance and Documentation, Laxmi Publications, Ltd.
• Ghosh, A., 2009. India’s Foreign Policy, Pearson Education India.
• Prasad, M., 2011. India’s Foreign Trade:From Antiquity to Date, Kalpaz Publications.
71
Self Assessment
1. India’s trade to GDP ratio has increased from 15 percent to ____ percent of GDP between 1990 and 2005.
a. 25
b. 35
c. 45
d. 55
2. Which of the following fosters free trade between nations?

a. WTO
b. IMF
c. IFT
d. GATT
3. WTO was established in which year?

a. 1991
b. 1993
c. 1995
d. 1997
4. Which of the following was created to maintain global monetary cooperation and stability by making loans
to countries with balance of payment problems, stabilising exchange rates and stimulating growth and
employment?
a. WTO
b. IMF
c. IFT
d. GATT
5. The ________ aims to lower tariffs and non-tariff barriers in order to increase international trade.
a. IMF
b. WTO
c. GATT
d. SEBI
6. Which of the following was able to create monetary equilibrium between nations and prevent the accumulation
of economic and political power to creditor nations?
a. IMF
b. IFT
c. ICU
d. GATT
72
7. In 2000, an _______ confirmed this in a report which concluded that neoliberal trade measures primarily benefit
corporate interests.
a. ECOSOC
b. UNCTAD
c. UNDP
d. UDP
8. What does ICU stands for?

a. International Calling Unit
b. International Clearing Union
c. Internal Call Unit
d. Internet Call Unit

a. The Paris Club of creditors, through the IMF, quickly approved the cancellation of 80% of Iraq’s debts,
approximately $39 billion.
b. The WTO’s Trade Related agreement on International Property Rights (TRIPS), forces developing countries
to extend property rights to seeds and plant varieties.
c. The IMF, working in conjunction with Wall Street bankers and the US Treasury, has failed to effectively
force many emerging economies to liberalise their financial markets.
d. Bolivia’s per capita income is less than it was 25 years ago, with 63% of Bolivians living in poverty.
10. In WTO and IMF the maximum number of votes right is allocated to which country?
a. Britain
b. USA
c. India
d. Japan
73
Chapter VI
Financial System in India: Structure and Evolution
Aim
• explain financial system
• elucidate evolution of financial environment
• explicate financial intermediation
Objectives
• explain the structure of financial markets
• explain the concept of money market
• explicate evolution of financial market
Learning outcome
• describe commercial banks
• identify foreign exchange market
• understand other financial institutions
74
6.1 Introduction
The financial system of any country is comprised of the financial institutions, financial markets, financial instruments,
and financial services. These constituent parts of the financial system are interdependent and work complementary
to each other. The financial system contributes to growth and development of the economy by mobilising savings
and allocating these to investors. The initiation of financial reforms in the early1990s was essentially to bring about
a transformation in the structure, effectiveness and stability of the financial system. In order to assess the limitations
and prospects of the reforms, we need an understanding of the organisational structure of the financial system. This
chapter is designed to look at the structure and working of the Indian financial system (IFS), and its evolution in the
post independence era. In section 2, an attempt is made to look at the way the financial environment in India has
evolved over time. In section 3, the structure of the IFS is discussed in terms of its institutions. Lastly, in section 4,
the evolution of the financial markets is looked at. Special emphasis is laid on discussing the reforms with a view
to seeing whether they facilitate the removal of institutional barriers preventing the effective functioning of the
system.
Financial system plays a vital role in the economic development of a country. The financial system intermediates the
flow of funds from the savers to the investors. A financial system is a complex, well-integrated set of sub-systems
of financial regulators, Institutions, Instruments, Markets and Services which facilitates the transfer and allocation
of the funds efficiently and effectively. The Indian financial system is broadly divided into two systems. They are:
• Formal Financial system (Organised)
• Informal Financial system (Unorganised)
Financial System
Financial Financial Financial Financial

Services Markets Instruments Institutions
Organised Unorganised Primary Secondary Regulatory Intermediaries Others
Primary Secondary Short Medium Long

term term term Banking Non-Banking
Capital Money
Markets Markets Non-Intermediaries
Fig. 6.1 Structure of Indian financial system

(Source: http://madhanmohan1988.blogspot.in/2010/11/indian-financial-system.html)
6.2 Evolution of the Financial Environment

The environment in which the Indian financial system has functioned in the post independence era can be divided
into three distinct periods. The first period is between the nationalisation of RBI in 1949 and the nationalisation
of the commercial banks in 1969. The fairly liberal environment in which the banking sector operated marks this
period. The second period is from 1969 till 1991 when the structural adjustment cum stabilisation programme
was initiated. This period is basically characterised by the active participation of the Reserve Bank in the banking
policy formulation and re-orientation. The nationalisation of 14 commercial banks in 1969 was a turning point in
the evolution of financial sector policies in India. Due to the more direct and active role of RBI in devising the
policies so as to meet the social objectives such as the reduction in inequalities of income and the concentration of
economic power, this period is dominated by the policies of financial repression - interest rate controls, directed
75
credit programmes, etc. The third period starts in 1991, when the attempt is made by the policy-makers to deregulate
and develop the financial markets. In this period, a more comprehensive liberalisation of the financial system was
aimed at, though the initial steps had actually started in the late 1980s.
Soon after independence, the banking sector was recognised as the major sector of Indian financial system. The RBI
was nationalised in January 1949 and has consolidated its position as the supervising and controlling agency of the
banks. All scheduled banks were required by the RBI Act to maintain a minimum cash reserve of 5 percent of their
demand liabilities and 2 percent of their time liabilities on a daily basis. In addition banks had to maintain liquid
assets in cash, gold or government securities amounting to not less than 20 percent of demand and time liabilities.
This was referred to as the statutory liquidity ratio (SLR). In 1962 the RBI was empowered to vary the cash reserve
requirements (CRR) between 3 percent and 15 percent of total demand and time liabilities while the SLR was
raised to an additional 25 percent over and above the CRR. RBI was also empowered to stipulate minimum lending
rates and ceiling rates on various types of advances. There was a voluntary agreement among the important banks
operating in India regarding the interest payable on deposits prior to 1964. Since 1964, RBI directly regulated the
interest rates on various deposits.
Right from the beginning, the RBI was envisaged to play a promotional role in augmenting the advancement of
credit to the agricultural sector. However, the allocation of credit from commercial banks was largely to industry
and, in particular, to the corporate sector. Between 1951 and 1968 there was an increase in the share of credit to
industry from 34 percent in 1951 to 67.5 percent in 1968, whereas the share of bank credit to agriculture was a little
over 2 percent .The second period of the development of financial system started with the nationalisation of the 14
largest Indian scheduled commercial banks. The broad objective of the nationalisation of banks was to mobilise and
disburse resources in accordance with the needs of development. This led to an emphasis on lending to the priority
sectors, viz., agriculture and other allied activities. The public sector banks were directed to advance 40 percent of
their total credit to the priority sectors with not less than 16 percent going to agriculture. Other financial institutions
like LIC, UTI, IDBI, IFCI, and ICICI etc., had been nationalised in this period with special objectives. UTI was
envisaged to promote the stock market and the IDBI to provide direct and indirect long-term finance to firms in
industrial sector. Term loans were also provided by the IFCI and ICICI.
The rationale for such social controls was diluted subsequently with the government’s increasing need to use the
banking sector for financing its own deficits. It was at this time that the financial repression could be said to have
set in. It was in the 1970s and 1980s that government started using the banking sector as a captive source of funds
by raising the SLR and CRR. The SLR requirement, which was 28 percent in 1970-1, was gradually increased
to 38.5 percent in 1989-90. The CRR requirement was raised from 7 percent in 1973-4 to 15 percent in 1989-
90. At the same time, to keep the cost of borrowing low for itself, the government systematically suppressed the
government securities markets and money markets during this period. This financial repression led to segmented and
underdeveloped financial markets, inefficient use of credit, and most of all, adversely affected the bank profitability.
The nationalisation of banks also meant that the competition in the banking sector was inhibited. It was against
this background that the need for financial reforms was felt. The impetus for this came with the submission of the
two influential committee reports to the RBI- the Chakravarty committee report in 1985 and the Vaghul committee
report in 1987. The Chakravarty committee, which was meant to suggest measures to improve the efficiency of
monetary policy recommended to:
• develop treasury bills as a monetary instrument to make the open market operation as a dominant instrument
of monetary policy
• revise upwards the yield structure of government securities so as to create a demand for public debt; and
• adopt monetary targeting as an important monetary policy tool with price stability being the ultimate objective
of monetary policy
The second committee, which was set up to study the money market, recommended for a phased decontrol and
development of money markets and the gradual integration of these markets with other key short-term markets
such as the treasury bills market.
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The actual reform in the financial sector started in the mid-eighties with the RBI implementing some of the
recommendations of the two committees. The major steps in this regard are introduction of 182-day treasury bills
in 1986, commercial paper and certificate of deposits in 1989, institution of DFHI in 1988 etc. In May 1989, as
a further step towards the liberalisation of the money markets, the ceiling on the call money rate was withdrawn.
More radical reforms have taken place in 1991, when the government of India adopted the structural adjustment cum
stabilisation programme. Two conditions called for financial sector reform. Firstly, the government’s use of banking
sector to finance its fiscal deficit has reduced drastically. Secondly, the reforms in the industrial and trade sectors
necessitated the allocation of resources to be market-driven and therefore required reforms in the financial sector.
The financial sector reform got a major boost with the implementation of some of the recommendations of the
Narasimham committee set up in 1991 to study the working of the financial system. These recommendations
were:
• lowering the SLR to 25 percent in a phased manner and to use CRR as an instrument of monetary policy
• phasing out directed credit programmes and to bring the interest rate on government borrowing in line with
other market-determined interest rates
• that banks and financial institutions achieve a minimum 4 percent capital adequacy ratio in relation to risk
weighted assets by March 1993
• that banks and financial institutions adopt uniform accounting practices in regard to income recognition and
provisioning for non-performing loans
• that freedom be given to issuers of capital to decide on the nature of the instrument, its terms and its pricing in the
capital market (Narasimham committee report, 1991). Most of these recommendations have been implemented
by1995-96
All this led to significant deregulation and development of the money market. Thus we note that while the financial
sector had been repressed earlier, several reforms were undertaken from the mid-eighties to deregulate and liberalise
it. Also a wide range of financial institutions had been set up. This facilitated the comprehensive reform package
brought about in 1991.
6.3 Financial Intermediation: Pattern and Institutions

The financial sector mediates between the ultimate savers and investors, acting as a mobiliser of credit and finance.
The level of financial development is indicated by the extent of mobilisation and dispersion of funds, viz. the financial
intermediation process. Several indicators are used in the literature to show the level of financial development1
(Goldsmith, 1969). Over time the level of financial development in India has shown a steady growth, whichever
indicator is used (Sen and Vaidya, 1997). However, the general pattern appears to have been a growth in the banking
sector in the 1970s while the capital market grew in the 1980s.
Looking at the financial intermediation process in terms of the flow of funds, the flow has been from the household
sector and the rest of the world to the government sector including the public sector enterprises and the private
corporate sector. The surpluses of the household and the rest of the world sectors have increased steadily over time
and so have the deficits of the government and private corporate sector (Sen and Vaidya, 1997, pg. 26). Government
sector has been the largest borrower till 1991. After the 1991 reforms, there is an indication of a reversal of this
trend with the government sector reducing its dependence on external funds. While government securities are still
the most important instrument, the non-financial sector has increased its holding of corporate and other financial
institutions’ securities. The household sector too has been shifting towards holding corporate securities and mutual
funds. As we would expect, this reflects the rising differential between the rate of return on these securities and on
bank deposits. The private corporate sector’s dependence on external funds has increased steadily till 1985-86, after
which it has reduced, with an improvement in the availability
The indicators of financial development are:

• Finance ratio
• Financial inter-relations ratio
• New issue ratio
• Intermediation ratio
77
The definitions of these ratios basically imply the importance of financial institutions relative to non-financial
units in raising resources to finance investment of internal funds. Other financial institutions as a source of funds
for the private sector have increased relative to banks in the 1990s. Also, banks have increased their lending to the
government, though a larger share of their funds is held with the RBI or in government securities due to high SLR
and CRR.
6.4 Financial Institutions

Next we look at the structure of the financial system in terms of its institutions. Financial institutions are business
organisations that act as mobilisers and depositories of savings, and as purveyors of credit or finance. Financial
institutions are divided into banking and non-banking institutions; the distinction between them is that banks can
advance credit by creating claims against themselves while other institutions can lend only out of their resources
put at their disposal by savers.
The banking sector consists of the RBI, commercial banks and cooperative banks. Among these, commercial banks
form the dominant component. Other non-bank financial institutions can be classified into three groups term lending
institutions including development banks, mutual funds and the insurance sector. We briefly review developments
in the banking and non-banking sectors in this section.
6.4.1 Commercial banks

Since the nationalisation of the commercial banks in 1969, there has been a significant growth of banking systems
in India both in geographical coverage and amount of resources mobilised. There has been an increase in deposits
as a percentage of national income from 15.3 percent in 1969 to 51.8 percent in 1994. Most of this increase in
deposits has been in the form of time deposits, which has resulted in a spectacular increase in the M3/GDP ratio
since the late sixties.
There are two reasons for mobilisation of such high levels of deposits:
• Firstly, the geographical area covered by the commercial banks has increased significantly with a more than
seven-fold increase in the number of bank branches since 1969. Most of the new branches have been set up in
the rural areas, which led to a sharp decline in the population per bank branch and mobilised savings from the
rural sector
• Secondly, the impressive performance in the mobilisation of deposits is due to the positive real rate of return on
the deposits, which McKinnon (1973) had argued is an essential prerequisite for financial deepening
It has been argued that the social control of banks had led to a decline in the productivity and efficiency and reduction
of the profitability of the banking sector (Ministry of Finance, 1991). The reduction of profitability of banks has
ensued from factors influencing both income and expenditure in the banking industry. On the income side, banks have
not been able to realise their potential income due to various restrictions on the use of funds. The most important of
these have been the directed credit programmes and high levels of SLR and CRR in the late eighties. However, since
1991, there has been a scaling down of the directed credit programmes and a reduction in the SLR and CRR.
Between 1973 and 1993, 84.5 percent of the increase in aggregate bank deposits was in the form of time deposits.
In end-March 1993, time deposits constituted 84.3 percent of total deposits. The rigidly enforced branch licensing
policy is an important contributing factor in the poor profitability performance of the commercial banks.
6.4.2 Other financial institutions

As mentioned earlier, the other financial institutions can be classified into three groups, with almost all the major
institutions in all three categories being government owned. The first category consists of Development Banks,
which include Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of
India (ICICI), Shipping Credit and Investment Company of India (SCICI), Industrial Finance Corporation of India
(IFCI), and Small Industries Development Bank of India (SIDBI). The largest in size and influence among these
are the IDBI and the ICICI. The IDBI was started in 1964 as a subsidiary of the RBI, but in 1975, the ownership
of IDBI was transferred to the Government of India. It has been operating as the apex financial institution that is
78
responsible for the coordination of all financial institutions engaged in financing the industrial sector. Till 1990,
the IDBI used to provide loans to the small scale and large-scale industries. In April1990, IDBI set up a subsidiary
company called SIDBI to which it handed over all operations pertaining to the financing of small-scale industries.
The ICICI, a public limited company, was set up in 1955 as a private sector development bank. Its share capital
was subscribed to by foreign institutions, banks and insurance companies. The other development banks, likewise,
cater to the financing needs in specific areas.
Till 1990, the rates of interest at which these institutions lent credit to firms were fixed. But in Augus1991, the
government permitted all term lending institutions to charge interest rates according to the riskiness of the project.
This basically freed the interest rates. The interest rates initially rose after this, but subsequently fell between
1993 and 1996. Another major change in their functioning since 1990-91 has been the reduced dependence on the
government of India and the RBI for funds. Some of them, specifically the ICICI and the IDBI, have diversified
their operations into various fields of activity since 1991. Broadly speaking, in the post-liberalisation period they
have attempted to transform themselves into financial institutions with a reduced dependence on the government
for subsidised and captive sources of funds and having a diversified field of activity.
Among the mutual funds, by far the largest in size is the UTI (though in recent years, several new mutual funds
have also arrived on the scene). It was set up in 1964. It is a 50 percent subsidiary of IDBI, the rest of the share
capital being held by the LIC, commercial banks, ICICI, and IFCI. UTI was never constrained in any way either by
regulation or by policy decisions of the Government of India in the manner in which it invested its resources, and
it has invested in both equity and fixed income securities. Financial liberalisation of this sector, thus has involved a
removal of legal barriers to entry in the mutual funds business in a phased manner, and a strengthening of regulations
aimed at ensuring transparency, and the provision of reliable information to investors. Till 1987, UTI had a monopoly
position but in 1987-88 commercial banks and other publicly owned financial intermediaries were allowed into the
mutual fund sector. In1993-94, it was opened out to the private sector, and SEBI announced regulations aimed at
increasing transparency and safety. The investments of the UTI have undergone significant changes over the time.
After 1990-91, the share of investments in government securities and deposits with banks has declined, while the
share of investments in equity shares has dramatically increased.
The major insurance funds are the LIC and the GIC, both of which are government owned. The LIC was established
in September 1956 by nationalising all life insurance companies operating in India at that time. Unlike UTI, LIC
since its inception had to operate under severe constraints regarding the way it could allocate its investible resources
among various instruments. A large part of its investments had to be in government securities, and in socially oriented
sectors like public sector, cooperative sector, house building, etc. As of March 1992, the LIC owned about 13.3
percent of all outstanding central and state government securities. The restrictions imposed on LIC have significantly
reduced the yields on investments. However, the situation has improved in recent years with the yield of government
securities increasing significantly. In 1994, the Malhotra committee has recommended that the private sector should
be allowed into insurance, and the LIC and GIC should reduce investment in government securities.
This brief overview of the financial institutions allows us to make the following remarks. Earlier, most of the
institutions, even if not completely in government control, had been strictly regulated in terms of rates of interest,
source of funds, and the priority areas to which they could advance credit. However, starting mid-eighties, and
picking up momentum in the nineties, we can say that several areas have been opened up to private firms there
has been a phased deregulation of interest rates; captive and subsidised sources of funds to the development banks
has been reduced and they have had to turn to the market for funds; and above all, the pre-emption of funds by the
government has been reduced. The whole process however has been gradual, and it is to be noted that mandatory
lending requirements of commercial banks to priority sectors is still maintained.
6.5 Structure and Evolution of Financial Markets

We look now at the financial markets in which these institutions participate. Financial markets are the centres or
arrangements that provide facilities for buying and selling of financial claims and services. The participants on the
demand and supply sides of these markets are financial institutions, agents, brokers and savers. Financial markets
may be classified as organised and unorganised markets.
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Unorganised market refers to a place where the financial transactions take place outside the well-established exchanges
or without systematic and orderly structure or arrangements and largely cater to the rural and unorganised sector.
The financial sector reforms are naturally centred on organised markets, although it is expected that they will have
an indirect effect on unorganised markets as well. Discussion in this section is confined to the organised financial
markets.
These may in turn be classified into the money market, capital market, credit market, government securities market,
and foreign exchange market, each of which we discuss separately. Most of the financial markets were characterised
till the early nineties by controls over the pricing of financial assets, restrictions on flows or transactions, barriers to
entry, low liquidity and high transaction costs. These characteristics came in the way of developments of the markets
and allocative efficiency of resources channelled through them. The initiation of financial sector reforms in the early
nineties was essentially to bring about a transformation in the structure, efficiency and stability of financial markets,
as also an integration of markets. Some of the important structural changes enabled by financial sector reforms
relate to introduction of free pricing of financial assets in almost all segments, relaxation of quantitative restrictions,
removal of barriers to entry, new methods of flotation of securities, increase in the number of instruments and enlarged
participation, improvement in trading, clearing and settlement practices, improvement in the informational flows,
transparency and disclosure practices.
6.5.1 Money Market

The money market performs the crucial role of providing a conduit for equilibrating short-term demand for and
supply of funds thereby facilitating the conduct of monetary policy. The instruments traded in money market are
short term in nature. Important among them are:
• Call money
• Certificate of deposit
• Commercial paper
The RBI and Securities and Exchange Board of India (SEBI) regulate the participants and use of instruments in
the money market.
Call money market is that part of the national money market where the day-to-day transactions in surplus funds of
banks are one. Call loans are short term in nature, their maturity varying between one day and a fortnight and are
payable on demand. They are given to the bill market, for the purpose of dealing in the bullion markets and stock
exchanges and between banks. Among these uses, intero bank use has been the most significant and their use on
stock exchanges and other markets has been modest. In the inter-bank call money market, funds are supplied by the
member banks that have reserves on a particular day in excess of reserve requirements. Banks borrow from other
banks in order to meet a sudden demand for funds, large payments, large remittances, and to maintain liquidity
with RBI.
Participants in the call money market are scheduled commercial banks, non-scheduled commercial banks, foreign
banks, cooperative banks, and some financial institutions and multinationals. A characteristic of the call money
market in India had been that of a few large lenders viz. LIC and UTI and a large number of borrowers. This led to
a deficiency in obtaining short term funds. But in 1988, the RBI set up the DFHI, which participated as both lender
and borrower. Steps were also taken to widen the market in 1990. At one time, only a few large banks particularly
foreign banks operated in the call money market. Over time, however the market has expanded and now small banks
and non-scheduled banks also participate in this market. There has been a significant increase in annual turnover
since 1991.
The rate of interest in the call money market was market determined till 1973, but between 1974 and 1989 there were
ceilings fixed. In May 1989, the ceiling on interest rate was removed. The removal of the ceiling on the call money
rate let to an increase in fluctuations since 1991, and the rate is highly variable from day to day. As a consequence,
companies hesitate to issue floating rate bonds in the capital market. Another fall-out of the fluctuations in the call
money rate is that the rate presents arbitrage opportunities to players in the foreign exchange market. Foreign banks
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now participate in the market, borrowing foreign exchange from their overseas branches and selling in the swap
market in India. This has led to an increase in the forward premia on the foreign exchange. To combat this, the RBI
introduced ‘Repos’, which were meant to even out liquidity. However, as Rangarajan (1994) pointed out, the RBI
has only used repos to drain reserves from banks and not to replenish them. Commercial paper (CP) is quite a new
instrument in the money market. CPs are short-term promissory notes with fixed maturity. In 1990 RBI introduced
a scheme under which certain borrowers could issue CPs in the Indian money market. This enables highly rated
corporate borrowers to diversify their sources of short-term borrowings and to borrow at a lower rate than the bank-
lending rate.
CPs are issued at a discount to their face value and the discount rate is freely determined by the company issuing
them. The success of CPs and the development of the market depend crucially on the emergence and growth of the
secondary market for them. But so far, the secondary market for CPs has not grown significantly in India. In an
attempt to deepen the market some relaxations have been made in the recent past. The maturity period, has been
changed from between 91 days to 6 months, to between 15 days to 1 year. The minimum size has been reduced
from `. 1 crore to `. 5 lakhs. The issue base has also been widened by allowing Primary Dealers, Satellite Dealers
and AIF is to issue them.
The major part of demand for CPs comes from the commercial banks, which in turn is governed by bank liquidity.
Though, there is a positive interest rate differential between the bank loan rate and CP rate, commercial banks
purchase CPs because bank loans involve a greater transaction cost. As inter-bank Call rates are lower than the CP
rate, banks used to borrow in the call money market and invest in CP market to grab the arbitrage opportunity.
Certificate of deposit (CDs) is a short term securitised time deposit issued by commercial banks at the time of tight
liquidity condition. They are negotiable because they are payable either to the bearer or to the order of the depositor
and are traded on the secondary markets. CDs are virtually riskless in terms of default of payment of interest and
principal. Banks issue or sell CDs either directly to the investors or through the dealers. CDs are quite flexible in
respect of maturity period, which varies between 2 weeks to 5 years; the more common period is 3 months to 1
year.
Since the beginning of the 1980s, the possibility of introducing CDs in India was being seriously assessed. The
Tambe Working Group, in 1982, recommended against it because there were no secondary money markets, there
was an administered system of interest rates and there was the possibility that CDs might give rise to fictitious
transactions. The Vaghul committee studied the matter again 5 years later (1987) and was in favour of introducing
CDs, provided short-term deposit rates were aligned with other interest rates in the system. Ultimately, following
the rationalisation of interest rates on short-term deposits, the RBI formulated and launched, in June 1989, a scheme
permitting banks to issue CDs.
Initially, the issuance of the CDs was limited to a certain percentage of fortnightly average of the outstanding
aggregate deposits of 1989-90. Over time the limits were raised and subsequently it was abolished on October 16,
1993, enabling the CD to emerge as a market determined instrument. Again, to deepen thanarket for CD, the issuance
size has been reduced to `. 5 lakhs and the minimum maturity period has been reduced to 15 days in April 2000.
Reforms in money market

In 1985, the Chakravarty committee first underlined the need to develop money market instruments in India, while
in 1987 the Working Group on the Money Market (Chairman: Shri N. Vaghul) laid the blueprint for the institution
of money markets. The Reserve Bank has gradually developed money markets through a five pronged effort:
• Interest rate ceilings on inter-bank call/notice money, inter-bank term money, rediscounting of commercial bills
and inter-bank participation without risk were withdrawn effective May 1, 1989
• Several financial innovations in terms of money market instruments, such as, auctions of treasury bills (beginning
with the introduction of 182-day treasury bills effective November 1986), certificates of deposit (June 1989),
commercial paper (January 1990) and RBI repos (December 1992) were introduced
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• Barriers to entry were gradually eased by increasing the number of players (beginning with the DFHI in April
1988 followed by primary and satellite dealers and money market mutual funds), relaxing both issuance
restrictions and subscription norms and allowing determination of yields based on demand and supply of such
paper, and enabling market evaluation of associated risks, by withdrawing regulatory restrictions, such as bank
guarantees in respect of CPs
• The development of markets for short-term funds at market determined interest rates has been fostered by a
gradual switch from a cash credit system to a loanbased system, shifting the onus of cash management from
banks to borrowers and phasing out the 4.6 per cent 91-day tap treasury bills, which in the past provided an
avenue for investing short-term funds
• Institutional development has been carried out to facilitate inter-linkages between the money market and the
foreign exchange market, especially after a market-based exchange rate system was put in place in March
1993
The changes in the money market structure need to be seen in the context of a gradual shift from a regime of
administered interest rates to a market-based pricing of assets and liabilities. The development of money markets
in India in the last few years has been facilitated by three major factors. Firstly, the limiting of almost automatic
funding of the government, largely realised with the replacement of ad hoc treasury bills (which bore a negative real
interest rate for most part of the period) by ways and means advances at interest rates linked to the bank rate, and the
development of the government securities market, discussed later in the chapter, permitting a gradual de-emphasis
on cash reserve ratio as a monetary policy instrument. Secondly, the development and use of indirect instruments
for monetary policy such as the bank rate, the strategy of combining auctions, private placements and open market
operations in government paper (put in place in 1998-99) and the liquidity adjustment facility (instituted in June
2000). Thirdly, an enabling institutional framework was introduced in the form of primary and satellite dealers
and money market mutual funds. The monetary authority uses money markets to adjust primary liquidity in the
domestic economy and monetary policy is often, in turn, shaped by developments in the money and the foreign
exchange markets.
6.5.2 Credit market

With a relatively underdeveloped capital market and with little internal resources, firms or economic entities
depend largely on financial intermediaries for their fund requirements. Credit market is the predominant source of
finance. The major institutional purveyors of credit in India are banks and non-banking financial institutions, i.e.,
development financial institutions and other financial institutions and non-banking financial companies including
housing financial companies. While banks and NBFCs predominantly cater to short-term needs, FIs provide mostly
medium and long-term funds.3
Prior to the financial system reforms, this sector had been highly repressed with government restrictions on both
pricing and allocation of credit. There were mandatory lending requirements to the priority sectors as well as
administered rates. This led to low productivity and efficiency, and low profitability in the banking sector. It is in
this background that the recommendations of the Narasimham committee were made in 1991. The consequential
financial sector reforms envisaged interest rate flexibility for banks and reduction in reserve requirements, besides
a number of structural measures. Interest rates, as a consequence, have emerged as a major signalling device for
resource allocation. Credit market reforms included introduction of new instruments of credit, changes in the credit
delivery system and integration of functional roles of diverse players such as banks, financial institutions and non-
banking financial companies. The gradual introduction of a loan system in the place of a cash credit system has
facilitated banks in planning their cash flows better, and in reducing the costs of uncertainty. There has also been
greater competition with the introduction of new private sector banks and the permission given to foreign banks to
open branches, as also with progressive improvement in the role of the nonbanking sector. Restrictions on project
financing by banks have been removed.
However, there are non-institutional sources of credit as well. These are basically the indigenous bankers and
moneylenders. It is in the field of credit that the unorganised sector is most important. There has been considerable
deregulation. While lending requirements still remain, there has been rationalisation of the lending rates and a
82
scaling down of cash reserve and statutory liquidity requirements. Selective credit controls have been eliminated
over time. Credit restrictions have been gradually removed/relaxed for purchases of consumer durables, and loans
to individuals against shares and debentures/bonds. As a result, the share of term loans as percentage of total bank
loans has increased.
A large variety of non-bank financial institutions such as development banks, specialised financial institutions,
investment institutions, and refinance institutions also function in the credit market. As noted earlier, development
banks (IDBI, IFCI, ICICI, SIDBI and IIBI) occupy an important position in the financial system as the main source of
medium and long-term project finance to industry. Investment institutions in the business of mutual fund and insurance
activity have also played significant roles in the mobilisation of household sector savings and their deployment in
the credit and the capital markets. In the agriculture and rural sector and the housing sector, the NABARD (1982)
and NHB (1988) respectively, are the chief refinancing institutions. Besides providing direct loans (including rupee
loans, foreign currency loans), financial institutions also extend financial assistance by way of underwriting and
direct subscription and by issuing guarantees. Recently, some development financial institutions (DFis) have started
extending short term/working capital finance, although term lending continues to be their primary activity.
Historically, the Reserve Bank and the Central Government have played a major role in financing these institutions
by subscribing to the share capital, by allowing them to issue Government guaranteed bonds and by extending long-
term loans at concessional terms. However, with the financial sector reforms, concessional lending by the Reserve
Bank and the Government was phased out, leaving the financial institutions to rely for their financing needs on the
equity capital and the debt markets. Expansion of their equity base through public offers and public issues of long-
term bonds has become an important element of their market-based financing. In order to provide flexibility, the
Reserve Bank has also allowed Fls to raise resources by way of term deposits, CDs and borrowings from the term
money market. A large number of them have also been entering various businesses - venture capital, mutual funds,
banking and finance. This portends well for a greater integration of the financial system.
6.5.3 Capital Market

Capital market structure has evolved over time, with market practices earlier reflecting government policies and
five-year plan priorities. The stock market in India has been fairly well developed. Its role in financial markets
had increased during the 1980s, with household savings in corporate securities increasing between 1985-86 to
1994-95. But an important feature of the pattern of stockholding had been that a large proportion of shares belong
to government owned financial institutions e.g., UTI. The implication of this is that government was capable of
indirectly influencing the market.
Till the reforms in the early 1990s, pricing was not determined by market conditions. Though volume of transaction
was high, securities continued to exist in the physical form creating uncertainties for the investor, and increasing
transaction cost. Long and uncertain settlement cycles created serious problems for clearing houses. Informational
flows to the participants were also deficient. Raising of capital from the securities market before 1992 was regulated.
Under the Capital issues (control) act, 1947, firms were required to obtain approval from the Controller of Capital
Issues (CCI) for raising resources in the market. New companies were allowed to issue shares only at par. In 1992,
the Capital Issues (Control) Act, 1947 was repealed and with this ended all controls relating to raising of resources
from the market. SEBI was given statutory powers in 1992 to undertake the tasks of regulation and supervision.
The most important fall-out of the reforms was the freeing of pricing and setting up of new guidelines regarding
new issues.
Initially, only fixed price mechanism of floating new capital issues was followed. An alternative mechanism of
book building was introduced in 1995 giving the issuer the choice to raise resources either through this or the fixed
price mechanism. Although the book building guidelines were prescribed in 1995, no issue was floated due to
certain restrictive guidelines, which were modified in 1999. The book building mechanism of floating new capital
issues has been devised in such a way that small investors are also able to subscribe to securities at a price arrived
at through a transparent process. Issuers of capital are required to meet the guidelines of SEBI on disclosure and
investor protection.
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In September 1992, foreign institutional investors were allowed unrestricted entry1n terms of volume of investment
in both primary and secondary markets. In the secondary market, major reforms were the laying down of capital
adequacy ratio for brokers; the banning of inside trading and the introduction of computer based trading system.
Till recently, trading on the Indian stock exchanges took place through open outery system barring NSE and OTCEI,
which adopted screen-based trading system from the beginning (i.e., 1994 and 1992, respectively). At present all
other stock exchanges have adopted on-line screen-based electronic trading, replacing the open outcry system. Of
the two large stock exchanges, the BSE provides a combination of order and quote driven trading system, while
NSE has only an order driven system. All stock exchanges operating in India have over 8000 terminals spread wide
across the country. While in 1999-00, the SEBI issued guidelines for opening and maintaining the trading terminals
abroad, no trading terminal could be opened abroad due to high cost of connectivity. For ensuring greater market
transparency, the SEBI has recently banned negotiated and cross deals (where both the seller and the buyer operate
through the same broker). In September 1999, all private off-market deals in both shares as well as listed corporate
debts were banned. All such deals are now routed only through the trading screens. There are three main advantages
of electronic trading over floor-based trading as observed in India, viz. transparency, more efficient price discovery,
and reduction in transaction costs. It also reduces the segmentation of markets.
Thus the emphasis has been on disclosure of information, safeguarding of investors’ interests and opening up to
foreign investors. The result of this has been a dramatic increase in the number of new issues and amount of capital
raised after 1991-92. While traditionally, mainly two instruments, viz., debt and equity, were traded, a large number
of new and hybrid instruments were introduced in the first half of the nineties, through the increase in new issues.
Markets have widened with an increase in the number of players such as mutual funds and foreign institutional
investors. A major implication of this is that firms may be in a position to substitute one source of funds for another,
depending on relative costs. Also, while the amounts raised on foreign markets are modest, this also enables firms
to diversify their source of funds.
6.6 Government Securities Market

Government securities consist basically of treasury bills and dated securities, the difference being that the former
consists of maturity less than one year, while the latter are longer-term. They are strictly speaking, part of the money
and the capital markets respectively. But this market is discussed separately in this section since the characteristics
of government securities and therefore the issues concerning them are different.
The market for government securities had been relatively underdeveloped until the mid-eighties, largely because the
returns (administered rates) had been kept artificially low. The demand for government securities was therefore largely
restricted to a captive market, consisting of commercial banks, cooperative banks, and some financial institutions
like the LIC, UTI etc. and this too through the SLR requirements. Most of the treasury bills were 91-day ad hoes
meant to monetise the budget deficit, and ended up being held by the RBI. However, following the Chakravarty
committee report, in 1986 a phased deregulation was carried out. Rates of interest were revised upwards, even
within the context of administered rates. The idea here, as mooted by the committee, was to help the transition from
direct tools of monetary policy (such as credit controls, CRR), to the use of indirect instruments like open market
operations. Thus the 182-day treasury bill was introduced in November 1986 to increase the real rate of interest.
This was phased out in April 1992, when 364-day treasury bill to be sold on an auction basis, was introduced. In
1993, an auction system for 91-day treasury bill was also introduced. At present, the sale of government securities
is carried out both through auction and through pre-determined coupon issues. Non-competitive bids are, however,
accepted outside the notified amount. The Reserve Bank also participates on a non-competitive basis in treasury
bills and dated securities to primarily take up some part of the issues in case of under-subscription. In the recent
years, with a view to moderating the market impact of the large borrowing programme on interest rates, the Reserve
Bank has accepted private placement of government stocks and released them to the market when the interest rate
expectations turned out to be favourable.
84
These measures have led to a significant growth in the primary market for treasury bills, with the amount outstanding
for 91-day auction based Treasury bills rising from `. 250 crores in January 1993 to `. 3450 crores in August 1994.
In August 1994, only sixteen percent was held by the RBI. The amount outstanding for 364-day treasury bills rose
from `. 666 crores in April 1992 to `. 7160 crores in August 1994. This is mainly due to the use of open market
operations by the RBI. Secondary activity has however not developed. Deregulation has given rise to a tendency
for the rates of interest to fluctuate; but the 364-day Treasury bill has been more stable.
Following the Chakravarty committee recommendations, the rates of interest on dated securities has also been
gradually aligned with other rates of interest, and the maximum maturity period has also been reduced from twenty
to ten years. The main investors in the Government securities market in India are commercial banks, cooperative
banks, insurance companies, provident funds, financial institutions, mutual funds, primary dealers, satellite dealers,
non-bank finance companies and corporate entities. The Reserve Bank also absorbs primary issues of government
securities, either through private placement or development. Though banks have traditionally been the dominant
investors in the government securities due mainly to SLR requirements, they have, in recent years, found it
advantageous to invest in the government securities beyond the statutory requirements partly because of the better
risk-return characteristic of such securities in the context of adherence to capital adequacy requirements and partly
because of relatively sluggish demand for commercial credit. The share of commercial bank holdings continued to
rise during the eighties and the nineties.
A large participant base reduces the borrowing cost for the government, reduces market volatility and imparts
competition in the market. A market with adequate depth and liquidity for participants with different perceptions and
liquidity requirements should emerge. The present structure of the government securities market is pre-dominantly
institutional, while the household participation is negligible or nearly absent. Foreign institutional investors are also
permitted to invest in the dated government securities and treasury bills, both in the primary and secondary markets,
within the overall debt ceilings.
Since the secondary activity/s not very high, to promote the retail market segment and provide greater liquidity
to retail investors, the Reserve Bank allowed banks to freely buy and sell government securities at prevailing
market prices, removing restrictions on the period between sale and purchase. Furthermore, the interest income
on government securities was exempted from the provision of tax deduction at source with effect from June 1997,
facilitating quotations at ‘clean prices’ and genuine trading in the secondary market. This has led to some growth
as is evident from the fact that secondary market transactions in government securities increased to `. 5,39,255
crores in 1999-00 as against `. 1,27,179 crores in 1995-96 (Bhole, 1999). Thus it can be said that the size of the
government securities market is large and is growing.
6.7 Foreign Exchange Market

Foreign exchange market includes the market for all deposits, credits and balances payable in any foreign currency,
and any instrument payable at the option of the drawee partly in foreign currency. It facilitates the transfer of
purchasing power denominated in one currency to another. In the context of globalisation of the Indian economy,
the foreign exchange market is an important element of the financial system.
The working of the foreign exchange market depends upon the exchange rate mechanism followed. In India, till
1975, the par value of the Rupee was expressed in terms of gold. Between 1975 and 1992, the rupee was linked to
a basket of currencies, and the exchange rate followed a managed float system. The regime was characterised by a
daily announcement by the RBI of its buying and selling rate to authorised dealers (ADs) for merchant transactions.
Given the various exchange controls that were in position, these were the rates around which the market operated, with
the RBI performing a market-clearing role on a day to-day basis. In 1992, the liberalised exchange rate management
system involving a dual exchange rate was introduced and the rupee became convertible for all approved external
transactions. Under this system, exporters were able to sell sixty percent of their exchange receipts to ADs at market
determined rate. However, it was the unification of the exchange rates in 1993 that ushered in the market- determined
exchange rate, based on demand and supply in the foreign exchange market. Full current account convertibility,
introduced in August 1994, was a further step in this regard.
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The structure of the foreign exchange market in India may be briefly described. It operates from major centres like
Mumbai, Delhi, Calcutta, Chennai, Bangalore, Kochi, and Ahmedabad. It is comprised of customers, ADs in foreign
exchange and the RBI. It consists of two segments, the customer or merchant segment consisting of transaction of
customers to meet transaction needs, and the interbank segment encompassing transaction between banks (ADs). The
customer segment includes major public sector units, corporates, and other business entities with foreign exchange
exposure. Of late, foreign institutional investors have also been playing a major part. The inter-bank segment is
dominated by a few large Indian banks, particularly SBI and a few foreign banks.
Since 1993, several steps have been taken to widen and deepen the foreign exchange market. Firstly, banks have
been given the freedom to:
• fix net overnight position limits and gap limits
• initiate trading position in the overseas markets
• determine the interest rates of NRI deposits and maturity period
Secondly, inter-bank borrowings have been exempted from statutory pre-emptions of SLR and CRR. Thirdly, banks
have been permitted the use of derivative products for asset-liability management. Fourthly, in order to facilitate
integration of domestic and overseas money markets, ADs have been allowed to borrow abroad. The funds so
borrowed are allowed to be used for any purpose, other than lending in foreign currencies. Fifthly, corporates have
been provided significant freedom in managing their foreign exchange exposures.
They are permitted to hedge anticipated exposures, though this facility has been temporarily suspended after the Asian
crisis. Other risk management tools like crosscurrency options on back to-back basis, lower cost option strategies
like range forwards and ratio range forwards and hedging of external commercial borrowing (ECB) exposures have
been allowed subject to prudential requirements.
At any time in the exchange market there is a spot exchange rate at which current transactions are carried out, and
a forward rate for deliveries in the future. Both of these are market determined. In the absence of transaction cost,
the difference between the two rates (i.e., the forward premium) should reflect the interest differential between the
two countries. This obviously requires the exchange market to be integrated firstly with the other domestic financial
markets, and secondly with foreign financial markets.
86
Summary
• The financial system of any country is comprised of the financial institutions, financial markets, financial
instruments, and financial services.
• Financial system plays a vital role in the economic development of a country. The financial system intermediates
the flow of funds from the savers to the investors.
• The Indian financial system is broadly divided into two systems.
• The environment in which the Indian financial system has functioned in the post independence era can be
divided into three distinct periods.
• The nationalisation of 14 commercial banks in 1969 was a turning point in the evolution of financial sector
policies in India.
• The broad objective of the nationalisation of banks was to mobilise and disburse resources in accordance with
the needs of development. This led to an emphasis on lending to the priority sectors, viz., agriculture and other
allied activities.
• The nationalisation of banks also meant that the competition in the banking sector was inhibited.
• The financial sector mediates between the ultimate savers and investors, acting as a mobiliser of credit and
finance.
• Financial institutions are business organisations that act as mobilisers and depositories of savings, and as
purveyors of credit or finance.
• Financial markets are the centres or arrangements that provide facilities for buying and selling of financial
claims and services.
• The money market performs the crucial role of providing a conduit for equilibrating short-term demand for and
supply of funds thereby facilitating the conduct of monetary policy.
• Credit market is the predominant source of finance.
• Capital market structure has evolved over time, with market practices earlier reflecting government policies
and five-year plan priorities.
References
• Khan, M.Y., 2007. Indian Financial System, 5th ed., Tata McGraw-Hill Education.
• Dr. Murthy, D.K., 2006. Indian Financial System, I.K. International Pvt. Ltd.
• Financial System in India:Structure and Evolution [Pdf] Available at: <http://shodhganga.inflibnet.ac.in/
bitstream/10603/1732/10/10_chapter%203.pdf> [Accessed 11 July 2013].
• Current and Structural Developments in the Financial System [Pdf] Available at: <www.oecd.org/finance/
financial-markets/44362303. pdf> [Accessed 11 July 2013].
• 2013. Indian Financial System [Video online] Available at: <https://www.youtube.com/watch?v=-ShUE6n_4pc
‎> [Accessed 11 July 2013].
• 2013. Indian Financial Services System [Video online] Available at: <https://www.youtube.com/watch?v=
zsanyYtQQ2I ‎> [Accessed 11 July 2013].
Recommended Reading
• Gurusamy, S., 2009.Indian Financial System, 2nd ed., Tata McGraw-Hill Education.
• Pathak, B.V., 2011.The Indian Financial System, 3rd ed., Pearson Education India..
• Bhole, L. M., 2004.Financial Institutions and Markets:Structure, Growth and Innovations, 4th ed., Tata McGraw-
Hill Education
87
Self Assessment
1. The environment in which the Indian financial system has functioned in the post independence era can be divided
into how many distinct periods?
a. Two
b. Four
c. Six
d. Three
2. The first period of the Indian financial system in the post-independence era lies from _______.
a. 1949-1969
b. 1969-2000
c. 1949-1991
d. 1969-1980
3. The nationalisation of RBI was done in _________.

a. 1959
b. 1969
c. 1949
d. 1979
4. Which of the following was a turning point in the evolution of financial sector policies in India?
a. Nationalisation of RBI in 1949.
b. Nationalisation of 14 Commercial Banks in 1969.
c. Increase in foreign trade .
d. Decrease in excise duty.
5. In which year RBI started directly regulating the interest rates on various deposits?
a. 1949
b. 1969
c. 1972
d. 1964
6. In which year the ownership of IDBI was transferred to the Government of India?
a. 1964
b. 1975
c. 1986
d. 1996
7. The ________, a public limited company, was set up in 1955 as a private sector development bank.
a. IDBI
b. IFCI
c. ICICI
d. SCICI
88
8. Which of the following market performs the crucial role of providing a conduit for equilibrating short-term
demand for and supply of funds thereby facilitating the conduct of monetary policy?
a. Capital market
b. Credit market
c. Foreign market
d. Money market
9. What does SEBI stands for?

a. Security Exchange Board of India
b. Social Exchange Board of India
c. Shipping Export Board of India
d. Shipping Exchange Bay of India
10. The LIC was established in _______.

a. 1949
b. 1969
c. 1975
d. 1956
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Chapter VII
Changing Role of Government
Aim
• explain economic growth
• elucidate structure of investment and capital formation
• explicate structure of national output
Objectives
• define economic development
• elucidate basic structural changes in the economy
• explicate India’s saving and investment
Learning outcome
• define structure of consumption
• identify growth rate of NNP and NNP per capita
• understand financial-asset structure of the household sector
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7.1 Introduction
It will be an interesting exercise for you to compare the role played by the governments in two Asian countries – Japan
and China. These two countries differ from each other tidally in terms of their political and economic ideologies.
The tiny Japanese nation is considered to be a capitalist giant. The populous Chinese nation is one of the very few
countries which still, by and large, practice communism.
Of course, both in Japan and China, justice, police and defence are part of the responsibilities of the government.
But as regards the economic role of the government, the situations in the two counties are strikingly different. In
Japan, there are hardly any government enterprises and the means of production are almost entirely in closely hands.
The government at present has a very negligible role in the Japanese economy. In China the situation is almost
exactly the opposite. The means of production are almost entire in government hands and the government plays a
very prominent economic role even these days.
Actually, if you scan books of economics, you will decipher two diametrically opposite viewpoints about the
economic role of government. One is the laissez-faire view as propounded by Adam Smith. According to this, a
government that interferes lest with the economy is the best. In such an economy, everyone acts according to his or
her own self-interest. But the invisible hand operating through the market mechanism ensures that social interest
gets promoted in this process. In striking contract is the view held by Karl Marx and his group of scientific scoliosis.
Corroding to the Marxists, centralised planning with public ownership of the means of production leads to an ideal
economic and social set up.
Let us not take a brief look at the economic history of the developed nations of today. This is necessary to understand
the prevalence of the different viewpoints on the economic role of government. It will also reveal the process of
change in these viewpoints over time. In fact there is adequate historical evidence that, basically, economic policies
of laissez-faire helped the countries of Western Europe and the United States of America attain high levels of
economic development. Actually, till the early parts of the twentieth century, scientific socialism was looked upon
as something theoretically sound, but impractical and utopian.
You will notice that the birth of the Soviet Union in 1917 based on scientific socialism changed all this considerably.
Further, since the late 1920s the lacunae father laissez-faire economies started looming larger and larger. As a result,
government intervention became increasingly popular even in traditional lassie-faire economies. A number of
countries turned communist for various reasons particularly after the Second World War. Due to all this a number
of Asian and African countries, regarding independence in the 1950s and 1960s, opted for considerable government
intervention in their economies.
The pendulum has, however, swung the other way particularly since the 1970s. Many countries of Easter Europe
found central planning of the communist variety difficult to practice and hence ineffective. Many of them like
Poland, Hungary and Yugoslavia started being less rigid forms of Centralised planning. Private ownership omens of
production also began to be allowed in some sector soft the economy in these countries. Moreover, both the Soveit
Union and China started inducting market forces to supplement Centralised planning. The breakup of the Soviet
Union of Yugoslavia and the pulling down of the Berlin Wall are taken as further manifestations of this wind of
change. The magic formulae on everybody’s lips these days are liberalisation and globalisation. It looks as if the
laissez-faire economic philosophy has been reinstated. Almost all countries of the world, including, India, have been
swept off their feet as a result. The changes, particularly, since the 1990s, of the economic role foot he Government
in India bear ample testimony to this.
It is, however, being increasingly realised that there are no simple panacea for improving for the levels of living
of the people. Most analysis agree that neither laissez-faire nor Centralised planning of the communist verity can
deliver the goods. It has, of cause, been admitted for years that even capitalist countries there are certain aspect where
government intervention in the economy impose its performance. We are living in an age which is also witnessing
attempts to make scientific socialism market friendly. You might have come across the popular saying that we are
in the ear of Karl Smith and Adam Marx these days.
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In view of all this, we now embark on a more detailed analysis of the role of government in today’s world.
7.2 Role of Government in Capitalist Economies

You will find that the laissez-faire economic philosophy underlying the capitalist economies has come to inform
strong analytical justification. This is done by point out that such polices would lead to a Pareto-optimal allocation
of resources in the economy concerned. A Pareto-optimal situation exists in any economy if one person cannot be
made better off without making someone else worse off in their respective options. Under certain assumptions the
proponents of laissez-faire have promoted that such a Pareto-optimal situation will emerge in a free market economy
with no government intervention. But the assumptions made in deriving the Pareto-optimal solution from laissez-faire
economic logic are far from reality. Further, the actual results in countries following laissez-faire economic police
reveal serious drawbacks. You will hence find that on both these counts, even confirmed protagonist of laissez-faire
favour economic intervention by government. We take up these issues one by one now.
7.2.1 Unrealistic Assumptions

Three basic assumptions underlie the justification of a laissez-faire economic philosophy. Firstly it is assumed that
markets are characterised by perfect competition. Secondly, it is taken for granted that there are no externalists.
Thirdly, not all types of goods can be taken into account in the analysis. The meanings and implications of each of
these are discussed below.
Perfect competition
Perfect competition has a number of characteristics. There are a large number of buyers and sellers each buying and
selling only a small quantity of the product. The product produced is perfectly homogenous and both buyers and
seller are guided solely by economic considerations. There is perfect knowledge and perfect mobility of consumes
and of the factors of production. The net result of all this is that there will be only one price for the commodity at
one point of time in a market. Further no single buyer or seller can affect the price or the demand or the supply, as
the case may be, by his independent action.
You can see by now that the actual situation in most market is a far carry from this. Joan Robinson and E. Chamberlain
had pointed this out even in this late 1930s. They build alternative models of market structure, namely imperfect
competition and monopolistic competition. Later writers have gone on to build even more realistic models of market
structure. These oligopoly models visualise the existence of raw large producers in each industry with some of these
working even in collusion.
A Pareto-optimal situation in the allocation of resources even does not emerge with laissez faire polices under any
of these alternative and more realistic forms of market structure. Hence we find that government intervention to
prevent non-optima allocation of resources, and higher prices, excessive advertising expenditure, etc., under these
forms of market structures, is universally accepted.
Absence of externalities
Externalities are defined as incidental benefits and detriments accruing out of nay economic activity. If your
neighbour sets you a motor cycle repair shop, the noise will bother you. The setting up of their repair shop will thus
lead to a detrimental externality for the entire neighbourhood. In contrast, assume that one of your neighbours has
a beautiful garden. Whenever you pass by the garden, you will feel happy and refreshed. The neighbour cannot
charge you for this happiness that he, incidentally, provides you. The setting up of a beautiful garden by someone
in the neighbourhood thus generates this beneficial externality.
You will certainly agree that if society’s interest is to be promoted, these externalities have also to be taken into
account in determining economic activities. For this purpose, economic activities have to be based on calculations
of social cost and social benefit and not on mere private cost and private benefit. In laissez-faire logic, however, we
find that costs and benefits are considered without taking into account these externalities. As a result, the output of
those goods and services which cause beneficial externalities will be too little. As against this the output of these
goods and services which have detrimental externalities will be too much. Government intervention to correct this
anomaly is therefore an accepted practice even in capitalist economics.
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Public goods excluded
You find that economists make a distinction between private and public goods. According to them, private goods
posses the attributes of both delectability and excludability. On the contrary, public goods are conspicuous by the
fact that they have neither of these attributes. We will not proceed to explain each of these attributes. Assume that
an item has the attribute of delectability. If so, the use of threat item an individual will reduce the total available
supply for use by others, to that extent, at least temporarily. Goods are excludable if a person not paying for it can
be prevented from enjoying it. You notice that the goods that we buy from the market posses both these attributes. In
contrast, many things that we collectively consume like street lighting are devoid of both. For private goods, market
mechanism determines the price to be charged and the quantity to be produced. But the market mechanism cannot
help us on both these counts in the case of public goods. Public goods are hence the responsibility of governments
the world over.
7.2.2 Lacunae in Performance

You will agree with the statement that the proof of the pudding is in the eating. It is indeed true that some countries
following laissez-faire economic policies have attained very high eels of growth in terms of per captain real income.
But it has also to be admitted that the laissez-faire economic pudding has actually turned out to be somewhat less
tasty than it was supposed to be. In fact, three serious lacunae have been noticed in the economic performance of free
market economies. Firstly, these have been experiencing periodic ups and downs in national income, employment
and prices. Secondly, there are huge inequalities of income and prevalence of considerable poverty. Thirdly, there
is also enough reason to believe that such economics do not make adequate provision for the future at least on two
counts, namely in promoting developing and in making development environmentally sustainable. We now take up
these three issues one by one.
• Cyclic Fluctuations: Periodical upward and downward changes in national income, employment and prices have
characterised free market economies. The laissez-faire economists over refused to accept this reality and went
on harping the theme that there is an automatic tendency towards full employment in a free market economy.
An extreme downswing- the great depression of the 1930s – made John Maynard Keynes questions the view
and propound an alternative theory. According to Keynes, there will be equilibrium at less than full employment
in a free-market economy. His view, with minor modifications, has come to be accepted by a large number of
countries
Hence government intervention through a combination of monetary and fiscal policies is considered essential
for free market economics. The purpose of such polices it ego ensure stability in national income, employment,
and prices
• Inequalities: Developed free market economies are characterised by considerable interpersonal inequalities
of income and wealth. This causes concern because people in the lowest income groups are often found to be
living in poverty. It is also seen that distribution is not equitable between different regions within a nation. Some
regions are pockets of poverty. Further, there is usually a gender bias in distribution. The majority of the poor
in developed free market economies are often found to be women
A little analysis will convince you that this is not very surprising. It is true that there is a direct relationship
between effort and reward in a free market economy. But the effort is judged by the means of production that
an individual or a region has. If these are not initially distributed equitably, inequalities arise and are likely to
get compounded over time
Hence, we see that measures to lessen extreme inequalities income and wealth are part of the agenda set before
the governments of free market economies. And in these measures, particular attention is paid to the removal of
poverty in the less developed regions and of the less advantaged groups. The last two aspects of the distributional
issue have come into policy focus only in the past few years
• Inadequate provision for the future: Generally, we also find that a laissez-faire economic policy does not result
in adequate economic provision for the future. This is so from two important points of view. Firstly you will
agree that most Third World countries cannot attain a high level of economic development without he adoption
of specific policy measures in this regard by their government. Secondly, inter-generational equity in terms of
attaining environmentally sustainable development is conspicuous by its absence in almost all countries of the
world. These points, we believe, need to be discussed in slightly greater detail
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Developing countries need a lot of investment in area like heavy industries and infrastructure. These arrays need
substantial capital and yield returns only in the long run. Further, they are often highly risk and are, often in the
form of pubic goods with a good deal of beneficial externalities. Moreover, the political, social and economic
institutional structure in these countries is far from congenial for the promotion of economic development. It
is therefore accepted that without the government playing a positive role, these institutional constraints cannot
be overcome nor can heavy industries or requisite infrastructure come up.
As regards the environment, we find that in private cost-benefit calculations in free market economies, this aspect
never used to be taken into considerations. This is hardly surprising because leaving a better environment for the
succeeding generations has become an economic policy objective only in recent years. Even centrally planned
soloist economies have a miserable record on this count. It must however to be admitted that environmental
impact assessment is a gray area even today. There are umpteen problems in working out the cost of detrimental
externalities on the environment resulting from economic activity. But the environmental aspect is being
increasingly recognised the world over. As a result, even in free market economies, governments insist on
project getting environmental clearance.
7.3 Pitfalls of Communism

We have, by now, discussed what are called cases of market failure in free market economies, justifying government
intervention. A question that naturally would arise in your mind is whether we can go to the other extreme and leave
all aspects of the economies in government hands. It may appear that ideal solutions from the social point of view
would emerge in the economy if this is done. The experience of communist economies suggests that this is simply
torture. Economies praising central planning under scientific socialism have had serious difficulties on at least three
counts. Firstly, there have been problems in finding out the consumer’s tastes. Secondly, in a number of cases, there
have been difficulties in seeing to it that adequate inputs are made available to produce planned outputs. Lastly, it
has also been noticed that these economies have lagged far being the others in terms of technology. We shall take
up these issues in greater detail one by one now.
7.3.1 Good produced not in line with consumer’s preferences

In communist countries, the planning authorities decide the basket of commodities to be produced. Price again is
fixed not by market forces, but by these authorities. Thus the market mechanism of the type that operates in after
market economy is conspicuous by its absence in these economies. The result is that there is often a large unsold
stock of goods unwanted by consumers in shops. There are also big lines in front of shops of people wanting to
buy goods which are much in demand but not produced in adequate quantity by the planners. In fact one of the
major reasons for the so-called breakdown of communism is that the strong preference of consumers for VCRs, fast
foods, cameras, etc., had not been adequately met by the planners in these countries. Hence, many of the former
communist countries are making efforts these days to overcome these lacunae by giving the market mechanism its
due place in their economies.
7.3.2 Difficulties in training martial balancing

The planners in a communist country have to see that adequate resources are made available at the proper time and
place. This is to ensure that the production of outputs takes place according to the plan. Hence such planning for
internal consistency takes care of material balancing according to which inputs supplied equal inputs demanded.
Material balancing is sought to be achieved in communist countries by the use o the input-output technique. The
input-output table is worked out on the basis of the information regarding the inputs required for producing outputs
in the different sectors of the economy. On the basis of such a table, the input requirements needed to produce the
targeted output of all sectors together can be mathematically worked out.
The detailed information required for building such a table is seldom available. It has also to be borne inside that if
information about input requirements is collected from particular enterprises; there is always a danger of deliberate
misinformation. Communist countries are often bedevilled with serious input bottlenecks. More often than not,
planners in these countries are consternated to solve these problems by mere trail and error. Other such attempts to
minimise input bottlenecks result in scarce inputs being diverted to “priority” sectors like spacecraft to the ultra neglect
of sectors producing consumer durables. Due to all this, communist countries also witness the strange phenomenon
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of some enterprises keeping unusually high levels of stock scarce raw material to fulfil their production quotas as
determined by the planning authorities. In the light of all this, communist countries these days are attempting to
make socialism market friendly. This is done by gradually introducing private ownership of means of production
and using market mechanisms to bring about material balances.
7.3.3 Outdated technologies

It is true that countries which took to communism earlier began their process of economic development by borrowing
state of art technologies from other countries. You may notice, however, that the communist system was such that
there is little incentive for enterprises in these countries to go in for continuous technological up gradation. We can
think of at last three important reasons for this lack of incentive. One is the fact that enterprises in communist are
static monopolies. Secondly, there is the unpleasant reality that technological up gradation by an enterprise is often
not an unmixed blessing for it. The benefits of up gradation may not necessarily accrue to that particular enterprise.
We shall now briefly dwell on the reasons for the unpleased consequences.
• No spur of competition: In free market economies, the enterprise competes with each other to capture the
market. This enables customers to look for other producers if the quality of the product of one of the producers
is not up to the mark. The producer with poor quality product is forced either to improve his quality or leave
the industry
In communist countries, scene enterprise are state monopolies, the consume has no such choice. The state decides
how much each producer has to produce and there is no continuous rivalry between the producers to improve
quality and capture the market. It is found that in a number of these countries, the quality of the products has
instead improving gone down over time
• Technological improvement causes problems: In free market economies, a good deal of technological up
gradation takes place on shop floors. Such improvements come in favour acclaim and often result in less input
being used to produce the same output
It is true that in a community se top too such an improvement may result in a part on the back of the concerned
enterprise. It may, however, not be an unmixed blessing for it. This is so because it may often imply a much large
quote of output to be produced by it. Getting the extra volume of input in time would often cause much greater,
if not insurmountable, difficulties to the management. This may act as a strong disincentive to the management
touring about technological improvements
As a result of all these factors, countries which took to communism early are facing problems of outdated
technology. This is particularly so in their non-priority sectors where government R & D efforts have not been
undertaken. More or less the same is the situation in countries which took to communism later on. These coteries,
for political reasons, had to adopt outdated technologies prevalent another communist countries
7.4 Indian Experience

The Indian economy has also witnessed a bight change in the role of the Government over time. Ever since
independence till around the 1980s, as we discussed in the previous units, our objectives was to have planned economic
development without adopting extreme forms of capitalism or communism. Heavy industry and infrastructure were
left in the hands of the government to develop. Priority sectors were decided upon by the Government. In agriculture,
development was encouraged along capitalistic lines. To prevent monopoly, motivate cyclical fluctuations, lessen
interpersonal inequalities of income and wealth and promote economic development, measures of command and
control were frequently resorted to, though some measures operating through the market mechanism were also
adopted. Little attention was however paid by the Government to prevent environmental degradation or reduce
inter-regional or gender-based inequalities.
The situation in which we found ourselves by the 1980s was not a happy one. Our Government could not provide
adequate infrastructural facilities. While we had some success in increasing agricultural production, even now, seems
affected by the vagaries of the weather, causing cyclic fluctuations in the economy. You will find that there have been
official statements that while the Indian economy has grown, this growth has not trickled down sufficiently. Further,
Government-owned enterprises in basic and heavy industries were functioning far from efficiently and have mostly
been using outdated private sector units of the Indian economy were also more or less in the same boat. There were
hence slow rumblings of change in India’s economic policy from the 80s.
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It soon became clear, however, that such gradual changes will simply not work. The unprecedented crisis in the Indian
economy in 1990-91 was the last straw on the camel’s back. Our foreign exchange reserves fell to an all-time low
level $42.2 billion. Inflation rate had already crossed the double-digit figure and was actually at 14%. Fiscal deficit
had risen to 8.4% of the Gross Domestic Product. The current account deficit on balance of payments was as high
as $ 9.9 billion. International Credit Rating agencies went on to considerably downgrade India’s creditworthiness.
The Government and many economists agreed that a shock therapy was immediately required to pull the Indian
economy out of the woods. The World Bank agreed to bail India out, but imposed certain conditionality for doing
so. It wanted two major types of programmes to be carried out. Firstly, there were to be short-term stabilisation
measures to control inflation and wipe out the balance of payments deficit. These were agreed upon. You are aware
that attempts are being made to rationalist subsidies and cut down wasteful Government expenditure to reduce
the fiscal deficit. The rupee has been devalued to correct the balance of payment deficit. Secondly, there had to be
structural reforms to make the Indian economy competitive and attain a high rate of growth with social justice. These
have also been accepted and measures are being taken to liberalise and globalise the Indian economy.
As a result of all this, there was considerable rethinking, reinforced by the conditionality imposed by the World
bank to help India out of her difficulties. Steps Began to be initiated in the 1980s and these gathered considerable
momentum in the 1990s. A sea change has thus come about in the economic role of the Government in India since
the 1990s. Many of the sectors reserved for the public sector have now been thrown open to the private sector. More
and more physical controls are being replaced by measures to guide the economy through the market mechanism.
Restraints in the way of international trade and factor movements are being gradually reduced. The seeming intention
is to make the Indian economy face international competition and become efficient in performance. The Government
role in the provision of public goods is not likely in increase, but as regards the protection of the environment, the
Government is likely to play an increasing role.
7.5 Emerging Consensus on the Changed Role of Government

You might have noted by now that the vast difference that existed between capitalist and communist countries
regarding the role of government in their economies has almost disappeared. A certain consensus seems to be
emerging these days on the role the government is supposed to play on the economic front.
Capitalist countries are increasingly accepting the fact that governments have to play an important role in their
economies. The governments come into the picture to provide public goods and to ensure that competitive forces are
not impeded in play their role. The governments promote the production of commodities with beneficial externalities
and curb the production of commodities with detrimental side effects. Measures to reduce interpersonal inequalities
in income and wealth, with particular focus on the removal of poverty, especially among disadvantaged groups,
are part of government agenda. So steps to foster economic development and to prevent widespread fluctuations in
national income, employment and price level.
Communist countries are similarly waking up to the fact that everything about the economy cannot be left to the
state. It is, by and large, agreed that the record of these countries in overcoming cases of market failure as regards
cyclic fluctuations, poverty removal and provision of public goods has been somewhat good. But there have been
glaring cases of state failure in such countries regarding production of commodities wanted by the people, material
balances (or stocks) and technological up gradation. To overcome these difficulties the governments of these countries
are getting slowly out of the responsibility of running productive enterprises. They are also gradually introducing
market forces and adopting more decentralised planning techniques.
It has also to be noted that in both sets of countries, increasing attention is being paid by governments to tackle
problems of environmental degradation. As regards the modus operandi of government intervention in this and
other areas, the tendency is to adopt measures operating through the market mechanism in preference to command
and control measures.
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Summary
• This chapter gave you a brief overview of the change in the role of government in the economies of the world
guided by different politico-economic systems.
• We studied capitalist economies, the economic role of government had increased over time. This attributed to
market failure on two counts.
• Three basic assumptions underlie the justification of a laissez-faire economic philosophy.
• Firstly, the assumptions of perfect competition, absence of externalities and non-existence of public goods have
been found to be not based on realities.
• Secondly, there have been lacunae in the performance of these economies in terms of cyclic fluctuations of
income, employment and prices, existence of inequalities, poverty and inadequate provision for future.
• Thirdly, not all types of goods can be taken into account in the analysis.
• You will find that the laissez-faire economic philosophy underlying the capitalist economies has come to inform
strong analytical justification.
• The Indian economy has also witnessed a bight change in the role of the Government over time.
• A certain consensus seems to be emerging these days on the role the government is supposed to play on the
economic front.
References
• Ramachandran, K. S., 2007. Economic Environment of India:Lesson from Past and for the Future, Northern
Book Centre.
• Batley, R. & Larbi, G. A., 2004. The Changing Role of Government, Palgrave Macmillan.
• The Changing Role of Government [Pdf] Available at: <www.cuhk.edu.hk/gpa/wang_files/UNDP.pdf > [Accessed
11 July 2013].
• The changing role of governments in corporate social [Pdf] Available at: <www.eurada.org/files/Social%20
affairs/CSR%20Business%20Ethics.pdf> [Accessed 11 July 2013].
• 2010. Changing Role of Government in Society [Video online] Available at: <https://www.youtube.com/
watch?v=fnrAZPExSPg‎> [Accessed 11 July 2013].
• 2012. The Role of Government in the Economy [Video online] Available at: <https://www.youtube.com/
watch?v=D23YY11cvzY‎> [Accessed 11 July 2013].
Recommended Reading
• Shaffer, H.G., 1999. American Capitalism and the Changing Role of Government, Greenwood Publishing
Group.
• Tanzi, V., 2011. Government Versus Markets:The Changing Economic Role of the State, Cambridge University
Press.
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Self Assessment
1. The tiny ________ nation is considered to be a capitalist giant.
a. Chinese
b. Japanese
c. Indian
d. Afghani
2. According to the laissez-faire view as propounded by Adam Smith, “A government that interferes _________
with the economy is the best”.
a. most
b. least
c. fully
d. partially
3. A number of countries turned ________ for various reasons particularly after the Second World War.
a. Monarchy
b. Democratic
c. Communist
d. Aristocratic
4. Which of the following are defined as incidental benefits and detriments accruing out of nay economic
activity?
a. Externalities
b. Internalities
c. Variability
d. Realities
5. _____________ free market economies are characterised by considerable interpersonal inequalities of income
and wealth.
a. Advanced
b. Developed
c. Undeveloped
d. Pre-mature
6. _________ countries are increasingly accepting the fact that governments have to play an important role in
their economies.
a. Communist
b. Socialist
c. Mixed-Economic
d. Capitalist
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7. ___________ countries are similarly waking up to the fact that everything about the economy cannot be left to
the state after the changing role of government.
a. Communist
b. Socialist
c. Mixed-Economic
d. Capitalist
8. _____________ is sought to be achieved in communist countries by the use of the input-output technique.
a. Material balancing
b. Capital balancing
c. Technology balancing
d. Profit balancing
9. __________ countries need a lot of investment in area like heavy industries and infrastructure.
a. Developed
b. Developing
c. Undeveloped
d. Less developed
10. An extreme downswing- the great depression of the _______ made John Maynard Keynes questions the view
and propound an alternative theory.
a. 1910s
b. 1920s
c. 1930s
d. 1940s
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Chapter VIII
Structural Dimensions of Indian Economy
Aim
• explain economic growth
• elucidate structure of investment and capital formation
• explicate structure of national output
Objectives
• define economic development
• elucidate basic structural changes in the economy
• explicate India’s saving and investment
Learning outcome
• define structure of consumption
• identify growth rate of NNP and NNP per capita
• understand financial-asset structure of the household sector
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8.1 Introduction
The socio-economic environment of any country can be explained in terms of an institutional framework and a
physical framework, the economic policy statements of the government, economic plan documents, the political
constitution, economic regulations and controls, among others which define the role and status of private sector, public
sector, multinationals, corporations, small business, etc. The critical elements constitute the institutional framework
of an economic environment. The trends in economic variables such as income, price, output, investment, foreign
trade, labour supply and other factor endowments and the structural relation among these variables constitute the
physical framework of an economic environment.
Describing and analysing the economic environment is a difficult task. Discretion and personal judgement play
an important part. Difficulties arise in the context of both institutional and physical framework. Just as various
interpretations of policy statements are possible various conclusions could also be drawn from the economic data.
The purpose of gathering (mainly from official sources) and analysing data is to obtain a clear picture of major
economic trends and structural changes in the economy. The trends and structural coefficients together enable us
to make a quantitative assessment of the economic environment of a business/firm and thereby to outline strategies
for macroeconomic management. Knowledge of economic trends and structural changes thus helps the firm to plan
out a corporate strategy and policy to cope with short-run and long-run challenges of business environment. This
argument is particularly valid for a developing country.
This chapter attempts to present the relevant economic trends, and discuss the structural changes. It then examines
the implications of growth and structural changes that have occurred. It also analyses the current economic trends,
and discusses the impact of environment on business management. In this chapter, you may have to refer to
additional statistical materials time and again. Of course, you are not expected to remember the details of all such
data. You should only take note of such trends which are useful to the analysis of the system-environment of your
own business.
8.2 Economic Growth and Development

“Growth” and “development” are sometimes used synonymously in economic discussion. Though the two terms
are used interchangeably, they have different connotations. Economic growth means more output, while economic
development implies both more output and changes in the technical and institutional arrangements by which it is
produced and distributed.
Growth may well involve not only more output derived from greater amounts of inputs but also greater efficiency,
that is, an increase in productivity or an increase in output per unit of input. Development goes beyond this to imply
changes in the composition of output and in the allocation of inputs by sectors. As with human beings, to stress
“growth” involves focussing on height or weight (or national income), while to emphasize development draws
attention to changes in functional capacities in physical coordination, for example, or learning capacity (or ability
of the economy to adapt).
8.2.1 Economic Growth

Economic growth may be defined as a significant and sustained rise in per capita real income. One must distinguish
the “level” from the rate of economic growth, though these two concepts are obviously related. The level of economic
growth of a country is measured by the size of national (or per capita) real income. The percentage change in this
level over a year is the annual rate of growth. That is, if we denote the levels of real income in two years Y1 and
Y2 and g as the rate of growth (expressed in percentage terms), then per capita
real income is supposed to be the least imperfect measure of economic growth of a country. It takes into account
changes in national income, population and price level.
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8.2.2 Economic Development

‘Economic development’ is a broader concept than ‘economic growth’. As and when the economies grow in terms
of national and per capita income levels, certain structural changes accompany the process of growth. Conceptually,
the trends in income and the structural changes together constitute economic development.
The structural changes which are quite fundamental in character are inherent in the process of economic growth.
The upward trend in per capita real income (i.e., economic growth) implies, given the labour force participation
rate, arise in product per worker or labour productivity. An increase in labour productivity cannot result without
capital accumulation and fundamental changes in the production function (functional relationship between flows
of output and corresponding flows of inputs) of the economy. A progressive shift in the production function is the
direct outcome of technological advancement, and science is the base of modern technology.
As science and technology advance, innovations (new products, new production processes and methods, new
markets ,etc.) take place; inventions result and get spread. Such process of growth (scientific progress, invention and
innovation) cannot be economically sustained for long unless it increases the productivity of labour. The increase in
the flow of material goods and service must also be absorbed; otherwise the process of growth gets obstructed by
market limitation. In other words, the changes in production structure must be synchronised and balanced with the
changes in the consumption structure. The structure of society’s wants and preferences (in short, structure of demand)
must change in such a way as to induce or assist changes in production and productivity and thereby to accommodate
the changes in science and technology. Similarly, the progressive development through science and technology
cannot come about unless the society manages to generate capital formation (through savings and investments)
and to finance research and development of science. (The present day developing countries can supplement their
scientific research efforts with science and technology transfer from more developed countries). Thus we find that
during the process of economic growth, economy experiences manifold changes in its structure: social, political and
economic. For an understanding of the changing economic environment in a developing country, we may examine
specifically the nature of some of the structural changes which are economic in character.
Structure of National Output

Studies of economic development of many present day “more developed countries” (a phrase suggested by Everett
E. Hagen) like the U.S.A., the United Kingdom, and Japan suggest that a change in the structure of national output
is a concomitant feature of economic growth. As an economy grows, on the one hand the level of national income
increases while on the other, composition of national income changes. The percentage contribution of agriculture to
gross domestic product declines and the contribution of industry and services to gross domestic product increases.
This reflects positive income elasticity of demand for non-agricultural output. This means that a given percentage
increases in the income will result in higher percentage increase in demand for non-agricultural output. As the
ratio of non-agricultural to agricultural output increases during the period of economic growth, labour productivity
increases in both agricultural and non-agricultural sectors. The rate of growth of non-agricultural output is observed
to be faster than that of non agricultural employment and therefore, the labour productivity (output per worker), in
mining, manufacturing and services registers improvement during the process of economic growth.
Structure of Employment
Economic growth is also associated with a change in the structure of employment of people. It is generally accepted
that one of the structural changes that occur in the course of economic growth is a progressive shift of labour from
agriculture and allied activities to secondary and tertiary sectors. Studies based on historical data of the industrialised
economies of the West have amply demonstrated the validity of this Fisher-Clark thesis. The shift in occupational
pattern runs parallel to the shift in output pattern because the same factor positive income elasticity of demand for
non-primary goods and services underlies the process of economic growth.
Structure of Investment and Capital Formation

A change in the structure of investment and capital formation is another development during the process of economic
growth and development. With industrialisation and consequent urbanisation, the structure of industries changes.
Capital and producer goods industries grow in importance and consumer goods industries decline in relative
importance. In developing countries (particularly those with planning) in the initial stage of development, resources
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are deliberately shifted from consumption goods to capital goods. Thus the investment structure changes. The
investment in human capital (education and health) and in social overhead capital (like irrigation, transport, etc.)
increases very rapidly in the early stage of development when the infrastructure of development is laid strongly.
Similarly, in the early stage of development, the dependence on foreign capital (aid, loans and grants) and foreign
technology may also be very high. This means that the ratio of gross (and net) domestic capital formation to gross
(and net) national capital formation is affected. The point is that different capital formation proportions reflect the
nature and tempo of economic growth.
While on the subject of capital formation, we may refer to an important determinant of the rate of economic growth.
This determinant is the capital output ratio. We distinguish average capital-output ratio from marginal or incremental
capital output ratio. Incremental Capital-Output Ratio (ICOR) is the additional capital required to increase output
by one more unit. The following is the basic economic growth rate (g) equation.
Rate of investment
g=
ICOR
In the above equation g is growth rate and ICOR is Incremental Capital-Output Ratio. In macro-economic planning
process as well as micro-level management decisions, this ratio proves very useful. Consider, for example, the
macroeconomic planning process. If a planning agency wants to achieve an annual growth rate of 5% (growth rate of
national income) and if the incremental capital output ratio is 4, then what should be the annual rate of investment?
The above equation helps us in answering the question.
Rate of investment
g=
ICOR
In our above example, g = 5% and ICOR = 4.
Rate of investment
5%
4
Rearranging terms we get

Rate of investment = 5% x 4 = 20%
Changes in the capital-output ratio are a dimension of economic growth and development process.
Structure of Consumption
The upward trend in per capita income (economic growth in short) which initiates and accelerates changes in
production, employment, factor proportion, initiates and accelerates changes in production, employment, factor
proportion, skill and capital formation directly brings about a change in the structure of consumption. As income
changes, the pattern of income distribution (between regions, between sectors and between persons) also changes. This
is backed up by changes in relative price structure of the economy, the domestic terms of trade between agriculture
and non-agriculture change. It is through the interaction of all these factors that the structure of consumption and
the standard of living undergoes a fundamental change reflecting changes in social values, beliefs and consumer
preferences.
Finally, with changes in the structure of employment production, income distribution and consumption, there comes
naturally a change in the structure of foreign trade. In the initial stage of development, an economy may have to
import metals and machinery for modernisation and industrialisation. But as the industrialisation proceeds with
economic growth, the acceleration in the pattern of exports and imports change.
Structure of foreign trade, in short, changes (a separate block in this course is devoted to the external sector) as
economy changes from primary commodity exporting to export of manufactures. In the next section we give an
outline of the Indian economic growth experience. The remaining sections deal with major structural dimensions
of India’s economic development experience.
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8.3 Indian Economic Growth Experience

In this section we present an overview of the Indian growth experience. The interest is to map the broad contours
of the Indian growth experience for the period of little over four decades. This is to enable you to get a perspective
on country’s economic growth which has at the root of major structural changes in the economy.
During the period 1950-51 and 1999-2000, the Net National Product (NNP) at factor cost at constant (1993-94)
prices (real national income) recorded an annual growth rate of 2.4 per cent and 6.2 per cent respectively, while per
capita NNP growth rate was only 1.71 per cent. The per capita NNP at constant (1993-94) prices (real per capita
income) increased from `. 3687 in1950-51 to `. 10306 in 2000-01. Thus during the 41 years period, the per capita
income more than doubled itself approximately.
8.3.1 Growth Rate of NNP and NNP Per Capita

The growth rates of NNP and NNP per capita during different plan periods give an overview of the Indian growth
experience. During the First Five Year Plan period (1951-56) the NNP in real terms grew at an annual compound
rate of 3.6 per cent, while per capital income grew at 1.8 per cent. The performance of the economy during the
Second Plan period significantly improved over the previous Plan period. The growth rates of national income and
per capita income were 4.1 per cent and 2.0 per cent respectively, higher than the first plan growth rates. The growth
rates significantly fell during the Third Plan Period (1961-66). While the NNP grew at an average annual rate of 2.5
per cent, the NNP per capita grew at the rate of 0.2 per cent only.
During the three annual plans (1966-69), income and per capita income growth rates picked up significantly. They
were 3.8 per cent and 1.5 per cent respectively. During the Fourth plan (1969-74) the growth rates fell again. While
the NNP growth rate was 3.3 per cent, the NNP per capita grew at the rate of 1.0 per cent. The growth rates improved
significantly during the Fifth Plan period (1974-79). The NNP during the Plan period grew at an annual compound
rate of 5.0 per cent, while per capita NNP grew at 2.7 percent. During the annual plan 1979-80 both NNP and per
capita NNP recorded negative growth rates. The growth rates were -6.0 per cent and -8.3 respectively. During the
Sixth Plan (1980-85) period the growth rates were significantly high. The NNP and NNP per capita grew at annual
average rates of 5.4 per cent and 3.2 per cent respectively. Growth rates slightly increased during the subsequent
Seventh Plan (1985-90) period. They were 5.8 per cent and 3.6 per cent respectively. In 1990-92 NNP at constant
(1993-94) prices grew at 3.0 per cent, per capita income growth rate being 0.9 per cent. During the Eighth and
Ninth Plan period percentage income growth rates were 6.7 and 4.6. Thus, growth rates significantly picked up and
exceeded the average for the 1980s decade.
8.3.2 Income and Per Capita Rate

The above account shows that both income and per capita income growth rates fluctuated significantly. Several
factors explain fluctuations in respect of growth experience during the last four and half decades. Fluctuations in
weather conditions (alternating droughts and floods and periodic unfavourable monsoons) unfavourable increase in
capital-output ratio (aggregate), balance of payments problems and the consequent foreign exchange crises, wars
with China and Pakistan dislocating the development efforts, international transmission of inflation through foreign
trade, exogenous shocks such as oil price hikes during early part of 1970s and later, and the structural imbalances
which have developed in the economy as development proceeded were some of the major
factors to be noted in this connection.
While one can discern several dimensions of economic progress of the Indian economy in the post-independence
period, the rate of economic growth has not been adequate enough to take care of the twin problems of unemployment
and poverty. Added to this are the problems of growing inequalities in income distribution and in regional development.
India’s per capita income is very low relative to per capita income of more developed countries like the USA. Despite
low growth rate and low level of per capita income, India today has one of the most diversified industrial structures
in the world. In the remaining sections of this unit we examine the structural changes in the economy.
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8.4 Basic Structural Changes in the Economy
Economic growth has brought about a structural change (change in sectoral shares of the national income) in the
economy. This is evident in the form of a shift in the sectoral composition of production (income), diversification
of activities and a gradual transformation of a feudal and Colonial economy into modern industrial economy. The
composition of gross domestic product has changed steadily during the planning era.
Historical Overview
While the share of agriculture and allied activities fell from 58.73 per cent to 27.69 per cent during 1950-52 to
1998-2000, the share of manufacturing increased from 13.29 per cent to 24.71 per cent during the same period. The
share of tertiary or service sector increased from 27.98 per cent to 47.60 per cent. Thus a growth has been observed
where the relative share of agriculture is declining, industry nearly constant and services rising in the GDP. The
expansion of service sector has not only been conducive for employment generation but also for better efficiency
of the system and better quality of life. Thus significant structural changes have taken place in the Indian economy
during the period 1950-2000 when we go by sectoral distribution of national income. Thus by income criterion
structural change in the Indian economy has been very significant.
Now let us consider structural change by employment criterion. It is generally accepted (as we noted before) that
one of the structural changes that occur in the course of economic development is a progressive shift of labour
from agriculture and allied activities to secondary and tertiary sectors. Studies based on historical data have amply
demonstrated the validity of this Fisher-Clark thesis.
While this broad trend in sectoral reallocation of labour as development proceeded is thus firmly established, the
interesting fact about these structural shifts in economic activity for our purpose is not so much the ultimate decline
in the importance of agriculture (in relative terms) as the rate at which it occurred. To quote Paul Bairoch, “the
proportion of active persons in agriculture diminished at a rate of less than 0.4 per cent a year till 1860, about0.9
per cent from 1860 to 1950, but at 4 per cent from 1950 to 1970. The changes in the redistribution of the active
population in Western developed countries have thus been more important in the last twenty years.”
Indian Experience
The above historical experience tells us that the sectoral redistribution of the active population is a time-taking
process. Unlike structural change based on income criterion, structural change based on employment is a slow
process. This is demonstrated by the Indian experience also.
The share of primary sector in total employment declined from 12.28 per cent to 8.65 per cent during 1961-63 to 1998-
2000. That is if we go by employment criterion structural change in the Indian economy has not been significant.
The share of secondary sector (mining and quarrying, manufacturing, and construction) declined from 36.7 per
cent to 31.7 per cent during the same period. The share of tertiary sector (trade and commerce, transport, storage
and communications and allied services) increased from 51.03 per cent to 59.65 percent during 1961-63 to 1998-
2000.
Two structural features of the Indian economy emerge clearly from the above account:
• Agriculture continues to be important in the Indian economy. A little more than 30 per cent of national income
originates in the agricultural sector
• There is only slight structural change in the economy if we go by the employment criterion
The underdeveloped nature of the Indian economy becomes evident when we compare the employment structure
of the Indian economy with that of a more developed country U.S.A. Agriculture in USA in 1986 accounted for
only 7 percent of total workforce. The industrial sector and tertiary sector accounted for36 per cent and 57 per cent
respectively. In the remaining two sections of this unit we will consider some more structural dimensions of the
Indian economy. Structure and changes in foreign trade are separately dealt within the block dealing with “External
Sector”.
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8.5 India’s Saving and Investment: Trends and Components

Given the supply of labour force and its annual rate of growth, economic growth is primarily a matter of rate of
capital accumulation and resource productivity improvements. Capital accumulation in different sectors of a national
economy takes place through investments in those sectors. To finance investment, saving from current income is
necessary. Further a well-developed financial system is necessary for mobilising savings from net surplus units in
order to lend to the net deficit units largely to finance their investment activity. Financial intermediation is the core
function of the financial system.
8.5.1 Savings Rate

In our country, the saving rate (net domestic saving as percentage of NNP at current prices) was a mere 6.2 per cent
in 1950-51. In the same year, the household sector accounted for `. 441.3 crores of the total net domestic savings
of `. 572.2 crores or in percentage terms for 77.1 per cent of the total net domestic saving. Of the total household
saving of `. 441.3 crores, about 96 per cent was held in the form of physical assets and about only 4 percent was
held in the form of financial assets. This is one aggregative indicator of economic underdevelopment, on the one
hand, and financial underdevelopment on the other, of the country at that time.
But during the last four decades the country has experienced significant economic and financial development. The
saving rate has been recording significant improvements. From 6.2 per cent in 1950-51, it rose to 9.3 per cent by
1960-61. By 1990-91 it further rose to 14 per cent. By 1993-94 it stood at15.3 per cent.
Households, private corporate sector (including cooperatives) and public sector are three sources of saving. Let us
see what has been the trend in respect of the relative contributions to national saving of these sources? In 1980-81,
household sector accounted for 75.9 per cent of the total net domestic saving.
Next in importance was the private corporate sector (including cooperatives) which accounted for 8.0 per cent of
net domestic saving and public sector accounted for the remaining 16.2 per cent of net domestic saving. By 1990-
91the picture has changed significantly. Household sector accounted for 84.4 percent of the net domestic saving. The
saving rate of the corporate sector fell significantly and was at the level of about 42 per cent. Public sector saving
stood at 0.15 per cent of the net domestic saving. Thus the household sector (which includes apart from individuals,
all non-government, non-corporate enterprises) accounts for most of the savings in the economy. The dissaving of
public sector was increasing from year to year during the period.
It is seen that household sector saving provides the bulk of national saving. The share of total household saving to
total National saving is more than three quarters. It does further suggest that the public sector saving rate declined
but the corporate saving rate improved. This declining trend of public sector saving rate is due to negative saving
of government administration. A decline in public savings was attributed to poor performance of government on-
statutory corporations, mounting government employment.
Household savings take broadly two forms. One is the form of physical assets. Savings in the form of physical assets
comprise additions to ‘construction’,’ machines’ and equipment and inventories. Savings in the form of financial
assets comprises of currency, deposits with banks with corporate enterprises, provident/pension funds, claims on
government, insurance and compulsory deposits. In 1999-00 financial assets accounted for 10.5 per cent of the gross
savings of the household sector and 10.3 per cent savings were in the form of physical assets. By 2001-02 the saving
in the form of financial assets accounted for 11.2 per cent, 11.3 per cent being accounted for by saving in the
form of physical assets. Thus there took place significant financial development during the three decades.
8.5.2 Financial-Asset Structure of the Household Sector

Let us now look at changes in the financial asset structure of the household sector. The significant changes in the
composition of assets of the household sector indicate rapid strides made by the financial system of the country. The
currency component decreased in relative importance as its share in the total gross saving decreased from 31.8 per
cent in 1960-61 to 17.8 per cent in1987-88. The importance of deposits in the portfolios of household sector increased
substantially during the period from 2.4 per cent in 1960-61 to 27.9 per cent in 1987-88. The phenomenal growth of
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banking facilities and other financial intermediation and spread of banking habit among households becomes evident
from this. There is still an untapped potential in respect of government securities, investments in UTI (Unit Trust of
India) and life insurance business. Evolving an appropriate structure of interest rates and through LIC rationalising
its premium structure which helps in boosting its business, the potential can be realised.
Savings when invested results in capital formation. The share of the commodity sector (agriculture, forestry, fishing
etc. and mining and manufacturing, construction, electricity and water supply) in gross domestic capital formation
improved from 56 per cent in 1980-81 to about 60 per cent in 1989-90 and that of the non-commodity sector
(services) declined from about 44 per cent to 40 per cent during the same period. Within the commodity sector, the
share of mining and manufacturing significantly rose during the period from 37.5 per cent to 48.5 per cent. This is
an indicator of the growing importance of mining and manufacturing in gross domestic capital formation
8.5.3 Gross Domestic Capital Formation

Gross Domestic Capital Formation (GDCF) is classified on the basis of type of assets into two components:
• Gross Fixed Capital Formation (GFCF) and
• Changes in stocks or inventories
The share of the former improved from about 84 per cent in 1950-51 to 92 per cent in 1990-91. This was a healthy
trend because it indicated that inventory accumulation was low.
Gross Domestic Capital Formation as a percentage of Gross domestic products increased from about 81 per cent
in 1960-61 to about 23 per cent in 1990-91.This shows significant improvement in investment effort. As for the
division of GDCF between public sector and private sector, in 1960-61 GDCF in public sector was 38.9 per cent,
while that in private sector was 61.1 per cent. By 1990-91 the percentages were 37.5 and 62.5.
The economic growth rate has not been commensurate with the rate of investment. Among many reasons for this
(such as under-utilisation of productive capacity, inefficiency in resource use, etc.), rising capital-output ratio has
been one The ICOR (Incremental Capital- Output Ratio) rose from about 2.95 during 1951-52 to 1955-56 to 4.36
during1985-86 to 1991-92. During Eighth Plan period it declined to 3.43 and again rose to 4.53 during Ninth Plan
period.
8.6 India’s Monetary and Price Trends

A serious concern for the Indian economy since the middle of the Second Plan period has been the upward trend in
the general price level. The price trends are related to, among others, the trends in money supply and government
budget deficits. The imbalances between demand for and supply of wage goods, particularly food, triggered the price
rise in early 1960s and several other factors have made inflation a persistent feature of the Indian economy.
8.6.1 Money Supply

Money supply has increased rapidly and regularly. The money supply with the public (currency plus demand deposits,
plus other deposits with RBI, referred to as M1 in RBI publications) during the 21 year period 1970-71 to 1991-92
increased at the annual average rate of 17.7 per cent. In only one year (1977-78) it registered a fall from `. 15609
crores to `. 14388 crores. In all other years, M1 registered positive growth rates. One interesting fact is that while
the average annual growth rate of M1 during the 19 year period 1970-71to 1987-88 was 13.12 per cent, during the
subsequent four year period from1988-89 to 1991-92 it was 18.5 per cent. Thus, prior to the severe economic crisis
in 1991, M1 was growing at a significantly high rate, higher than the average for the period 1970-71 to 1987-88.
M3 is defined as M1 plus time deposits. M3 grew at an average annual rate of 20.8 per cent during the period 1970-
71 to 1991-92. The high growth rate observable in respect of M3 is largely accounted for by the growth rate in time
deposits. During 1995-2001 M1 increased from 192257 crores to 472827 crores, while M3increased from 527596
crores to 1725222 crores during the same period.
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Components of the Money Supply over Time

12000.000
10000.000 M3-M2
M2-M1
6000.000 M1
8000.000
4000.000
2000.000
0.000
Jan - 03
Jan - 63
Jan - 67
Jan - 71
Jan - 83
Jan - 87
Jan - 99
Jan - 59
Jan - 81
Jan - 75
Jan - 79
Jan - 95
Fig. 8.2 M1, M2, M3 Money Supply Components
(Source: http://bigpicture.typepad.com/comments/2005/11/chart_of_the_we_2.html)
8.6.2 Growth Rate: Principal Factors

Money supply growth rate has been an important factor behind the Indian inflation experience. The three principal
factors responsible for the expansion of money supply are:
• Bank credit to commercial sector
• Bank credit to government
• Net foreign exchange assets of the banking sector
Inflation rate based on Wholesale Price Index (WPI) averaged 9 per cent during the period 1970-71 to 1991-92. It
reached high levels during the two years 1973-74 (20.2 per cent) and 1974-75 (23.2 per cent).
Inflation rate based on Consumer Price Index (CPI) numbers (urban nonmanual employees) averaged about 9 per
cent reaching the highest level of 22.2 per cent in 1974-75. Besides the government deficits and the consequent
money supply growth rate, several structural and institutional factors have been at the root of inflationary rise in
prices in India beginning from mid-1950s at a slow rate, accelerating from mid-1960s and recording considerably
high rates during the first half of 1970s.
The following factors have been responsible for inflation:

• The very plan strategy adopted for accelerating development and the consequent trends in the composition of
domestic output and foreign trade with adverse influence on domestic output and foreign trade with adverse
influence on domestic price level
• Closely related to the above is the forced pace of structural change with little regard for sectoral balance and
price stability
• Role of expectations emanating from inflationary psychology
• Plethora of controls inspired by ideological fixation with no firm economic basis and ineffectiveness in operating
them leading to the growth of parallel economy making monetary and fiscal measures almost ineffective
• Ineffective institutional measures for redistribution of wealth and income
• Inflationary nature of the role of distributes trade prompted by the seller’s market conditions
• Exogenous shocks such as wars and oil price hikes
• International transmission of inflationary pressures
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The rate of change in wholesale and consumer prices suggest that the overall trend in prices has been on decline
since 1992. One striking trend noticeable is the growing divergence between the rate of inflation based on wholesale
prices and that for consumer price index since 1993-94. Until 1993-94 the two rates generally converged. Since
1995-96, the consumer price index based rate of inflation has exceeded the based on wholesale prices by a wide
margin. The divergence trend in the wholesale and consumer prices has been explained in terms of the change in
the weighting scheme for the two indices.
In the Block dealing with “Economic reforms since 1991”, you will learn about the “New Economic Policy” to
tackle with the problems of Indian economy, including the problem of inflation.
8.7 Other Structural Dimensions

Some of the other structural dimensions of the Indian economy are:
• As for the tax structure, heavy reliance on indirect taxes and declining importance of direct taxes, such as income
tax, have been resulting in adverse consequences so far as the objectives such as price stability and reduction
in inequalities in income and wealth distribution are concerned.
• Growth in non-developmental government expenditure has been a significant factor in several economic ills
facing the economy.
• Heavy reliance on debt financing of government expenditure has been another feature of the Indian fiscal
system.
• Rapid population growth largely because of fast decline in death rate and very slow decline in birth rate is
another feature of the country with adverse consequences. Remember, from the standpoint of analysis of business
environment, it is important for you to gain mastery over the structural dimensions we have examined in this
unit.
8.8 Demographic Trends and Structure

The main problem in India is the high level of birth rates of accompanying falling death rates. The rate of growth of
population which was about 1.3 percent per annum during 1941-50 rose to 2.1 per cent during 1981-91. The chief
cause of the rapid growth of population was the steep fall in death rate from 49 per thousand during 1911-20 to
about 11 per thousand by the end of 1980s.But the birth rate declined from about 49 per thousand during 1911-20
to about31 per thousand by the end of 1980s.
The fast rate of growth of population, given the rate of growth of GNP implies lower per capita GNP growth rate.
For example, if GNP growth rate is 5 percent per annum, and population growth rate is 2 per cent, then per capital
GNP growth rate is 3 per cent annum. To maintain a rapidly growing population, the requirements of food, clothing,
shelter, medical and educational facilities and so on will be rising. Therefore a rapidly rising population imposes
greater economic burdens and, consequently, the society has to make greater efforts to accelerate the process of
economic growth. Moreover, rapidly rising population implies larger additions to labour force and higher dependency
ratio. In 1990, for example, 36.9per cent belonged to 0-14 age group, while 58.7 per cent belonged to age group of
15-64 in India’s population. The rapid growth of labour force creates a higher supply of labour than demand for it
leading to the problem of chronic unemployment.
One heartening feature is that over the last three decades there has been declining trend in population growth rates.
During 1965-80 the average annual population growth was 2.3 per cent. In subsequent 1980-90 period, it declined
to 2.1 per cent. With the government policies for population control and family welfare it is expected that by the
end of this century population growth rate will come down. The annual growth rate of population declined to 1.73
by 2002-03.
As for the sex composition of population, the sex ratio (females per 1000males) declined from 972 in 1901 to 933
in 2001. The explanation for a declining sex ratio lies in the poverty of the Indian people. In a country where even
after more than 40 years of planned economic development nearly 35 percent (the poverty estimates differ widely)
of the population live below the poverty line, high infant mortality, extremely poor or non-existent medical facilities,
extremely unhygienic conditions of living and absence of pre-natal and post-natal care, high death rate among women
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are all manifestations of an object low level of living of the people. Preference for male children and attempts to
avoid female children is rather a recent phenomenon which contributes to keeping sex ratio at the lower level.
Age structure of population is an important demographic dimension. As noted before, rapid population growth
implies high dependency ratio. 0-14, and 60 and above, age groups constitute dependent population. In 1911, 0-14
age group constituted 38.8 per cent of population. In the same year 60 and above age group constituted 1.0 per
cent of population. Together they constituted 39.8 percent. By 2001, the first age group constituted 35.6 per cent of
population and the latter age group constituted 6.3 per cent. Thus the percentage of dependent population increased
from 39.8 per cent in 1911 to 41.9 per cent in 2001.A high proportion of children (0-14 age group) only reflects a
large proportion of unproductive consumers. To reduce the percentage of non-productive consumers, it is essential
to bring down the birth rate.
Rural-urban composition of population is an important demographic dimension, particularly from point of view of
economic development. Along with economic development in general and industrialisation in particular the rural-
urban composition of population has been changing in India. In 1901, 89 per cent of Indian population was rural,
the remaining 11 per cent being the urban population. By 2001 the percentage of rural population declined to 77.2
percent, while that of urban population increased to 22.8 per cent.
The quality of population can be judged from life expectancy, the level of literacy and the level of technical training
attained by the people of a country. In respect of all the three indicators India achieved significant progress although
the country is still to go a long way in achieving the standards of more affluent countries. The literacy rate has gone
up from 18.2 per cent in 1951 to 65.4 percent in 2001. Life expectancy at birth has gone up from 41.2 per cent in
1951to 65.3 per cent in 2001.
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Summary
• The critical elements constitute the institutional framework of an economic environment.
• The trends in economic variables such as income, price, output, investment, foreign trade, labour supply and
other factor endowments and the structural relation among these variables constitute the physical framework
of an economic environment
• “Growth” and “development” are sometimes used synonymously in economic discussion
• Economic growth may be defined as a significant and sustained rise in per capita real income.
• ‘Economic development’ is a broader concept than ‘economic growth’.
• Economic growth is also associated with a change in the structure of employment of people. It is generally
accepted that one of the structural changes that occur in the course of economic growth is a progressive shift
of labour from agriculture and allied activities to secondary and tertiary sectors.
• A change in the structure of investment and capital formation is another development during the process of
economic growth and development.
• The growth rates of NNP and NNP per capita during different plan periods give an overview of the Indian
growth experience
• Economic growth has brought about a structural change (change in sectoral shares of the national income) in
the economy.
• Given the supply of labour force and its annual rate of growth, economic growth is primarily a matter of rate
of capital accumulation and resource productivity improvements.
• The significant changes in the composition of assets of the household sector indicate rapid strides made by the
financial system of the country.
• Gross Domestic Capital Formation (GDCF) is classified on the basis of type of assets into two components:
• The price trends are related to, among others, the trends in money supply and government budget deficits.
• Money supply growth rate has been an important factor behind the Indian inflation experience.
• The main problem in India is the high level of birth rates of accompanying falling death rates.
• The fast rate of growth of population, given the rate of growth of GNP implies lower per capita GNP growth
rate.
References
• Jain, T. R, Trehan, M. & Trehan, R., 2010.Indian Economy, Revised ed., V.K. Publications.
• The Structure of the Indian Economy [Pdf] Available at: <www.iioa.org/pdf/15th%20Conf/dasguptachakraborty.
• Structural Changes in the Indian Economy [Pdf] Available at: <isidev.nic.in/pdf/WP1202.pdf‎> [Accessed 11
July 2013].
• 2008. Structural Dimensions of Indian Economy [Video online] Available at: <https://www.youtube.com/
watch?v=7Ibcvolgi2w‎> [Accessed 11 July 2013].
• 2011. Sectors of Indian economy [Video online] Available at: <https://www.youtube.com/watch?v=lPQUCRb_
DYo‎> [Accessed 11 July 2013].
Recommended Reading
• Gupta, S. P., 1987. Structural Dimensions of Poverty in India, Mittal Publications.
• Gupta, K. R. & Gupta, J.R., Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.
• Jain, T. R., Trehan, M., Trehan, R. & Uppal, R., 2010. Indian Economy, V.K.Publications.
111
Self Assessment
1. __________________ may be defined as a significant and sustained rise in per capita real income.
a. Capital growth
b. Income growth
c. Economic growth
d. Revenue growth
2. Which of the following is the additional capital required to increase output by one more unit?
a. Incremental Capital-Output Ratio (ICOR)
b. Gross Domestic Capital Formation
c. Gross Development Product
d. Investment Capital-Output Ratio
3. Which of the following has been an important factor behind the Indian inflation experience?
a. Money supply growth rate
b. Gross Fixed Capital Formation (GFCF)
c. Consumer Price Index (CPI)
d. Investment Capital-Output Ratio
4. Which of the following is not the principal factor responsible for the expansion of the money supply ?
a. Bank credit to commercial sector
b. Bank credit to government
c. Net foreign exchange assets of the banking sector
d. Net custom exchange of goods
5. ______ is defined as M1 plus time deposits.

a. M2
b. M3
c. M4
d. M5
6. _________ when invested results in the capital formation.

a. Savings
b. Commodities
c. Equities
d. Assets
7. The share of total household saving to total National saving is ______ three quarters.
a. Less than
b. Equal to
c. More than
d. Approximately
112
8. What does CPI stands for?
a. Customer Price Index
b. Consumer Price Index
c. Capital Price Index
d. Custom Price Index
9. The main problem in India is the ____ level of birth rates of accompanying ______ death rates.
a. High, high
b. Falling, high
c. High, falling
d. Falling, falling
10. The _______ of population can be judged from life expectancy, the level of literacy and the level of technical
training attained by the people of a country.
a. Quantity
b. Quality
c. Number
d. Rate
113
Case Study I
Perfect Competition
Coke and Pepsi both are trying to gain market share in the beverage market, which is valued at over $30 billion a
year. The facts are that, each company is coming up with new products and ideas in order to increase their market
share. The creativity and effectiveness of each company’s marketing strategy will ultimately determine the winner
with respect to sales, profits, and customer loyalty. Not only these two companies are constructing new ways to sell
Coke and Pepsi, but they are also thinking of ways to increase market share in other beverage categories. Although
the goals of both companies are same, the two companies form different marketing strategies. Pepsi has always
taken the lead in developing new products, but Coke also learned their lesson and started to do the same. Coke
hired marketing executives with good track records. Coke also implemented cross training of managers so it would
be more difficult to form groupism. On the other hand, Pepsi has always taken risks, acted rapidly and developed
new marketing ideas.
Both the companies tried to capture the foreign markets. Coke had carried out market research in different regions,
and got to know that the customer requirements differ according to their regions. So, Coke has been more successful
in foreign markets than Pepsi. However, after 2-3 years, many changes were made by both the companies; some
of the development techniques failed, while some gained profit. For instance, the transformation of Coke into New
Coke was a major failure. Pepsi’s failure included Pepsi Light, Pepsi Free, Pepsi AM, and Crystal Pepsi.
To overcome failures, the company has to take next step to develop new products to meet customer requirements.
If both companies sell the same product, they will never succeed. Gaining market share is possible if the company
knows what the customer wants, and takes one step ahead than the competitor to achieve customer satisfaction. To
understand the customer requirement, market research is necessary. The companies should collect feedback from
customers, next analyse this data, and then develop the new product based on the data. Thus, once the product is
developed it should be in the marketplace at the right time. Therefore, if any company follows these factors, it can
achieve the market share.
(Source: Coke Vs. Pepsi Case Study, [Online] Available at: <www.exampleessays.com/viewpaper/84955.html>
[Accessed 4 June 2013] ).
Questions
1. Which type of competition is seen in this case study? Give reasons.
Answer
In this case study, Perfect Competition is seen. The factors that are present in the perfect competition are as
follows:
• Coke and Pepsi are the two competitors which sell an identical product
• The industries are characterised by freedom of entry and exit
• The firms have relatively small market share
2. What are the different marketing strategies adopted by both the companies?
Answer
Coke hired marketing executives with good track records. Coke also implemented cross training of managers
so it would be more difficult to form groupism. On the other hand, Pepsi has always taken risks, acted rapidly
and developed new marketing ideas.
114
3. In perfect competition, how can a company achieve complete market share?
Answer
Gaining market share is possible if the company knows what the customer wants, and takes one step ahead
than the competitor to achieve customer satisfaction. To understand the customer requirement market research
is necessary. Get the feedback from customers, next analyse this data, and then develop the new product based
on the data. Thus, once the product is developed it should be in the marketplace at the right time.
4. How Coke has been successful in foreign market?

Answer
Coke had carried out market research in different regions, and got to know that the customer requirements differ
according to their regions. So, Coke has been more successful in foreign markets than Pepsi.
115
Case Study II
Gross Domestic Product: JP Morgan Chase
The formation of the Future Generation Initiative was the beginning of a strategic approach to diversity that
acknowledged diversity as a business imperative. J P Morgan needed to create processes reflecting the importance
of achieving results that could be measured in numbers, behaviours and attitudes.
The Solution - Diversity effort began in U.S. headquarters with an acknowledgement of retention challenges for
women and minorities. An exit survey highlighted the need to create an inclusive work environment. External
consultants were hired to design a one-day awareness workshop entitled “Managing Inclusion”. After “Managing
Inclusion”, employees expressed desire for follow up programme that told the stories of real employees. Another
external diversity-consulting firm was hired to design “Leading Diversity”. “Leading Diversity”, a one-day workshop
using real case studies as the learning platform was launched in the U.S.
The London office launched the “Future Generation Initiative”, which was later renamed the “War for Talent Steering
Group” (WFT) in recognition of the need to focus on recruitment and retention challenges. Maureen Powell and
Pauline Brown and Farrah Qureshi were amongst a team of Leading Diversity consultants who had helped launch
the programme in the U.K. worked with London based team to identify issues unique to the London office via 14
focus group. The first pilot programme for U.K. version of “Leading Diversity” successfully launched and to date
almost 100% of London employees have attended. This group consisted of all nationalities.
The War for Talent Steering Group wrote a diversity strategy to identify commitment, approach, accountability
and feedback loops. WFT is business aligned, comprising 16 senior professionals of diverse backgrounds, both
part-time and full time. Sub groups focus on implementation of strategic and HR policy-related initiatives. Finally,
Employee Networks were formed to provide communications networks for special interest groups such as Women,
Gays/Lesbians, Ethnic Minorities, Support staff etc.
Outcomes of this intervention:

• 100% of European employees have attended “Leading Diversity” Workshop
• Recruitment efforts have increased for diverse candidates.
• Employee Networks are active, well supported and successful
• Employee Climate Survey had 63% return rate and results reflected significant areas of improvement 90%
agree their manager treats everyone the same regardless of race, gender, religion, sexual orientation or other
characteristics unrelated to performance 85% have not experienced unfair treatment 78% agrees that senior
management supports policies/practices that ensure a diverse workforce.
• Feedback from “Leading Diversity” workshops has resulted in task forces forming to tackle issues such as age,
work/life balance, disability etc.
(Source: GDP Case Study : JP Morgan Chase, [Online] Available at: <http://www.globaldiversitypractice.
com/?p=415> [Accessed 15 July 2013]).
Questions
1. What are the outcomes of the intervention?
2. How many percentages of employees attended the Leading Diversity Group?
3. Employee Climate Survey had how many percentage of return rate?
116
Case Study III
The Indian Economy Dealing with Inflation in 2006-07
In the early 2007 and the end of 2006, the inflation rate in India was around 6-6.8%. Previously, the main cause of
high inflation in India was the rise in global oil prices. However, in early 2007, the main reason for the inflation
was the increase in the prices of food articles which was caused by increased demand as well as supply constraints.
According to analysts, the increased demand was because of high economic growth and increased money supply,
while the stagnant agricultural productivity caused supply constraints.
Causes of Inflation
Generally, the two main reasons behind inflation are:
• rise in demand or demand pull inflation
• rise in cost of factor production or cost push inflation
• The average annual GDP growth in the 2000s was about 6% and during the second quarter (July-September)
of fiscal 2006-2007, the growth rate was as high as 9.2%. This was definitely going to increase the demand for
goods. However, the growth in the supply of goods, especially food articles such as wheat and pulses, was not
increasing directly with the growth in demand. As a result, the prices of food articles increased considerably.
Measures Taken to Control Inflation

In late 2006 and early 2007, the RBI announced some measures to control inflation. These measures were as
follows:
• increase the repo rates
• increase the Cash Reserve Ratio (CRR)
• reduce the rate of interest on cash deposited by banks with the RBI
• With the increase in the repo rates and bank rates, banks had to pay a higher interest rate for the money they
borrowed from the RBI. Consequently, the banks increased the rate at which they lent to their customers. The
increase in the CRR reduced the money supply in the system because banks now had to keep more money as
reserve
(Source: The Indian Economy Dealing with Inflation in 2006-07, [Online] Available at: <http://www.scribd.com/
doc/25490961/inflation-case-study> [Accessed 12 July 2013]).
Questions
1. What were the causes of inflation?
2. In India, why the inflation rate increased in 2006-07?
3. How inflation rate can be controlled?
4. What happens when banks increases the repo rates and bank rates to control inflation?
117
Bibliography
Reference
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watch?v=7Ibcvolgi2w‎> [Accessed 11 July 2013].
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watch?v=fnrAZPExSPg‎> [Accessed 11 July 2013].
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• 2011. Indian Economy: The Road Ahead [Video online] Available at: <https://www.youtube.com/
watch?v=BqyGaT0RCt0‎> [Accessed 11 July 2013].
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DYo‎> [Accessed 11 July 2013].
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watch?v=EWhRy4MaUeA‎> [Accessed 11 July 2013].
• 2012. The Economy of India [Video online] Available at: <https://www.youtube.com/watch?v=mwBrsP61U9I‎>
• 2012. The Role of Government in the Economy [Video online] Available at: <https://www.youtube.com/
watch?v=D23YY11cvzY‎> [Accessed 11 July 2013].
• 2013. Foreign trade policy [Video online] Available at: <https://www.youtube.com/watch?v=G9EcpZ18Dtg‎>
• 2013. Indian Financial Services System [Video online] Available at: <https://www.youtube.com/
watch?v=zsanyYtQQ2I ‎> [Accessed 11 July 2013].
• 2013. Indian Financial System [Video online] Available at: <https://www.youtube.com/watch?v=-ShUE6n_4pc
‎> [Accessed 11 July 2013].
• 2013. What is Industrial Policy [Video online] Available at: <https://www.youtube.com/watch?v=BqyGaT0RCt0‎>
• 2013.What hope for Industrial Policy [Video online] Available at: <https://www.youtube.com/watch?
v=veIpUWF6bd8‎> [Accessed 11 July 2013].
• Batley, R. & Larbi, G.A., 2004. The Changing Role of Government, Palgrave Macmillan.
• Callan, S.J. & Thomas, J.M., 2009.Environmental Economics and Management: Theory, Policy and Applications,
Cengage Learning.
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financial-markets/44362303.pdf‎ > [Accessed 11 July 2013].
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• Dixit, A.K., 1996.The Making of Economic Policy:A Tansaction-Cost Politics Perspective, The MIT Press.
• Dr. Murthy, D.K., 2006. Indian Financial System, I.K. International Pvt. Ltd.
• Economic Growth and Environment [Pdf] Available at: <https://www.gov.uk/government/uploads/system/
uploads/attachment_data/file/69195/pb13390-economic-growth-100305.pdf > [Accessed 11 July 2013].
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11 July 2013].
• Economic Policy Reforms 2013 [Pdf] Available at: <http://www.oecd.org/inclusive-growth/Economic%20
Policy%20Reforms%202013%20Going%20for%20Growth.pdf> [Accessed 11 July 2013].
118
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bitstream/10603/1732/10/10_chapter%203.pdf > [Accessed 11 July 2013].
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Trade_policy_2009-2014.htm‎> [Accessed 11 July 2013].
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GlobalEconomicEnvironment.pdf‎> [Accessed 11 July 2013].
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Policies%20Circulars%20and%20Notification/Attachments/87/Industrial%20Policy%20of%20Maharashtra%20
2013%20-%20Highlights.pdf‎> [Accessed 11 July 2013].
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Notification/Attachments/88/Industrial%20Policy%20of%20Maharashtra%202013.pdf> [Accessed 11 July
2013].
• Jain, T.R, Trehan, M. & Trehan, R., 2010.Indian Economy, Revised ed., V.K. Publications.
• Khan, M.Y., 2007. Indian Financial System, 5th ed., Tata McGraw-Hill Education.
• Kiado, A., 1979. Industrial Development and Industrial Policy.
• Mahajan, V.S., 1992.India’s foreign trade and balance of payments, Deep & Deep Publications.
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Policy.pdf‎> [Accessed 11 July 2013].
• Prasad, P. C., 1977. Foreign Trade and Commerce in ancient India, Abhinav Publications.
• Ramachandran, K.S., 2007. Economic Environment of India:Lesson from Past and for the Future, Northern
Book Centre.
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July 2013].
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11 July 2013].
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affairs/CSR%20Business%20Ethics.pdf> [Accessed 11 July 2013].
• The Structure of the Indian Economy [Pdf] Available at: <www.iioa.org/pdf/15th%20Conf/dasguptachakraborty.
Recommended Reading
• Acocella, N., Economic Policy in the Age of Globalisation, Cambridge University Press.
• Bhole, L.M., 2004.Financial Institutions and Markets:Structure, Growth and Innovations, 4rth ed., Tata
McGraw-Hill Education.
• Bianchi, P. & Laboy, S., 2011. Industrial Policy after the Crisis:Seizing the Future., Edward Elgar Publishing
Limited.
• Bianchi, P., 2006. International Handbook on Industrial Policy, Edward Elgar Publishing Limited.
• Dr. Mustafa, A., 2010. Foreign Tarde Finance and Documentation, Laxmi Publications, Ltd.
• Ghosh, A., 2009. India’s Foreign Policy, Pearson Education India.
• Gupta, K.R. & Gupta, J.R., Indian Economy Volume 1, Atlanic Publishers & Distributors (P) Ltd.
• Gupta, S.P., 1987. Structural Dimensions of Poverty in India, Mittal Publications.
• Gurusamy, S., 2009.Indian Financial System, 2nd ed., Tata McGraw-Hill Education.
• Jain, T.R., Trehan, M., Trehan, R. & Uppal, R., 2010. Indian Economy, V.K.Publications.
119
• Kapila, R. & Kapila U., 2004. Indian Economy, Academic Foundation.

• Krueger, A.O., Economic Policy Reforms and the Indian Economy, The University of Chicago Press,
Chicago.
• Pailwar, V. K., 2008. Economic Environment of Business, PHI Learning Private Limited.
• Pathak, B., 2007. Industrial Policy of India: Changing Facets, Deep and Deep Publications Pvt. Ltd.
• Pathak, B.V., 2011.The Indian Financial System, 3rd ed., Pearson Education India.
• Prasad, M., 2011. India’s Foreign Trade:From Antiquity to Date, Kalpaz Publications.
• Shaffer, H.G., 1999. American Capitalism and the Changing Role of Government, Greenwood Publishing
Group.
• Smith, A., Richards, M., Heale, G. & Meer, N. V., 2008. Economic Environment Level 3, Pearson Education
South Africa (Pvt.Ltd).
• Sterner, T., 1996. Economic Policies for Sustainable Development, Kluwer Academic Publishers.
• Tanzi, V., 2011. Government Versus Markets:The Changing Economic Role of the State, Cambridge University
Press.
120
Self Assessment Answers
Chapter I
1. b
2. a
3. d
4. a
5. d
6. b
7. c
8. d
9. a
10. b
Chapter II
1. c
2. a
3. d
4. a
5. b
6. d
7. c
8. b
9. a
10. c
Chapter III
1. a
2. b
3. a
4. b
5. a
6. c
7. a
8. b
9. a
10. b
Chapter IV
1. c
2. a
3. b
4. d
5. c
6. a
7. d
8. c
9. a
10. c
121
Chapter V
1. b
2. a
3. c
4. b
5. c
6. c
7. b
8. b
9. c
10. b
Chapter VI
1. d
2. a
3. c
4. b
5. d
6. b
7. c
8. d
9. a
10. d
Chapter VII
1. b
2. b
3. c
4. a
5. b
6. d
7. a
8. a
9. b
10. c
Chapter VIII
1. c
2. a
3. a
4. d
5. b
6. a
7. c
8. b
9. c
10. b
122

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Economic Environment

Prof. H. N. Verma Prof. M. K. Ghadoliya

Dr. Daniel J. Penkar Vijayalakshmi R.H

This book contains the course content for Economic Environment.

First Edition 2013

II. List of Figures..........................................................VI

III. List of Tables........................................................ VII

V. Case Study.............................................................. 114

VI. Bibliography......................................................... 118

VII. Self Assessment Answers................................... 121

Chapter VIII.............................................................................................................................................. 100

• explain various components of economic environment

• elucidate microenvironment and microenvironment

• explicate the various elements of non-economic environment

• define economic planning

• enlist the objectives of the study of economic environment

• explicate important economic policies

• define the tenth and eleventh five year plan

• identify the factors affecting economic environment

• understand tenth and eleventh five year plan

1.2 Objectives of the Study of Economic Environment

1.3 Non-Economic Environment

Fig. 1.1 Elements of non – economic environment

1.4 Technological Environment

1.5 Demographic Environment

1.6 Natural Environment

SOCIAL & NATURAL

Fig. 1.2 Macro-environment

1.8 Economic Environment

1.8.1 Various Components of Economic Environment

1.9 Non-Economic Environmental Factors

National Human Physical

Mktg Capital and Technology

Economic International Education

Fig. 1.3 Factors affecting economic environment

1.9.1 Socio-cultural Environment

1.9.2 Political-Legal Environment

1.10 Economic Planning

Definition of economic planning

Thus, planning comprises of the following essential features:

1.11 Need for Planning in Underdeveloped Countries

1.12 The Structure of the Planning Commission of India

1.12.2 Functional Area

1.13 Objectives of Planning Commission

1.14 Tenth Five Year Plan

1.14.2 Overview of Performance during the Tenth Five Year Plan

1.14.3 Achievements during the Tenth Five Year Plan

1.16 Comparison between Tenth and Eleventh Five Year Plan

The main objectives of the eleventh plan were:

Women and Children

Types of Data of Tenth Plan

Types of Data of Eleventh Plan

3. Which of the following statements is false?

4. Match the following

9. Which of the following statements is true?

10. ______ is another factor which governs business operations.

• explain the current population of India

• elucidate demographic trends in India

• explicate the effect of population growth on Indian economic development

• enlist the causes of rapid growth of population

• explicate causes of poverty

• describe balance of payments

• identify the types of unemployment