Economic globalisation refers to increasing economic interdependence of national economies across the world through a rapid increase in cross-border

movement of goods, service, technology and capital.[1] It is the process of increasing economic integration between countries, leading to the emergence of a global marketplace or a single world market[2]. Depending on the paradigm, globalisation can be viewed as either a positive or a negative phenomenon. Economic globalisation comprises the globalisation of production, markets, competition, technology, and corporations and industries.[1] Whilst economic globalization has been occurring for the last several hundred years (since the emergence of trans-national trade), it has begun to occur at an increased rate over the last 2030 years[3]. This recent boom has been largely accounted by developed economies integrating with less developed economies, by means of foreign direct investment, the reduction of trade barriers, and the modernization of these developing cultures, though through this investment, it may provide a loss (such as sending the textile industry overseas).

Globalization
The human society around the world, over a period of time, has established greater contact, but the pace has increased rapidly since the mid 1980s.The term globalization means international integration. It includes an array of social, political and economic changes. Unimaginable progress in modes of communications, transportation and computer technology have given the process a new lease of life. The world is more interdependent now than ever before .Multinational companies manufacture products across many countries and sell to consumers across the globe. Money, technology and raw materials have broken the International barriers. Not only products and finances, but also ideas and cultures have breached the national boundaries. Laws, economies and social movements have become international in nature and not only the Globalization of the Economy but also the Globalization of Politics, Culture and Law is the order of the day. The formation of General Agreement on Tariffs and Trade (GATT), International Monetary Fund and the concept of free trade has boosted globalization. Globalization in India In early 1990s the Indian economy had witnessed dramatic policy changes. The idea behind the new economic model known as Liberalization, Privatization and Globalization in India (LPG), was to make the Indian economy one of the fastest growing economies in the world. An array of reforms was initiated with regard to industrial, trade and social sector to make the economy more competitive. The economic changes initiated have had a dramatic effect on the overall growth of the economy. It also heralded the integration of the Indian economy into the global economy. The Indian economy was in major crisis in 1991 when foreign currency reserves went down to $1 billion and inflation was as high as 17%. Fiscal deficit was also high and NRI's were not interested in investing in India. Then the following measures were taken to liberalize and globalize the economy. Steps Taken to Globalize Indian Economy Some of the steps taken to liberalize and globalize our economy were: 1. Devaluation: To solve the balance of payment problem Indian currency were devaluated by 18 to 19%. 2. Disinvestment: To make the LPG model smooth many of the public sectors were sold to the private sector. 3. Allowing Foreign Direct Investment (FDI): FDI was allowed in a wide range of sectors such as Insurance (26%), defense industries (26%) etc. 4. NRI Scheme: The facilities which were available to foreign investors were also given to NRI's.

Merits and Demerits of Globalization The Merits of Globalization are as follows:

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There is an International market for companies and for consumers there is a wider range of products to Increase in flow of investments from developed countries to developing countries, which can be used for Greater and faster flow of information between countries and greater cultural interaction has helped to

choose from. economic reconstruction. overcome cultural barriers. Technological development has resulted in reverse brain drain in developing countries. The Demerits of Globalization are as follows: The outsourcing of jobs to developing countries has resulted in loss of jobs in developed countries. There is a greater threat of spread of communicable diseases. There is an underlying threat of multinational corporations with immense power ruling the globe. For smaller developing nations at the receiving end, it could indirectly lead to a subtle form of

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colonization. Summary India gained highly from the LPG model as its GDP increased to 9.7% in 2007-2008. In respect of market capitalization, India ranks fourth in the world. But even after globalization, condition of agriculture has not improved. The share of agriculture in the GDP is only 17%. The number of landless families has increased and farmers are still committing suicide. But seeing the positive effects of globalization, it can be said that very soon India will overcome these hurdles too and march strongly on its path of development. Functions Of The Board SEBI

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The Board is responsible for the securing the interests of investors in securities and to facilitate the To monitor and control the performance of stock exchange and derivative markets. Listing and monitoring the functioning of stock brokers, sub brokers, share transfer agents, bankers to

growth of and to monitor the securities market in an appropriate manner.

an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and others associated with securities markets by any means. Monitoring and Controlling the functioning of venture capital funds and mutual funds. Forbid unjust and dishonest trade practices in the security markets and forbid insider trading in the Undertake periodic audits of stock exchanges, mutual funds, individuals and self regulatory

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security market. organizations associated with the security market.

Reserve Bank Of India

The Reserve Bank Of India was established on April 1 1935, according to the provision of RBI Act 1934.Initially the Central Office of the RBI was in Calcutta, which was later shifted to Mumbai in 1937.The RBI policies are formulated by the governor at the Central Office. The RBI was nationalized in 1949. Preamble The Preamble of RBI states: "...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." Central Board The RBI is monitored by a central board of directors. The board is appointed by the Government of India in

accordance with the RBI act. Local Boards

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Local Boards are present in the four metros of Mumbai, Calcutta, Chennai and New Delhi. Local Board consists of five members. Local Board is appointed by the Central Government.

Local Board is for a period of four years. Financial Supervision The RBI accomplishes the role of financial supervision through the Board For Financial Supervision (BFS).The BFS was initiated in November 1994. Functions Of BFS

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Streamlining the system of bank inspections. Induction of offsite surveillance. Consolidating the role of statutory auditors and

y Consolidating the internal defenses of supervised institutions. Current Focus Of BFS y y y y y

Supervise financial institutions. Consolidate accounts. Deal with legal issues in bank frauds. Variance in assessment of nonperforming assets and

Supervisory rating model for banks. Legal Framework Umbrella Acts

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Reserve Bank Of India Act 1934 governs the Reserve Bank functions.

Banking Regulation Act 1949 governs the financial sector. Functions of RBI Monetary Authority: The RBI is responsible for implementing, formulating and monitoring the monetary policy of India. Objective: Keeping this authority in mind the RBI is required to maintain price stability and ensure adequate flow of credit to productive sectors. Regulator And Supervisor Of The Financial System: The Supreme Financial Body sets down broad parameters of banking operations within which the country's banking and financial system operates. Objective: This reasonably helps in maintaining public confidence in the system. It in turn protects depositors' interest and provides lucrative banking services to the public. Manager of Exchange Control: The RBI is responsible for managing the Foreign Exchange Management Act, 1999. Objective: It is the nodal agency which facilitates external trade and payment and promotes orderly development and maintenance of foreign exchange market in India. Issuer Of Currency: It is the only supreme body which issues and exchanges or destroys currency and coins not fit for circulation. Objective: This facilitates in giving the public adequate quan of currency notes and coins and in good quality. tity Developmental Role

The RBI since its inception performs a wide range of promotional functions to support national objectives and generate goodwill among the citizens of the country. Related Functions Banker to the Government: The RBI performs merchant banking function for the central and the state governments and also acts as their banker. The RBI often advises the Government of the current monetary condition in the state. Banker to Banks: maintains banking accounts of all scheduled banks. The RBI looks after the functioning of the state banks and grants them license and even cancels the same on account of fraud practice.

Income Tax Structure Post Liberalization The wave of tax reforms which started across the world in the second half of 1980's found its way into India. As part of its policy of liberalization, India introduced tax reforms in the 1990's.The reforms introduced in the Indian tax structure are different in comparison to other countries. The tax reforms in India took place independent of interference from any external multilateral agency unlike some other countries. But the tax reforms took place in such a way as to ensure its adherence to the prevailing International trends. During the initial stages of reforms, the restructuring of the tax structure took place with a view to increase savings and use the increased savings towards investment, to bring in equitable distribution of income and to rectify the disparities due to oligopolistic market that existed due to co existence of both private and public sector. The tax structure reform in India can be used as an example for many developing countries that are in the same path of development, due to the large size of the country and the disproportion in the socio economic condition across the country

When globalization leaves people behind

NEW YORK Going by economic measures, India is a globalization success story. Average incomes, rising at 3 percent to 4 percent a year, have doubled since the mid1980s. Dynamic new industries have emerged, most visibly in the high-technology hubs of Bangalore and Hyderabad. Foreign investment, while still dwarfed by flows to China, has grown from $1 billion a year in the mid-1990s to $5 billion this year. When we try to measure whether people's lives have improved, however, the figures tell a different story. Poverty has fallen far more slowly than one would expect, given India's economic success. One in three Indians live on less than $1 a day and India is still home to the world's largest conglomeration of malnourished people. Almost half of the country's children are underweight for their age - which helps to explain the two million child deaths each year. The latest UN Human Development Report draws attention to the worrying gap that is emerging between economic growth and social progress. What is going wrong? Part of the problem is that economic growth has been built on a narrow base. The information technology sector, for example, has so far created around one million jobs - but meanwhile, the labor force is expanding by about eight million a year. Broadening and deepening the growth process in labor-intensive manufacturing and in rural areas is vital.

The more profound challenge is to tackle head-on the deep-rooted inequalities that are holding back social progress, especially the deep inequalities in opportunity that divide women and men. These inequalities start at birth, with fatal consequences. Girls aged from 1 to 5 face a 50 per cent higher risk of childhood mortality than their brothers, reflecting disadvantages in access to nutrition and health provision. That statistic translates into 130,000 "missing" girl children - deaths that would be averted each year if death rates for girls were the same as those for boys. Overlapping with these gender-based differences are wider inequalities. Child mortality rates among the poorest 20 per cent are more than three times higher than among the richest. And there are glaring gaps between the northern "poverty belt" states like Uttar Pradesh and Bihar and more successful states such as Tamil Nadu and Kerala. With a population larger than Nigeria, Uttar Pradesh immunizes only one in five children against the major childhood diseases. Accelerating social progress will require more than sustained economic growth, critical as that may be. As Amartya Sen has written: "Even a hundred Bangalores and Hyderabads will not, on their own, solve India's tenacious poverty and deep -seated inequality." In 2004, India's electorate decisively rejected a government that celebrated "Brand Bangalore" instead of focusing on spreading prosperity more widely. Since then, the Congress-led government, has set a new course. Legislation has been approved for a $2.5 billion a year scheme that targets poor rural areas through public works programs. In last year's budget, the government signaled a far sharper focus on education, imposing a tax surcharge to fund a $1 billion increase in spending this year. Across rural India, the public health system, starved of resources, has become a byword for clinics that lack drugs and trained staff. If current budget plans are implemented, health spending will rise from less than 1 per cent of national income to 3 per cent. Changing public spending priorities is difficult. But changing the structures that consign India's rural poor, especially poor women, to a lifetime of disadvantage is more difficult still. It will require fundamental changes in governance and - more important - in public attitudes to gender equality. The challenges are immense. But economic growth and a thriving democracy provide India with an opportunity to become a real globalization success story
The Economic Aspects of Globalization The globalization of economic flows may be the most manifest nowadays, and it is the first thing one thinks of when globalization itself is discussed. Limiting the once sovereign role of nation state, expanding the market across the planet without a visible chance of anyone preventing it, amassing wealth in ever fewer countries is combined with the growing disproportion between the rich and the poor within these countries. What seemed probable over the few decades after World War II the prominent role of the so-called nation state, care for the less able, less healthy and elderly population, free schooling and healthcare seem to be vanishing into

historic oblivion. The ancient principle of survival of the fittest is more and more at work, not even trying too hard to mask its role with seemingly humane goals. As early as twenty years ago, far-sighted economists foresaw the creation of new global economy, which would be something different from the currently known and widely accepted international econo my. The so-called welfare states owe most of their current problems to the structural change of the worlds economic system, which is, for some, a synonym for globalization. As we have already said, these changes greatly limit (even tend to fully abolish!) the force of action of nation-states so that, even if they want it, they are unable to provide their own citizens with what they have been used to for decade. Transnational capital does not have much mercy on social policy, equal care for all strata of population, especially those who are unable to generate profit. The increasing dissatisfaction of masses spurred by this is directed at their own governments, who, in turn, have their hands tied. Unless an international system is created in the foreseeable future whereby the control and freedoms of states, corporations and individuals will be regulated more clearly, there are ever smaller chances that citizens will receive any kind of protection from their governments. This also renders the institution of democratic elections senseless, reducing it to the role of mere political folklore. It is implied that the poor societies (mostly those of the Third and even the Second World) have nothing to seek in the fair competition. A newly imposed problem is the fear that even the wealthiest and the most stable societies will not be able to endure this race. If the market demands as advocated by the neo liberal ideologists are accepted, the already attained wide scope of various social rights that their citizens are used to does not have much chance to survive. As Habermas clearly formulates it: To remain competitive on the growing global market, they (the OECD states) have to take steps causing irreparable damage to the harmony of civil society the most urgent task of the First World in the forthcoming decade will therefore be squaring the circle of welfare, social harmony and political freedom. [1] And we know all too well what a simple task squaring the circle is. Attempts at an appropriate response to the collapse (after a lengthy agony) of the so -called laissez-faire capitalism date back as early as the times of the great economic crisis in the 1920s. This is the time of the occurrence of controlled capitalism [2] , taking three forms in capitalist communities: as the New Deal in the USA, protective in Japan, and social capitalism in Western Europe. Regardless of certain differences, the common element in all these three forms of reformed capitalism presents a concern for wide strata of population. They form the basis on which the welfare state developed later. Witnessing the return to some old economic models thought to be outdated, we can conclude that this actually specific historical regression. If this opinion is founded, then the not so loud discourse of neo -liberally oriented intellectuals and economists on history, which has reached its final, ultimate step (of evolution) has no foundation. But more will be said on this later. As it was compellingly demonstrated by Naomi Klein as well, all the trends of capital movement to underdeveloped regions are present, but not out of concern fo the welfare of local population r as it is declaratively stated, but for their ruthless exploitation. But at the same time, such a manner of re-distributing production to the poor regions of the Third World will render millions of domestic workforce jobless, closing the circle of poverty. Regardless of the proclamations on the visible progress of global economy. The current progress of economic globalization points to the fact that capital is moving to underdeveloped regions, i.e. escaping developed regi ns, o causing, primarily, social problems in them. Stopping this process would mean leaving underdeveloped regions to their fate which would, in turn, whether they get stuck with being underdeveloped, or choose their own way of developing which could be radically different from the Western, mean the discontinuation of the current globalization trend, or it would be limited only to developed regions as some kind of mini-globalization. [3] It is clear that this is a threat to globalization itself, if it is to be understood as the export of the Western, already confirmed model of organizing human society. If it remained only in some regions of the planet, then it could not be fully and duly labeled as globalization. If it were the generator of the occurrence of an alternative globalization, then the results would be even worse for the neo -liberal ideology. This is undoubtedly one of the major problems to which the above -mentioned have not provided an adequate answer so far. Moreover, despite the proclaimed efforts (and perhaps even a genuine wish) to put an end to ethnically-based conflicts by reducing the significance of local identities, the growing poverty among and within various societies seems to be encouraging animosities, conflicts, and, in the foreseeable future, even wars of the conflicting ethic, religious, racial or class groups. The neo liberal type of globalization is creating a new geography of social inclusion (apartheid). The worlds of wealth and extreme poverty are not divided by the Great Wall of China a new poverty is spreading amid the society of affluence. The black holes of globalization, people and

regions excluded from progress, can be found in all the cities of the First World in American urban ghettoes, North African communities in France, Japanese Yoseba slums, Asian megalopolises. They are inhabited by millions of homeless people, by a world of prostitution, crime and drugs, the sick and the illiterate. [4] In one of her texts [5] , Naomi Klein gives a vivid example of how real is the advice of the intellectual gurus of neo-liberal provenance. Namely, explaining why capital is moving to underdeveloped regions, Thomas Friedman provides a very interesting answer. Claiming to have talked to several young Palestinians when he was at Ramallah at the West Coast in his twenties, he established that their desire for war, terrorist actions and suicide attacks results from lacking jobs, hope and dignity. At first sight, this explanation does not seem irrational. The listed reasons are surely a good reason for various sources of frustration. But what does Friedman propose for them? That moving jobs from the West not only to India or Pakistan, but to Palestine as well would create not only a more prosperous world, but also a safer world for our own twenty-year-olds! This should be one of the crucial reasons in favour of globalization as envisaged by similar intellectuals. More will be said about what kind of jobs these are in the section on Naomi Kleins book No logo. We shall dwell on another topic here. Friedman forgets to state what are the political causes of the dissatisfaction of the Palestinian or Iraqi people. Klein does not hesitate to remind him: In other words, economic development will not come to Palestine via call centers but through liberation. Friedman's argument is equally absurd when applied to the country where terrorism is rising most rapidly: Iraq. As in Palestine, Iraq is facing an unemployment crisis, one fueled by occupation. And no wonder: Paul Bremer's first move as chief US envoy was to lay off 400,000 soldiers and other state workers. His second was to fling open Iraq's borders to cheap imports, predictably putting hundreds of local companies out of business. K lein is even more lucid when finding an even more efficient way of fighting terrorism: Friedman's bright idea of fighting terrorism with outsourced American jobs is overly complicated. A better plan would be to end the occupation and stop sending American workers to steal Iraqi jobs. Although the current global economy is structured around three main centres of economic power, it can be best described as a post-hegemonistic order that no single centre, not even the USA, can control through rules of global trade or exchange. [6] By this, the advocates of such development of economic course mean that the complex world economy is developing on a totally free, unconditioned market and that individual, i.e. state responsibility is the only criterion of success or failure in this field. But regardless of this, despite internationalisation and regionalisation, the role and position of most developing countries in the global economy is changing incredibly slowly even in long time intervals of a whole century. Held and McGrew observe that the current international division of labour is based on the one recognised by Marx. [7] Todays globalisaton brings about an inconcievably united world for rich individuals, for the elites, but also a growing division inside societies, as the global international division of labour is divided into parts, into rich and poor countries, the globalizations winners and losers. If globalization were as successful as it is (perhaps) desired, then its favourable effect would influence most of the worlds population, rather than those (chosen?) groups that most offen have a share in its implementation. Neo-liberals suggest that economic globalization is the only effective road (highlighted by D.P.) leading to global poverty reduction, whereas, in practice, this looks completely different. The failure of certain countries to join the community of the socalled First World is explained by their failure to harmonise and integrate into the contemporary world economy fast enouth. Translated from the language of euphemism, they seem to mean that these are simply incompetent. Not only are differences increasingly felt between states, but they are increasingly obvious inside the countries themselves. Stratification is more and more under way, ever fewer (super)rich individuals own ever bigger capital, while the number of those living below the threashold of poverty is growing proportionately. A few percent of the richest population segment owns more than one-half of national wealth. This chiefly applies to the USA, although such trends exist in capitalist countries as well. How paradoxical it all is is maybe best expressed by the fact that powerful corporations posssess more assets than many (=most) countries of the world, and that this list may even include individuals! An argument that it is about the progress of global economy may be valid, if limited to people we have just mentioned. Then there is really no dilemma that this argument is valid. But if the moral issue of simultaneous impoverishment of the majority of the world is raised as equal, then such an attitude is significal+ntly overshadowed. This is what neo-liberally oriented intellectuals call struggle on the open market: To the extent that standardised life situations and careers are disappearing, individuals facing multiple options, feeling the growing burden of decisions they must now make themselves, i.e. arrangements that they have to negotiate themselves. The pressure of individualisation urges for new social rules to be discovered and controlled at the

same time. Freed subjects, no longer bound and governed by tradi ional roles, must create t binding relations through their own communication efforts. [8] The above is not questionable at all, but it is appropriate to remind that the freed subjects have never been asked anything about their forhtcoming roles! Although these decisions affect them most directly, they were made elswhere. It is therfore no wander that, in the ever wider regions of the losers of globalization, the globalization proces is percieved simply as the continuation of well-known colonisation, i.e. Western imperialism. It will remain so as long as the global inequality remains increasingly manifest. The fact that many citizens of the imperialist countries do not feel the benefits of the proclaimed process does not diminish in the least the justified anger of the inhabitants of all the underprivileged countries of the Second, Third and all all other worlds in the leaast. It is maybe here that one should look for the roots of growing terrorism which is really democratically shared affecting everyone equally! How do these radically oriented groups and their acts of violence come about? Even in developed countries, the increasing class differentiation brings about a fea that the existing r wealth will have to be shared and that the aliens present in a given society will take away their share of the cake undeserved. Such fears (and let us remember that the Nazis once took over the power riding on such demagogical cliches) are (ab)used by politicians who political points with populist, isolationist and even openly hostile messages. National, regligious, racial or class hatred, as well as xenofobia are for the most part rooted in the above. Needless to say, when such forces take over the power, genuine economic progress is out of question! And this is all a logical consequence of the philosphy of open, deregulated market. It only favours its favourites which adapt most sucessfull to its unwritten laws, to a way of life in which the absolute purpose of human life is generating and increasing profit. Its aim is not common good, but the realisation of the ancient idea of the human society as war of all against all. The road from there to universal harmony it proclaims declaratively is a long and rough one. It is also questionable how justifiable is to expand the impact of market ideology to all other non-economic segments of society, and the democratic legitimacy of international financial institutions (such as the IMF, the World Bank, WTO etc.) is also highly questinable, as they have no forms of control above themselves and, accordingly, are not accountable to anyone. We can only speculate what abuses are possible here. Held tries to provide an answer to all these questi ns: o These sobering realities lead to the conclusion that it is only within the borders of the state within the nation as a moral community that legitimate and effective solutions to the problem of global social injustice can be constructed. [9] Historically, the state saw the greatest expansion and prosperity in Germany at the time of World War I and during the Nazi rule in 1930s. It is interesting that it is in the Third Reich [10] that appeals to social justice and various forms of social protection were vociferous, parallel with the development of impressive military machinery. This was, of course, one of major arguments used by those who criticize contemporary welfare states as well. The fact that this happened in Germany becomes clearer bearing in mind that it was in this country that the first steps to creating a welfare system were made as early as 1883, by establishing health care, taking care of the unemployed, senior population segments, etc. At the time, the costs allocated for these expenditures were not too great a burden for the states production sector. The initiator of establishing such a system was the famous Chancellor Bismarck. This idea spread like wildfire all over the planet during the twentieth century, to such extent that the clear definition of social policies has become a key feature of the modern state. However, some things had to be sacrificed by these policies. In this case it was the efficiency of capitalist production methods. The advocates of neo -liberal society put the blame on the enormous growth of public expenditure, taxation and bureaucracy as one of the c auses of the inherent totalitarianism of the welfare stated. This can, of course, give an opportunity to the beneficiaries of the public social system to abuse it. Anthony Mueller does not fail to notice this: The coverage of old age, sickness and unemployment insurance, along with social aid, and disability insurance and with all the numerous special branches of social policy have turned Germany into an Eldorado for those seeking a free ride. Often described as "generous", the German social welfare system actually provides a plethora of incentives for intentionally becoming unemployed, seeking early retirement and fulfilling the necessary requirements in order to become eligible for social aid and disability payments. This especially applies to the period after World War II when any action directed against such policies was labeled as (expressed in modern terms) a form of politically incorrect discourse. Thus, increasing expenditure is imposed on the economically active population, and in view of the aging population structure of most of the countries of the Western hemisphere, the percentage of really economically active people is drastically reduced and, proportionally, more burdened by various categories of budget beneficiaries. How to balance the reasonable and objective needs of social policy

beneficiaries and their evident abuses is becoming a new problem to be addressed. We can take an example from Italy. Namely, the legislator (the state in this case) has stipulated that an employee laid off from an enterprise with more than 15 employees may sue his or her own employer. There have been cases in practice that many of such claims have received positive replies. Should the employer be forced to re-employ the same worker, apart from being entitled to payment of all lost receivables, he or she would receive further compensation for dismissal, as well as the money from social insurance. What does this tell us? That the employers hands are tied, that laying off workers may cause more economic harm than keeping them in their jobs. This is what opens space for various blackmail activities by employees, such as working to rule, lower productivity, open sabotage of the working process, etc. Not to mention that nothing would motivate the worker to achieve better work results, and the employer would not have the opportunity to make qualitative selection among different workers, under the threat of possible lawsuit and multiple damages that may follow. Furthermore, this is a direct hindrance to economic growth, as many companies will purposely remain within the limit of fifteen employees, lest they face this threat. This is only an example [11] of the implications of the excessive consideration of the employees interests in relation to the employer, which is still an important wheel in the development of every economy; and no less than referendum was held on this issue. Regarding this issue, Minardi quotes the opinion of Bruno Leoni from his book Liberty and Law, where he argues that employers are not the stronger side in a possible dispute, nor must employees be the weaker side. In cases when he or she needs workers more than the workers need him or her, and is unable to find them, the employer can by no means be regarded as the weaker side or seen through the traditional prism of the notorious exploiter. One of the positive examples of neo-liberally oriented economy comes from Chile, where they came up with the idea of private pensions! This is no doubt a very interesting suggestion, so let us see what it is about. The Chilean pension model is a comprehensive alternative to the social collectivism initiated by German chancellor Otto von Bismarck at the end of the 19th century, which was used as a model for the welfare states of the 20th century. By cutting the link between individual contributions and benefitsthat is, between effort and rewardand by entrusting governments not only with the responsibility but also with the management of these complex programs, the Bismarckian pay-as-you-go pension system turned out to be the central pillar of the welfare state, in which the possibility of winning elections by buying votes with other peoples moneyeven with the money of other generationsled to an inflation of social entitlements, and thus to gigantic unfunded, and hidden, state liabilities. In Chile, the same rationale that applies to the private pension system has already been extended, although imperfectly, to the areas of health and unemployment, with individual insurance (health) or accounts (unemployment) managed by the private sector. [12] This system has already been established in many South American countries (Mexico, Bolivia, Salvador, Peru, Columbia, Argentina, Uruguay), but also in many of the former Socialist block countries (Hungary, Poland, Kazakhstan), which may be especially interesting, but also indicative as a precedent. Hungary was the first former Socialist country to break the ice in 1998 and allow for a portion of the workers salaries to be invested in pension savings accounts. The previous method of investing in pension funds had been in deficit as early as the nineties, when the contributions amounted to 30% of the salary. If the system had remained unchanged, Hungary would have been forced to raise the taxes on wages up to 55%, which would, in a few decades (around 2035 as estimated) have lead to each pensioner be ing supported by only one worker. Knowing that in a country such as Italy the government used to pay disability pensions for 30,000 dead people, and also bearing in mind that it is the country with the lowest birth rate in the world, we can only imagine what the public expenditures were over a budget year. There was even an example of a woman receiving a (disability) pension as a blind person, while working as a driver at the same time. The annual expenditure on public pensions in Italy amounts to as much a s 14.5% of GDP. Jos Piera argues that nowadays pension systems are under the highest threat in Western Europe, with the proverbially strong influence of the traditional welfare state. Apart from purely economic, we can provide a non-economic argument in favour of private pension system. Poor people, who usually start working earlier than their somewhat better off peers, have (on the average) a shorter lifespan than the latter. Under such a method of pension payment, poorer workers would find it easier to accumulate higher amounts on their accounts, thereby de facto lessening the well-known gap between the rich and the poor, as the workers have so far been investing into a system providing them with the yield rate of less than 2%. Here is, finally a truly socially humane argument in favor of neo-liberal thinkers! If such a rate could be applied in different socio-economic models of different countries with an equal success rate, we see no reason why it should not be done.

Features of Globalization
y Characteristics of economic globalization include a rapid increase in international trade in goods and services, as well as the freer flow of labor and capital across borders. Technological and political factors drive modern economic globalization. Technological factors include improvements in transportation, which have reduced the cost of shipping goods internationally, and advances in communications and computer technology. Grieco and Ikenberry wrote that companies have learned to use these technological changes to their advantage, to be more active in the world economy. On the political front, nations have reduced tariffs and other trade barriers, allowing other countries goods access to their markets. Further, governments have worked together through international organizations such as the World Trade Organization to resolve economic problems.

Significance
y Grieco and Ikenberry cite American military power as playing a key role in facilitating economic globalization. They note that U.S. military strength has protected Japan and Western Europe since the end of World War II, allowing these countries greater freedom to pursue economic globalization efforts because of fewer worries about their own national security.

Effects
y While economic globalization has increased the connectedness of the worlds nations through increased trade and international investment, Grieco and Ikenberry point out that globalization also makes nations more vulnerable to economic shocks and c rises that originate in other parts of the world. The 2008 global credit crunch provides a useful illustration. Problems in the U.S. housing market that began in 2007 soon affected other the financial systems of other nations that had invested mortgage-backed securities.

Outcomes of Privatization
Literature reviews [10][11] find that in competitive industries with well-informed consumers, privatization consistently improves efficiency. Such efficiency gains mean a one-off increase in GDP, but through improved incentives to innovate and reduce costs also tend to raise the rate of economic growth. The type of industries to which this generally applies include manufacturing and retailing. Although typically there are social costs associated with these efficiency gains, {Citation needed}} [12] many economists argue that these can be dealt with by appropriate government support through redistribution and perhaps retraining. In sectors that are natural monopolies or public services (such as, say, passenger rail in the United States), the results of privatization are much more mixed, as a private monopoly behaves much the same as a public one in liberal economic theory. The government is actually seen as a more natural provider of public goods and services. However, the efficiency of an existing public sector operation can be put into question requiring changes to be made. Changes may include, inter alia, the imposition of related reforms such as greater transparency and accountability of management, an improved cost-benefit analysis, improved internal controls, regulatory systems, and better financing, rather than privatization itself. Regarding political corruption, it is a controversial issue whether the size of the public sector per se results in corruption. The Nordic countries have low corruption but large public sectors. However, these countries score high on the Ease of Doing Business Index, due to good and often simple regulations, and for political rights and civil liberties, showing high government accountability and transparency. One should also notice the successful, corruption-free privatizations and restructuring of government enterprises in the Nordic countries. For example, dismantling telecommunications monopolies has resulted in several new players entering the market and intense competition with price and service.

Also regarding corruption, the sales themselves give a large opportunity for grand corruption. Privatizations in Russia and Latin America were accompanied by large-scale corruption during the sale of the state-owned companies. Those with political connections unfairly gained large wealth, which has discredited privatization in these regions. While media have reported widely the grand corruption that accompanied the sales, studies have argued that in addition to increased operating efficiency, daily petty corruption is, or would be, larger without privatization, and that corruption is more prevalent in non-privatized sectors. Furthermore, there is evidence to suggest that extralegal and unofficial activities are more prevalent in countries that privatized less.[13]

Impact of Globalisation on Developing Countries and India

Introduction: Globalisation is the new buzzword that has come to dominate the world since the nineties of the last century with the end of the cold war and the break -up of the former Soviet Union and the global trend towards the rolling ball. The frontiers of the state with increased reliance on the market economy and renewed faith in the private capital and resources, a process of structural adjustment spurred by the studies and influences of the World Bank and other International organisations have started in many of the developing countries. Also Globalisation has brought in n ew opportunities to developing countries. Greater access to developed country markets and technology transfer hold out promise improved productivity and higher living standard. But globalisation has also thrown up new challenges like growing inequality acr oss and within nations, volatility in financial market and environmental deteriorations. Another negative aspect of globalisation is that a great majority of developing countries remain removed from the process. Till the nineties the process of globalisati on of the Indian economy was constrained by the barriers to trade and investment liberalisation of trade, investment and financial flows initiated in the nineties has progressively lowered the barriers to competition and hastened the pace of globalisation Definition: Globalised World - What does it mean? Does it mean the fast movement of people which results in greater interaction? Does it mean that because of IT revolution people can be in touch with each other in any part of the world? Does it mean trade and economy of each country is open in Non -Intrusive way so that all varieties are available to consumer of his choice? Does it mean that mankind has achieved emancipation to a level of where we can say it means a social, economic and political globalisati on? Though the precise definition of globalisation is still unavailable a few definitions worth viewing, Stephen Gill: defines globalisation as the reduction of transaction cost of transborder movements of capital and goods thus of factors of production an d goods. GuyBrainbant: says that the process of globalisation not only includes opening up of world trade, development of advanced means of communication, internationalisation of financial markets, growing importance of MNC's, population migrations and mor e generally increased mobility of persons, goods, capital, data and ideas but also infections, diseases and pollution

Impact on India: India opened up the economy in the early nineties following a major crisis that led by a foreign

exchange crunch that dragged the economy close to defaulting on loans. The response was a slew of Domestic and external sector policy measures partly prompted by the immediate needs and partly by the demand of the multilateral organisations. The new policy regime radically pushed forward in favour of amore open and market oriented economy. Major measures initiated as a part of the liberalisation and globalisation strategy in the early nineties included scrapping of the industrial licensing regime, reduction in the number of areas reserved for the public sector, amendment of the monopolies and the restrictive trade practices act, start of the privatisation programme, reduction in tariff rates and change over to market determined exchange rates. Over the years there has been a steady liberalisation of the current account transactions, more and more sectors opened up for foreign direct investments and portfolio investments facilitating entry of foreign investors in telecom, roads, ports, airports, insurance and other major sectors. The Indian tariff rates reduced sharply over the decade from a weighted average of 72.5% in 199192 to 24.6 in 1996-97.Though tariff rates went up slowly in the late nineties it touched 35.1% in 2001-02. India is committed to reduced tariff rates. Peak tariff rates are to be reduced to be reduced to the minimum with a peak rate of 20%, in another 2 years most non-tariff barriers have been dismantled by march 2002, including almost all quantitative restrictions. India is Global: The liberalisation of the domestic economy and the increasing integration of India with the global economy have helped step up GDP growth rates, which picked up from 5.6% in 1990-91 to a peak level of 77.8% in 1996-97. Growth rates have slowed down since the country has still bee able to achieve 5-6% growth rate in three of the last six years. Though growth rates has slumped to the lowest level 4.3% in 2002-03 mainly because of the worst droughts in two decades the growth rates are expected to go up close to 70% in 2003-04. A Global comparison shows that India is now the fastest growing just after China. This is major improvement given that India is growth rate in the 1970's was very low at 3% and GDP growth in countries like Brazil, Indonesia, Korea, and Mexico was more than twice that of India. Though India's average annual growth rate almost doubled in the eighties to 5.9% it was still lower than the growth rate in China, Korea and Indonesia. The pick up in GDP growth has helped improve India's global position. Consequently India's position in the global economy has improved from the 8th position in 1991 to 4th place in 2001. When GDP is calculated on a purchasing power parity basis. Globalisation and Poverty: Globalisation in the form of increased integration though trade and investment is an important reason why much progress has been made in reducing poverty and global inequality over recent decades. But it is not the only reason for this often unrecognised progress, good national polices , sound institutions and domestic political stability also matter. Despite this progress, poverty remains one of the most serious international challenges we face up to 1.2 billion of the developing world 4.8 billion people still live in extreme poverty. But the proportion of the world population living in poverty has been steadily declining and since 1980 the absolute number of poor people has stopped rising and appears to have fallen in recent years despite strong population growth in poor countries. If the proportion living in poverty had not fallen since 1987 alone a further 215million people would be living in extreme poverty today. India has to concentrate on five important areas or things to follow to achieve this goal. The areas like technological entrepreneurship, new business openings for small and medium enterprises, importance of quality management, new prospects in rural areas and privatisation of financial

institutions. The manufacturing of technology and management of technology are two different significant areas in the country. There will be new prospects in rural India. The growth of Indian economy very much depends upon rural participation in the global race. After implementing the new economic policy the role of villages got its own significance because of its unique outlook and branding methods. For example food processing and packaging are the one of the area where new entrepreneurs can enter into a big way. It may be organised in a collective way with the help of co-operatives to meet the global demand. Understanding the current status of globalisation is necessary for setting course for future. For all nations to reap the full benefits of globalisation it is essential to create a level playing field. President Bush's recent proposal to eliminate all tariffs on all manufactured goods by 2015 will do it. In fact it may exacerbate the prevalent inequalities. According to this proposal, tariffs of 5% or less on all manufactured goods will be eliminated by 2005 and higher than 5% will be lowered to 8%. Starting 2010 the 8% tariffs will be lowered each year until they are eliminated by 2015. GDP Growth rate: The Indian economy is passing through a difficult phase caused by several unfavourable domestic and external developments; Domestic output and Demand conditions were adversely affected by poor performance in agriculture in the past two years. The global economy experienced an overall deceleration and recorded an output growth of 2.4% during the past year growth in real GDP in 2001-02 was 5.4% as per the Economic Survey in 2000-01. The performance in the first quarter of the financial year is5.8% and second quarter is 6.1%. Export and Import: India's Export and Import in the year 2001-02 was to the extent of 32,572 and 38,362 million respectively. Many Indian companies have started becoming respectable players in the International scene. Agriculture exports account for about 13 to 18% of total annual of annual export of the country. In 2000-01 Agricultural products valued at more than US $ 6million were exported from the country 23% of which was contributed by the marine products alone. Marine products in recent years have emerged as the single largest contributor to the total agricultural export from the country accounting for over one fifth of the total agricultural exports. Cereals (mostly basmati rice and nonbasmati rice), oil seeds, tea and coffee are the other prominent products each of which accounts fro nearly 5 to 10% of the countries total agricultural exports. Where does Indian stand in terms of Global Integration? India clearly lags in globalisation. Number of countries have a clear lead among them China, large part of east and far east Asia and eastern Europe. Lets look at a few indicators how much we lag. yOver the past decade FDI flows into India have averaged around 0.5% of GDP against 5% for China 5.5% for Brazil. Whereas FDI inflows into China now exceeds US $ 50 billion annually. It is only US $ 4billion in the case of India yConsider global trade - India's share of world merchandise exports increased from .05% to .07% over the pat 20 years. Over the same period China's share has tripled to almost 4%. yIndia's share of global trade is similar to that of the Philippines an economy 6 times smaller according to IMF estimates. India under trades by 70-80% given its size, proximity to markets and labour cost advantages. yIt is interesting to note the remark made last year by Mr. Bimal Jalan, Governor of RBI. Despite all the talk, we are now where ever close being globalised in terms of any commonly used indicator of globalisation. In fact we are one of the least globalised among the major countries - however we look at it.

yAs Amartya Sen and many other have pointed out that India, as a geographical, politico-cultural entity has been interacting with the outside world throughout history and still continues to do so. It has to adapt, assimilate and contribute. This goes without saying even as we move into what is called a globalised world which is distinguished from previous eras from by faster travel and communication, greater trade linkages, denting of political and economic sovereignty and greater acceptance of democracy as a way of life. Consequences:
The implications of globalisation for a national economy are many. Globalisation has intensified interdependence and competition between economies in the world market. This is reflected in Interdependence in regard to trading in goods and services and in movement of capital. As a result domestic economic developments are not determined entirely by domestic policies and market conditions. Rather, they are influenced by both domestic and international polici s and economic e conditions. It is thus clear that a globalising economy, while formulating and evaluating its domestic policy cannot afford to ignore the possible actions and reactions of policies and developments in the rest of the world. This constrained the policy option available to the government which implies loss of policy autonomy to some extent, in decision -making at the national level

The need for privatization process: lessons from development and implementation. The decision to privatize state services is often a controversial one. What are the pitfalls commonly encountered, and how can a state avoid them? In Massachusetts, a healthy clash of interests between a Republican governor eager to privatize and a Democratic legislature responsive to state employees provides important lessons. Bruce Wallin finds that many mistakes, of both a political and policy nature, were made by an administrative crusade. The legislative response, a bill regulating privatization, suggests that it is best to establish a decision-making process for privatization that is well specified, inclusive, and ideally has some independent check on the decisions. Privatization of government services, or the use of the private sector to attain public goals, has taken center stage in federal, state, and local government attempts to reform service delivery and lower cost (Gore, 1993; Gormley, 1991; Chi, 1993; Florestano, 1994; Cigler, 1990). Although much has been written about the advantages and disadvantages of privatization, the conditions which support it, and the service areas most readily privatized (Savas, 1987; Donohue, 1989), there has been remarkably little discussion in the literature of how the privatization decision process might best be structured, especially at the state level (Kettl, 1993a). That is, how should the rules for privatization be written? Who should be involved? How should proposals be initiated? What guidelines are needed? This article discusses such questions based on a case study of Governor William Weld's privatization efforts in Massachusetts. Applied piecemeal in many states, privatization has not yet become an overarching theme for most states. While states differ in many ways, lessons can be learned from an analysis of the privatization politics and policy decisions of a state like Massachusetts, where privatization has been aggressively pursued by a Republican governor and equally aggressively opposed by a Democratically controlled legislature. Indeed privatization became one of the cornerstones of an administration that has increasingly attracted national attention, and yet, at the same time it remained a focal point of controversy within the Commonwealth. Although case studies have their limitations, they are clearly instructional in the early years of policy development and implementation (Pressman and Wildavsky, 1997). In their separate reviews of efforts at the state level, Florestano (1994), Kettl (1993a), and Chi (1993) have noted the need for more information on what states are doing with privatization, and how they are doing it.

Privatization must be done carefully. To overcome bureaucratic intransigence, union opposition, and partisan politics, proponents of privatization may feel that they have to aggressively promote their agenda. Privatization may then become a goal in itself, when it should be viewed as a means to more efficient and less costly provision of government services. Ideologically driven/overly promoted privatization crusades can, like most crusades, have innocent victims, with unintended consequences for those who deliver government services and for those who benefit from them. Opponents of privatization, on the other hand, may oppose its implementation for narrowly selfish personal or political reasons. Privatization in the states is most often initiated in and implemented by the executive branch, with governors cited as the most active players in one survey (Chi, 1993, 24). Although the gubernatorial perspective can provide insight on alternative service delivery, the Massachusetts experience suggests that legislative involvement may be beneficial and may provide an important check on potentially overzealous privatization. Decisions that, in effect, weigh flexibility, efficiency, and cost savings in the provision of government services against expertise, stability, and control are important ones and are best made with input from both administrative and political perspectives. The Massachusetts experience further suggests that, at the least, it is best to set up in advance of privatization a decision-making process that is well-specified, inclusive (especially including current government workers), and ideally has some independent check on the decisions, preferably by an office or organization with little to gain from the decision. Because of a favorable political climate, privatization policy in Massachusetts has moved in this direction, and the result is better policy.
Advantages: 1. Basic advantage in privatization is accurateness and commitment towards the service as they private organizations are very much concerned about the profits they make ultimately which depend on the quality of service being provided by them and the public response to it. 2. Privatization generates more revenue compared to government enterprises, thus govt can indirectly earn a bit more by leasing out enterprises to private organizations. 3. Customer support and satisfaction basically is of much interest in private enterprises comparatively. Disadvantages: 1. The biggest threat is reliability. There is nothing that backs up the private organizations, where as govt can back up its enterprises easily in terms of funds. There are more chances of bankruptcy in private orgs where are 0 to few in govt orgs. 2. Though the quality of service may be little compromised, its reliable. 3. Some departments need social responsibility which can be done only by government like police department, traffic management.

The proposed research is intended to survey the process of privatization in India and assess its impact on the Indian economy. The central issue we will address is the impact of privatization that has taken place so far on profitability and performance of PSUs. Going beyond this, we will attempt to understand what explains the impact of privatization on performance. Is it the use of market power by oligopolistic firms whose pricing power had been constrained under government ownership ? Is performance bought at the expense of labour through extensive lay- offs so that what we see is

essentially a transfer from workers to shareholders ? Or are we confusing the impact of privatization with the more generalised impact of deregulation in the economy, which in itself could spur efficiency ? The research output will comprise the following: 1. A survey of the literature on privatization, particularly with respect to less developed countries. 2. A review of the role of the public sector in the Indian economy, and the process of economic liberalization and privatization in India upto this point. 3. Impact of privatization on firm performance. 4. Explanation for the impact of privatization 5. Assessment of mechanisms of corporate governance in India.

Background: privatization in theory and practice A great wave of privatization has swept the world in the past two decades, embracing the industrial economies, the

transition economies of East Europe and large parts of the less developed world, and it continues to roll on. It is interesting, however, that its basis in theory was somewhat shaky to start with. Moreover, a sizable enough body of empirical evidence, on which hypotheses about its impact could be tested, became available only several years down the road. So much of the initial impetus to privatization entailed a leap in faith, and, as happens all too often in the development of knowledge, attempts to explain its impact have followed on the heels of widespread existing practice. Although ideological considerations - exemplified by such statements as, governments have no businesss to be in business - have often been paramount in driving privatization in various parts of the world, it is also true that governments have sought to justify privatization in relation to certain objectives. These objectives include one or more of the following: 1. to promote increased efficiency. 2. to raise revenues for the state (and thereby to bridge fiscal deficits). 3. to reduce government interference in the economy and promote greater private initiative. 4. to promote wider share ownership and the development of the capital market. Of these, the first objective, the need to promote efficiency in running commercial organizations, has arugably been the dominant motivation. There is a sense thatpublic ownership somehow leads to lower levels of efficiency than are possibleunder private ownership; and inefficient enterprises, in turn, are seen as creatingother problems such as pre-emption of government revenues (badly needed forinvestment in social sectors in the less developed countries ) through subsidies orrecapitalization and uncompetitive industries in the economy. All this is now virtually taken as axiomatic and is part of the conventional wisdom,but it is noteworthy that neoclassical theory dwelt does not have much to say aboutfirm ownership, dwelling instead on the importance of market structure ingenerating efficient outcomes . If anything under certain conditions of marketfailure that cannot not be entirely rectified through Pigouvian taxes or subsidies,there is a case for public, rather than private, ownership to meet overriding socialobjectives. Subsequent literature, drawing onagency theory has, however, come up with anumber of reasons why private ownership might be superior. One is that managersin the public sector lack incentives to perform because they are poorly monitored(Vickers and Yarrow, (1988)). Poor monitoring, in turn, stems from the fact thatownership is diffuse, and, moreover, the firms are not publicly traded and hence notvulnerable to the threat of takeover. From the perspective of the property rightsschool, inefficiency in PSUs arises from because the failure to assign propertyrights. When everyone owns a firm, through the state, nobody does, and hencenobody has the incentive to deisgn efficiency incentive structures. Another reason managers in the public sector lack incentives to perform is that theydo not fear bankruptcy; thanks to the soft budget constraint managers in the publicsector can expect to be bailed out by public funds (Kornai,

1980).Agency theoryalso suggests that, unlike their counterparts in the private sector, managers in thepublic sector might lack focus because they are expected to pursue a variety ofobjectives, not all of which are calculated to maximize profit (Shleifer and Vishny,1996). Multiplicity of objectives arise from the fact that public sector managers areanswerable to different constitutents, such as legislators, civil servants andministers, each with its own objective. In particular, politicians, who are answerableto constituents such as labour, would tend to push public sector managers to pursueobjectives, such as an increase in employment, that militate against profitmaximization. The proposition that agency problems are necessarily so much more acute in thepublic sector than in the private sector as to make a difference to performance hasnot gone unchallenged. Stiglitz (1997) makes the point that in all big firms, whetherin the public or the private sector, managers enjoy considerable discretion. Sincemanagers can appropriate only a small fraction of any improvement in productivity,in neither sector do managers have any incentive to design good incentivestructures. However, it is also true that the effort required to design incentivesstructures is not so great as to impose a major impediment in either case. As Stiglitzputs it, It seems extremely implausible to think, in either case, of managersmulling over whether to exert the little effort to design a good incentive structurethat will make the organization function better, carefully balancing the returns theywill obtain with the extra effort they will have to exert. Stiglitz cites theextraordinary performance of public enterprises in certain provinces of China tomake the point that economic success is possible even under conditions in whichproperty rights are ill-defined. The Sappington-Stiglitz theorem (1987) shows that conditions under whichprivatization could fully implement public objectives of equity and efficiency areextremely restrictive. This is reflected in some of the choices societies have madefor public production. It is difficult, for instance, to design Pigouvian taxes or subsidies to attain the right level of risk-taking or innovaion or to attainobjectives in public education such as social integration. The theorem alsodemonstrates that anideal government could do a better job of running anenterprise itself than it could through privatization- although, in practice, such anideal government may be hard to come by. All this has led to the contention that what matters is not ownership so much ascompetition. (Stiglitz (1993), VernonWetzel and Wetzel (1989)). However, it hasalso been pointed out that, while competition undoubtedly contributes to efficiencygains, the existence of a publicly-owned firm as the incumbent, might deter otherfirms from entering the market, no matter that competition is permitted. Moreover,since real competition means not only freedom to enter but freedom to fail, theexistence of PSUs may not conduce to meaningful competition (Sheshinski andLopez -Calva, 1998). Given the many ifs and buts about the theoretical merits of privatization,researchers have had to turn inevitably to the evidence on the ground in order toarrive at conclusions. But the empirical evidence on ownership and efficiency,contrary to impressions that might have been created in the popular press, is by nomeans unambiguous, least of all where less developed countries are concerned- asthe next section outlines. Econometric analysis of pre- and post-privatization performance: In thiscategory of studies are those that look at a large sample of firms that haveundergone privatization, whether in a given country or across several countries. Among the most detailed studies to date is by Megginson et al (1994). Theycompared the pre- and post- privatization financial and operating performance of 61companies from 18 countries and 32 industries during the period 1961 to 1990.They found increases in profitability, efficiency, capital spending, employment(which they admit is a surprising result) and real sales after divestiture. It is worthpointing out, however, that their study found the increase in profitability (measuredby return on sales) to be insignificant for regulated industries, such as utilities andbanking which would appear to reinforce the doubts raised by some of the otherstudies mentioned earlier about the benefits of privatization in such industries. One shortcoming of this study is that it does not control for changes in theeconomic environment (which in itself could contribute to improved performancein the post-divestiture period) or for pre-privatization restructuring. This problemhas been addressed by Frydman, Gray, Hessel and Rapaczynski (1997) in theirstudy of transition economies, part of a substantial body of work on privatization inEastern Europe. The authors argue that it is not enough to

compare pre- and post-privatization performance in selected firms. If better firms were chosen forprivatization, selection bias could occur. To avoid this bias, the authors combine the two approaches- comparing state and private firms, in addition to comparingpre-and post-privatization performance. They do this by breaking up their analysisin two parts. First, they compare post-privatization performance of privatized firmswith state firms; secondly, they compare the pre-privatization performance of theprivatized firms with state firms as well. If there a difference in performance only inthe first case, th en it is possible to infer that ownership has made a difference. The authors analysis is based on a sample of about 190 mid-sized companies in theCzech Republic, Hungary and Poland and covers the period 1990 to 1994 (medianemployment in the sample: 360 full-time employees; median sales: $6 million). Theauthors report that the privatization had a dramatic impact on performance,measured by four different variables: revenue, employment, revenue per employeeand cost/revenue ratio. The impact was most dramatic on revenue.The authorssuggest that because revenue falls were arrested, the impact on employment wasalso positive, contrary to the belief that privatization could impose costs in terms of lower employment. The authors also verified that the privatization effect is notlimited to a particular country, industrial sector or a particular vintage of privatizedfirm. As mentioned earlier, in order to eliminate selection bias, the authors attempted toascertain whether the same privatized firms that were outperforming state firmsafter privatization were also outperforming thesame state firms beforeprivatization. They found that when insider-owned firms were included, there is astatisticallly significant preprivatization effect as well. However, when insider-owned firms were excluded from the pre- and post-privatization comparisons, thepre-privatization effect becomes statistically insignificant. They suggest thatinsider-owned firms lead to a negative selection bias which masks the impact ofprivatization. It is noteworthy, however, in that one of the rare studies that attemptsto compare state and privatized firms before and after privatization, the results arenot unambiguously in favour of privatization. Galal et al (1994) attempt an explanation as to why studies on privatization come tocontradictory conclusions. One reason is that some of the studies comparecompetitive enterprises in the private sector with monopoly enterprises in the publicsector, and, not surprisingly, find superior performance in the former category.Secondly, some find private sector performance legitimately superior because theyare comparing reasonably competitive enterprises, and small public enterprises in acompetitive situation cannot be expected to do better than private enterprises Thirdly, some of the studies compare public and private monopolies, and this is an area where, as the authors put it, the results are all over the map. III. Privatization in less developed countries Many of the studies cited above have been carried out in the developed world. When it comes to less developed countries (a category that, in the World Banks classification, excludes the transition economies of Eastern Europe ), it becomes even more difficult to come by unambiguous evidence in favour of privatization. In its review of privatization programs, the World Bank (1992) noted, Most privatization success stories come from high- or middle-income countries. It is harder to privatize in low-income settings, where the process is more difficult to launch, although the study was quick to add, But even in low-income the results of some privatizations have been highly positive... It is interesting to note that the study by Megginson et al (1994), cited above, while finding improvements in profitability in developing countries post-privatization, found increases in efficiency only in companies headquartered in OECD countries. One of the earlier surveys done by Millard (1988) noted quite emphatically: There is no evidence of a statistically satisfactory kind to suggest that public enterprises in LDCs have a

lower level of technical efficiency than private firms operating at the same level of operation. In its assessment of privatization in sub-Saharan Africa, the World Bank (1994) concluded that such limited privatisation has had little impact on efficiency and economic growth. On Mexico, we have two studies with differing

conclusions. John Weiss (1995) looked at the 500 largest enterprises in Mexico over the period 1985-90, and compared measures such as sales at constant prices, sales per worker at constant prices and sales per unit of total assets at constant prices. His conclusion: In terms of the influence of ownership, which is the main focus of ths analysis, there is no support for the view that state ownership per se implies poor performance.... What is clear.. is that the results give no support for privatization of the remaining enterprises on efficiency grounds. The findings of LaPorta and Lopez-De-Silanes (1998) are diametrically opposite. Their study covered 218 firms in 26 different sectors, privatized between 1983 and 1991. They found that profitability, measured by the ratio of operating income to sales, increased by 24 per centage points. The authors decomposed the gains into three components: increase in prices, reduction in workers, and productivity gains. They found that 57% of the gains were on account of productivity increases. The authors also compared competitive and non-competitive markets and found that the former had higher gains in profitability than the latter. Boubakri and Cosset (1998) looked at the impact of privatization using data of 79 companies from 21 developing countries. They found significant improvements in return on sales, real sales, and capital expenditure/sales, but not in employment. There are, of course, good reasons why privatization may not yield quite the same impact in LDCs as in the developed world. It is by now well recognized that, broadly, two conditions need to be satisfied for successful outcomes to result from privatization. One, the prior existence of a market-friendly macroeconomic environment, supported by institutional and regulatory capacity. Two, the existence of competitive enterprises in sectors in which privatization takes place. In many LDCs, neither of these conditions may be adequately met, and, in addition, there are adverse factors such as weak law enforcement, thin capital markets, and the absence of mechanisms that spur private sector performance such as takeovers and monitoring by institutional shareholders. Under these circumstances, private ownership cannot be expected to produce high standards of performance, and indeed many of the studies on privatization in LDCs point to one or other of these factors to epxlain why privatization has not quite produced the expected results. IV. Privatization in India In many ways, India provides an excellent testing ground for hypotheses aboutprivatization and its impact, except that so far privatization has not been attemptedon a scale that researchers would like to see. The country has a large, welldiversified public sector. Unlike many of the transition economies, it also has along tradition of private enterprise, including big companies in the private sector,although there are certain sectors in which private sector participation is quite new,these sectors having been reserved until recently for the public sector. Privatization in India generally goes by the name of disinvestment or divestmentof equity. This is because privatization has thus far not meant transfer of control oreven of controlling interest from government to anybody else. The government hassold stakes ranging from one per cent to 40% in 40 PSUs, but in no company has itsstake fallen below the magic figure of 51% which is seen as conferring controllinginterest. The privatization program is itself relatively new to the country. It is part of anambitious process of economic reforms covering industry, trade, the financial sectorand agriculture and also involving a program of macro -economic stabilizationfocused on the federal budget, which commenced in 1991. Privatization is seen as anecessary concomitant of deregulation of industry, necessary in order to enablefirms in the public sector to compete and survive in the new environment. The major element in industrial deregulation has been the Industrial PolicyStatement of June 1991 which, among other things, drastically reduced the number of sectors of industry reserved for the public sector from 17 to eight. This list hassince been truncated to four: defence, atomic energy, specified minerals and railwaytransport. Moreover, all the areas earlier reserved for the public sector have alsobeen exempted from the system of industrial licensing under which the privatesector was required to obtain a license from the government in order to start abusiness. This has naturally exposed the hitherto cossetted public

sector tocompetition on a scale to which it has not been accustomed. Disinvestment, whileraising revenues for the government, has been perceived as necessary in order tosubject PSUs to market discipline and to ensure that they raise their standards ofperformance. Disinvestment of equity in 40 PSUs has raised about Rs12 billion ($ 2.8 bn) so far.Only profit-making enterprises have been offered for sale. In the first round ofdisinvestment, the government offered bundles of shares of various PSUs (eachbundle carrying a notional reserve price) to local institutions. Later, the biddingprocess was opened to foreign institutional investors and the public at large. Theoverwhelming chunk of funds raised through disinvestment (Rs9.9 bn) has beenthrough the auction route. The method of disinvestment was widened in 1996-97 when disinvestment was effected through both the GDR (Global depository receipts) route and public issue in the domestic market. There have been several criticisms of the disinvestment process. One is that valuations processes were unsound and that the government gave away its stakes too cheaply; two, disinvestment has been merely a revenue-raising affair for the government, with little thought being given to the requirements of the firms concerned; thirdly, it is contended that the governments reluctance to disinvest more than 51% and relinquish control over PSUs has meant that the government has been unable to attract suitably priced bids, as bidders do not believe the firms performance would improve significantly with small government stakes being offloaded. After the initial round of disinvestment in 1991-92, the process was guided by recommendations made by a Committee on Disinvestment set up in 1993. Later, realizing the sensitivity in political terms of the whole process, the government constituted in 1996 an independent body, the Disinvestment Commission (note the reluctance to use the dreaded Pword), to draw up a comprehensive programme of disinvestment over a 5-10 year period for public sector undertakings (PSUs) referred to the Commission by a Core Group of government secretaries. The Commission was asked to advise on such matters as the extent of disinvestment, the mode of disinvestment, selection of financial advisors to facilitate the process etc. The Disinvestment Commission has formulated a broad approach to disinvestment and also made specific recommendations in respect of 19 out of 50 PSUs referred to it by the Core Group. The Commission has broadly distinguished between a core group and non-core group of industries. In the core group are industries suchas telecommunications, power, petroleum etc that are capital-intensive and wherethe market structure could be an oligopoply. The core group also includes basicindustries in which PSUs have a considerable market presence and in which privatesector presence is still limited. For the core group, the Commission advocatesselling government equity upto 49%, that is, the government would retain 51% ofequity. In the non-core group, the Commission advocates sale of upto 74% ofgovernment equity. As for the 19 PSUs for which the Commission has madespecific recommendations, these include strategic sale of a large chunk of equity toa private party (domestic or foreign), offer of shares to the public, outright sale anddeferment of disinvestment. Although the value of disinvestment in the last two or three years has tended to flagand realizations have fallen short of targets proposed in the annual budgets, thereare signs that political parties are willing to give a major push to privatization in thecoming years, which would include reduction in the governments stake in somePSUs to below 51%. One sign is the recent offer of 26% of equity in Indian Petrochemicals Ltd (IPCL) through an advertisement placed in the London Economist; another is the equally bold move to sell of 76% equity in the lossmaking Modern Foods India Limited to a private party; a third is the governments recent announcement that it is willing to sell 51% of its stake in Indian Airlines. These are all moves announced by the current ruling coalition, whose most important constitutent had been implacable opposed to reforms while in the opposition. However, even as privatization gathers steam, there has been no attempt so far to assess the impact on PSUs of different degrees of disinvestment and to arrive at a judgement on the relative merits of full and partial

privatization.There are also unanswered questions about how control over managers would be exercised in instances where no dominant private owner emerges. The question of governance has considerable relevance in the Indian context. The Indian corporate sector falls into three broad categories: state firms, MNCs and family-managed Indian businesses. Government-owned financial institutions and banks hold equity in companies, but they have thus far played a passive role in companies except in extreme instances of mis-management. Questions have been raised in the context of privatization about the accountability of professional managers at state firms, once the governments stake falls below 51 per cent, given that large, private institutional player that are crucial to governance in the industrial economies are absent in the Indian context. This question has not been widely addressed in the literature, presumably because in the developed countries a certain acceptable level of governance can be presumed. One of the interesting findings of Frydman et al (1997), cited earlier, is that the privatization effect is best manifested when there is one dominant owner after privatization, whether it is a foreign owner, a privatization fund, an individual owner or the state itself . Where ownership is diffuse, as when ownership is distributed among workers, the privatization impact is much weaker. This aspect needs to be addressed in planning for future privatization. We expect that our research will address this crucial aspect based on the experience so far in the Indian context and also in other contexts. All in all, the findings of our proposed study would be timely and could conceivably make a valuable contribution to the formulation of policy on future privatization. V. Proposed research The proposed research is intended to survey the process of privatization in India and assess its impact on the Indian economy. The central issue we will address isthe impact of privatization that has taken place so far on profitability and

performance of PSUs. Going beyond this, we will attempt to understand what explains the impact of privatization on performance. Is it the use of market power by oligopolistic firms whose pricing power had been constrained under government ownership ? Is performance bought at the expense of labour through extensive lay-offs so that what we see is essentially a transfer from workers to shareholders ? Or are we confusing the impact of privatization with the more generalised impact of deregulation in the economy, which in itself could spur efficiency ? The research output will comprise the following: 1. A survey of the literature on privatization, particularly with respect to less developed countries. 2. A review of the role of the public sector in the Indian economy, and the process of
economic liberalization and privatization in India upto this point. 3. Impact of privatization on firm performance. 4. Explanation for the impact of privatization 5. Assessment of mechanisms of corporate governance in India Details of the research agenda under each of the above are spelt out below: 1.Literature survey: Expanding on the brief review outlined in this proposal, the proposed study will string together the evidence on privatization the world over, paying particular attention to studies on privatization in less developed countries.

2.Review of privatization : The review will detail the privatization program undertaken by the government of India, set against the backdrop of the overall programme of economic liberalization. It will list the companies privatized, the extent of divestment, the amounts raised through divestment, the methods adopted for divestment of the governments equity, and the criticisms of the privatization programme. 3.Impact on performance: We propose to test a number of hypotheses relating to the public sector and privatization. Our principal sources of data will be: company annual reports, the annual reports of the Bureau of Public Enterprises, and the database on listed companies,Prowess, supplied by an independent agency, the Centre for Monitoring Indian Economy, based in Mumbai. The hypotheses to be tested are listed below.

Hypothesis 1: PSUs in India are less profitable compared to the private sector Test: The above hypothesis is generally based on a comparison of profitability of the public sector in the aggregate with that in the private sector. Such comparisons often do not control for factors such as size, industrial sector, etc. We will test the hypothesis, controlling for such factors, for the period since economic liberalization began (1991- 99), for a comparable period before liberalization, and for the two periods combined as well. Hypothesis 2: PSUs are less efficient compared to the private sector Test: We will compare measures of efficiency in the public and private sectors.This comparison will again be made for the pre- and post- liberalization periods. Hypothesis 3: Privatization has improved profitability, efficiency, employment, capital spending, output and net taxes in the privatized firms Tests: As this hypothesis is central to the study, we propose three different tests. (i) First, we will examine whether key parameters (outlined below) under each of the heads- profitability, efficiency, employment, capital spending and net taxes- have changed significantly following privatization for our sample. (ii) The above test is open to the criticism of selection bias: it is possible that firms best likely to benefit from privatization were chosen in the first place. Moreover, other factors such as deregulation in the economy might have contributed to superior
performance in the post-privatization period. To deal with these issues, we will firstcompare the performance of privatized firms with PSUs not privatized; next, theperformance before privatization of the privatized firms will be compared with PSUsnot privatized. We will test to see if there are any significant differences in performancepostprivatization that were not there before privatization. (iii) We will also compare performance adjusted for industries. We will do this byusing a control group of listed companies in the private sector in the same industry foreach privatized firm. We will estimate the difference in parameters for the PSU and thecontrol group before privatization and after privatization and see if the industryadjusted ratios show any difference Hypothesis 4: Improvement in performance after privatization depends on the degree of divestment Test: Improvement in performance post-privatization will be compared, at different levels of divestment, with performance before privatization see whether the degree of divestment contributes to a statistically significant improvement in performance post- privatization Performance measures to be tested are : (i) Profitability: operating income/sales, operating income/fixed assets, net income/sales, net income/fixed assets (ii) Operating efficiency: cost per unit, log (sales/fixed assets), log (sales/employees), operating income/employees (iii) Employment: log (employees) (iv) Capital spending: log (fixed assets), investment/sales, investment/employees, investment/fixed assets, log (fixed assets/ employees) (v) Output: log (real sales) (vi) Net taxes: net taxes/sales, net taxes 4.Explaining the impact of privatization : In attempting to explain the impact of

privatization, we propose to test the following hypotheses: Hypothesis 1: Changes in performance are to be explained by use of market power by firms. Test: We propose to compare performance in competitive sectors with those in noncompetitive sectors. One view about privatization is that it is the non-competitive sectors that stand to register large gains in profitability; also that growth in output, employment and investment in these sectors is lower than in competitive sectors because the former lack the incentive to restructure aggressively. Hypothesis 2: Privatization transfers wealth from workers to shareholders Tests: (i) : Compare real wages of workers before and after privatization
(ii): Evaluate contributoin of savings from worker layoffs to profitability Hypothesis 3: Deregulation explains changes in performance after privatization Test: We will test this hypothesis by running regressions whose dependent variables would be thechange, following privatization, in the industry- adjusted parameters defined above. As independent variables, we use dummy variables for indicators of regulation (such as price/quantity controls for a given industry and barriers to trade in that industry)and also for nature of the industry (oligopolistic or competitive). The coefficients of thedummy variables for regulation should tell us whether the degree of deregulation is amaterial factor. The coefficient for the dummy variable for industry structure shouldhelp us cross-check the conclusion regarding hypothesis (1) above. 5.Mechanisms of corporate governance : In the industrial economies, mechanisms ofgovernance, such as takeovers and institutional monitoring, can be be safely assumed.This is not true of a context such as Indias. Indeed, one comment heard from foreigninvestors is that, whatever their other shortcomings, PSUs demonstrate superiorgovernance to the private sector. Leaving aside corporate governance, a morefundamental requisite for private sector performance, law enforcement, is quite lax inIndia. In taking a view on privatization in India, it is necessary, therefore, to be clearabout matters related to the structure of ownership in the private sector, the structure androle of domestic financial institutions as monitors, and mechanisms for governancedeveloped for privatization elsewhere and those proposed in India. These will bereviewed in our study.

When India became free, our top planners thought that socialism could be ushered in by centralizing production and setting up a large number of public sector units catering to the varied needs of the people. Huge investments were, therefore, made in public sector units and a number of autonomous or semi-government corporations were set up in the country. With the means of production and distribution under government control, it was thought, the economy of the country could be placed on a sound footing. Things, however, did not work out the way they should have. While public sector units performed well in some areas like water supply, defence services, postal and communication services, steel, oil and thermal power generation, they failed in several other areas. More than hundred public enterprises, for example, produced a loss of Rs. 3,06.o8 crore during the year 1990-91. The outstanding debt burden in different sectors also touched new heights in the year 1992 (coal 281 crore, Iron and Steel-3200 crore, Electricity-1081 crore, sugar-755 crore and so on). External debt burden of the country increased up to Rs. 2,97,413 crore in the year 1991-92.

In such a sad situation, it became impossible for the country to bail out this large number of sick public sector units by giving more financial support. The only way to bring the loss making public sector units into profit was to privatise them in a phased manner. Many countries like the U.S.A., the United Kingdom, Germany, Korea and France had already tried privatization under similar circumstances with wonderfully encouraging results. India, therefore, took the cue and came out with a liberalized trade and economic policy. Privatization means transferring of power from the government to the private individuals. It is based on the principle of least governmental interference and maximum private responsibility. In order to convert public sector units into private enterprise, the government decided to sell, in phases, some selected P.S.U shares to private entrepreneurs or to the general public through capital market. In some cases, the government thought of disinvesting the P.S.U .s in the form of privatization of the management and the ownership. The government is aware that it has to establish legal and institutional frame-work to make the market economy enforce competition and attract investment. The government has also opened up trade with the outside world together with currency control to ensure that domestic prices are related to the world market price. The private managed enterprises, it is expected, will show better results because of high managerial skills. It also brings about a social control over business, timely supply of goods and services and brings in belter competition. About 50 countries in the world have already taken to the process of privatization. The government of India has recently taken a big leap forward by signing the G ATT agreement. This agreement that has found favour with more than 125 countries, places the country in the open world market in respect of trade and commerce. We may have to face tough competition and initial problems but we are certainly on the road to a respectable place in the world market. We are not going to lag behind in the matter of quality or quantity of production. It is expected that the new liberal policy of the government of India would show better results in years to come.

Later reforms in liberalization

y y y

Atal Bihari Vajpayee's administration surprised many by continuing reforms, when it was at the helm of affairs of India for five years.[20] The Vajpayee administration continued with privatization, reduction of taxes, a sound fiscal policy aimed at reducing deficits and debts and increased initiatives for public works. The UF government attempted a progressive budget that encouraged reforms, but the 1997 Asian financial crisis and political instability created economic stagnation. Economic and technology-related sanctions have repeatedly not proved to be very effective in compelling nations to change their sovereign decisions made in enlightened self-interest. India faced severe sanctions after Pokhran-I (five nuclear tests on May 11 and 13, 1998 at the Pokhran range in Rajasthan Desert),and sanctions that were more comprehensive were

imposed following Pokhran-II. There were dire predictions of the collapse of the economy, double-digit inflation etc. After five years, most of the sanctions have been lifted and the Indian economy is continuing to grow at an acceptably satisfactory rate. The anticipated growth rate for 2003-04 is 6.0%. Though India s Gross National Income is only $477.4 billion by conventional calculations, it translates into $2,913 billion purchasing power parity (PPP), according to the latest world development indicators. In PPP terms, it is the world's fourth largest economy, behind only the US, China and Japan.

What is Fiscal Policy? Fiscal policy involves the use of government spending, taxation and borrowing to influence both the pattern of economic activity and also the level and growth of aggregate demand, output and employment. A rise in government expenditure, or a fall in the burden of taxation, should increase aggregate demand and boost employment. The size of the resulting final change in equilibrium national income is determined by the multiplier effect. The larger the national income multiplier, the greater the change in national income will be. However fiscal policy is also used to influence the supply-side performance of the economy. For example, changes in fiscal policy can affect competitive conditions individual markets and industries and change the incentives for people to look for work and for companies to invest and engages in research and development. Government capital spending on transport infrastructure and public sector investment in education and health can also have a direct but unpredictable effect in the long run on the competitiveness and costs of businesses in every industry. Government Spending Government spending can be broken down into three main categories: o o o General government expenditure - consists of the combined capital and current spending of central government including debt interest payments to holders of government debt General government final consumption - is government expenditure on current goods and services excluding transfer payments Transfer payments transfers are transfers from taxpayers to benefit recipients through the working of the social security system. The total welfare bill now exceeds 140 billion per year

Government Spending and Fiscal Policy Objectives The Treasury has outlined the main goals of fiscal policy to be the following: o o o Equity concerns: To ensure that government spending and taxation impact fairly within and across generations fiscal policy should be equitable to current and future generations Funding government spending: To meet the governments spending and tax priori ies t without a damaging rise in the burden of government debt The benefit principle: This principle seeks to ensure that those who benefit from public services such as the benefits from education, health and transport also meet as far as possible the costs of the services they consume Macroeconomic stability: Fiscal policy in the UK is now designed to support monetary policy in smoothing the path of aggregate demand over the economic cycle and in contributing to an environment of sustainable growth and stable inflation this is the main macroeconomic objective of fiscal policy. Gordon Brown has introduced two fiscal rules to support this objective

With the total level of government spending rising above 480 billion in 2004, much concern has been given to the actual results from this level of public sector spending. In particular the size of the state sector has been criticised by those who claim that public sector spending is open to a high level of waste and lack of efficiency. The media often talk of the need for the public services to deliver value for money in terms of meeting peoples needs and wants. Successive governments have striven to improve the efficiency with which public services are provided. This has included the widespread use of contracting-out and competitive tendering where private sector businesses compete with the public sector for the contracts to provide services such as NHS catering, laundry and cleaning services, together with maintenance of the road network and aspects of the prison service. The government has also introduced value for money audits for each major government spending department together with a huge and growing number of performance targets.

We decompose fiscal policy in three components: i) responsiveness, ii) persistence and iii) discretion. Using a sample of 132 countries, our results point out that fiscal policy tends to be more persistent than to respond to output conditions. We also found that while the effect of cross-country covariates is positive (negative) for discretion, it is negative (positive) for persistence thereby suggesting that countries with higher persistence have lower discretion and vice versa. In particular, while government size, country size and income have negative effects on the discretion component of fiscal policy, they tend to increase fiscal policy persistence.

Contents

Chapter 1: Indias key challenges to sustaining high growth The Indian economy has undergone a remarkable transformation over the past two decades. The growth rate of average incomes has increased from 1 per cent prior to 1980 to 7% by 2006. Between 1999 and 2004, the absolute number of people living under the national poverty line has fallen for the first time since Independence. Faster growth has been brought about by a paradigm shift in economic polices that has opened the economy to foreign trade and markedly reduced direct tax rates and government influence over most investment decisions. Despite this favourable performance, there is still much room for improving policy settings to further raise growth potential. This chapter first looks at Indias past reforms and the main sources of its improved growth performance and then identifies a number of key challenges that could make growth faster, more sustainable and more even across the country: i) making goods and service markets more competitive; ii) enhancing employment in the formal sector through broadranging labour market reforms; iii) further liberalising the banking sector; iv) improving public finances to achi eve more rapid growth through a more ambitious fiscal consolidation, reducing subsidies and further reducing tax distortions; v) improving infrastructure and facilitating urbanisation by involving private players more intensely; and vi) upgrading the quali ty of educational outcomes through institutional reforms. Chapter 2: Indias growth pattern and obstacles to higher growth Indias growth performance has improved significantly over the past 20 years, but it has been uneven across industries and states. While some service industries, notably the information and communications technology (ICT) sector, have become highly competitive in world markets yielding considerable gains for employees and investors manufacturing industries have lagged and improved their performance only recently. A divergence in performance has taken place, with firms in those states and sectors with the best institutions gaining, and those in the more tightly regulated states and sectors

falling further behind. As a result, the competitive landscape is uneven across sectors and states and a high degree of concentration continues in different industries. While this is partly the result of the legacy of licensing, change has been politically difficult, making it harder for the manufacturing sector than for the service sector to expand. The need for further institutional reforms is urgent, focusing on product and labour market regulations at the central and state levels. Chapter 3: Reforming Indias product and service markets The degree of competition in product markets has been found to be an important determinant of economic growth in both developed and developing countries. This chapter uses the OECDs indicators of product market regulation to assess the extent to which the regulatory environment in India is supportive of competition in markets for goods and services. The results indicate that although liberalisation has improved the regulatory environment to international best practices in some areas, the overall level of product market regulation is still relatively restrictive. In addition, estimating the product market regulation indicators for 21 Indian states shows that the relatively more liberal states have higher labour productivity, attract more foreign direct investment, and have a larger share of employment in the private formal sector in comparison to the relatively more restrictive states. The chapter goes on to review various aspects of Indias product market regulation and suggests a number of policy initiatives that would improve the degree to which competitive market forces are able to operate. Chapter 4: Improving the performance of the labour market Over the past decade, labour market outcomes have improved in India, with net employment rising markedly for the economy as a whole. However, these gains have arisen primarily in the unorganised and informal sectors of the economy, where productivity and wages are generally much lower than in the formal organised sector. It is only Indias organised sector that is subject to labour market regulation, and here employment has fallen. The role of employment protection legislation in affecting employment outcomes is controversial both in the OECD area and in India. This chapter looks at the impact of employment protection legislation and related regulation on the dynamics of employment in the organised sector of the economy, using newly constructed measures of national regulation and state labour reforms. We find that while reforms have taken some of the bite out of core labour laws, more comprehensive reforms are needed to address the distortions that have emerged. Chapter 5: Reforming the financial system This chapter examines the performance of Indias financial sector and compares its structure to that of other emerging economies. The financial sector went through a period of considerable re-organisation during the last 15 years. New regulators were introduced for all sectors of the market and this has boosted the development of highly efficient equity and commodity markets. The health of the banking sector has also improved and competition within the sector has increased. Nonetheless, costs remain high in a sector that is still dominated by public sector banks. The corporate bond market is still underdeveloped, as is the foreign exchange market. Considerable scope exists for improving efficiency in the financial sector by opening it to more foreign direct investment and removing a number of regulatory constraints that impede the development of a full set of financial markets. Chapter 6: Improving the fiscal system This chapter examines areas of government spending, taxation and fiscal federalism where further reforms are desirable to reduce economic distortions and improve the provision of public services. As to government spending, it finds that a large share is

used to subsidise commercial undertakings, agriculture and food distribution and that there is much room to improve the quality of spending and target it better to reduce poverty. On taxes, which have undergone major reforms since the early 1990s, it points to the large number of loopholes and suggests that a broadening of the tax bases would allow further reductions in tax rates and make the system simpler and more efficient. Reforms of indirect taxes should focus on creating a common market within India so that goods can move between states without border controls. Indias federal structure has led to a well-developed system of tax-sharing and transfers, both through constitutionally empowered bodies and delivered through the annual budget. Overall, this transfer system has worked well; moving resources towards the poorest states, but the system has become very complex and, in the past, weakened fiscal discipline. Furthermore, it has not been able to create an effective local government system; this would be important for improving accountability and responsiveness to citizens needs as threequarters of the population live in states with over 50 million inhabitants. Chapter 7: Removing infrastructure bottlenecks With high rates of economic growth and low public sector investment, Indias infrastructure is in short supply and potentially a major constraint on future growth. To alleviate fiscal constraints and improve infrastructure productivity, the government is turning increasingly to the private sector to finance and run infrastructure projects. In some infrastructure sectors in which the regulatory environment is conducive to private sector involvement, performance has improved significantly. However, although infrastructure policy is moving in the right direction in some sectors, there are still a number of ways in which the regulatory environment could be improved further. This chapter outlines a range of policy initiatives that would increase private sector participation and improve infrastructure service delivery to international standards. It begins by discussing the role of public -private partnerships in the provision of infrastructure services before moving on to review the regulatory environment in a number of infrastructure sectors with a focus on regulatory settings that constrain competition. Chapter 8: Improving human capital formation The provision of high -quality education and health care to all of the population is considered a core element of public policy in most countries. In India, the government is active in both education and health but the private sector also plays an important role, notably for heath, and to a lesser extent in education. At present, the quality and quantity of the outputs from education, and also form public health care, are holding back the process of economic development. Steps are being taken to draw more children into primary education and the chapter considers ways to keep children in school. The chapter also considers institutional changes that may help to improve the performance of the educational system and so boost human capital formation.

Characteristics of Reforms
Gradual and Step by Step Approach not a Big Bang or Shock Therapy Approach Democratic and political constraint Strong emphasis on human face

Least sacrifice made by people No write-off or rescheduling of external debt Agency constraint and No backtracking Nationality constraint Ownership of reforms

2.1 Motivation for Fiscal Reforms

Large fiscal deficits and automatic monetization of deficits leading to high inflation and high interest rates and crowding out private investment. High and irrational tax rates, high tariff walls led to industrial inefficiency, lack of competitiveness, high cost economy and non-optimal allocation of resources. Large variance and multiplicity of tax rates on the basis of end-uses led to complicated and weak tax administration and rent seeking.

2.2 Motivation for Fiscal Reforms

Low buoyancy and elasticity of both direct and indirect taxes. Complicated tax structure, legal laws, rules and procedures.

Low compliance rate, high degree of tax evasion, low administrative efficiency. Narrow tax base and greater dependence on indirect taxes leading to inequity Change in the role of the government from operator to regulator, supplier of goods and services to facilitator

2.3 Motivation for Fiscal Reforms

Liberalization of trade, industry, investment Emphasis of social services and safety net in the context of so-called LPG (liberalization, privatization and globalization). Public sector enterprises reforms and disinvestment of government equity. Integration of monetary, exchange rate, regulatory and other policies. Globalization and Regionalization of economic activities. Impact of WTO, SAARC, BTAs and FTAs.

2.4 Motivation for Fiscal Reforms

Demographic change (social security and health care for senior citizens and reforms in pensions, provident and insurance funds). Fiscal federalism, Centre-state relations, decentralization, grass root planning, Panchayati Raj. To tackle environment degradation

through filth tax /environment tax. IMF/ World Bank/ ADB conditionalities for reforms and fiscal sustainability.

3.1 Major Fiscal Reforms

Reduction of fiscal deficit Fiscal Responsibility and Budget Management Act 2003 Simplifying rules and procedures Strengthening tax administration Widening tax base & enhancing buoyancy Rationalisation and Reduction of both direct and indirect tax rates

3.2 Fiscal Responsibility and Budget Management (FRBM) Act 2003

FRBM Act 2003 and FRBM Rules 2004 came into force w.e.f. 5 July 2004. The Act mandates the Central govt to eliminate revenue deficit by March 2009 and to reduce fiscal deficit to 3% of GDP by March 2008. Under section 7 of the Act, the central govt is required to lay before both houses of Parliament Medium Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macro Economic Framework Statement along with the Annual Financial Statement and Demand for Grants

3.3 FRBM Rules 2004

Reduction of revenue deficit by 0.5% of GDP or more every year. Reduction of gross fiscal deficit by 0.3% of GDP or more every year. No assumption of additional debt exceeding 9% of GDP for 2004-05 and progressive reduction of this limit by at least one percentage point of GDP in each subsequent year.

3.4 FRBM Rules 2004

No guarantee in excess of 0.5% of GDP in any financial year. Four fiscal indicators to be projected for the medium term. These include revenue deficit, fiscal deficit, tax revenue and total debt as % of GDP. Greater transparency in the budgetary process, rules, accounting standards and policies having bearing on fiscal indicators. Quarterly review of the fiscal situation.

3.5 FRBM Rules 2004

The rules mandate the Central Government to take appropriate collective action in the case of revenue and fiscal deficits exceeding 45% of the budget estimates, or total non-debt receipts falling short of 40% of the budget estimates at the end of half year of the financial year. The rules also prescribe the formats for the

mandatory statements.

3.8 Recommendations of the Twelfth Finance Commission (1)

Fiscal deficit to GDP for the Centre and States be targeted at 3%. Revenue deficit f the Centre and States be reduced to zero by 2008-09. States recruitment policy must ensure that salary bill as % of revenue exp, net of interest payments, is within 35%. Each State must enact Fiscal Responsibility bill to reduce fiscal deficit to SDP ratio to 3% and revenue deficit to zero by 2008-09.

3.9 Recommendations of the Twelfth Finance Commission (2)

States share in net proceeds of shareable central taxes be increased from 29.5% to 30.5%. Indicative amount of overall transfers to States be fixed at 38% of the Centres gross revenue receipts. A grant of Rs.20,000 crore for Panchayati Raj Institutions and Rs.5,000 crore for urban local bodies to be given to States for the period 2005-2010.

4.1 Progress o F sca

Reforms
Status in June 1991 (a)Budget support to PSEs: 1.5% of GDP (b) Price and purchase preference for PSEs (c )Preferential treatment for bank credits (d) No hard budget constraints for PSEs (e) No disinvestment (f)SICA does not include sick PSUs Status in January 2007 (a) Support reduced to 0.5% of GDP (b)No price preference, but purchase preference exists (c )No preferential treatment for bank credits (d) MOUs strengthened (e) Divestment allowed (f)SICA applicable for PSUs

4.2 Fiscal Deficit (as % of GDP)

Status in 1990-91

Central Govt Fiscal Deficit 6.6% Revenue deficit 3.3% Primary deficit 2.8% State governments Fiscal Deficit 3.3% Revenue deficit 0.9% Primary deficit 1.8% Status in 2005-06 Central Govt Fiscal Deficit 4.1% Revenue deficit 2.6% Primary deficit 0.5% State governments Fiscal Deficit 3.3% Revenue deficit 0.5% Primary deficit 0.7%

4.3 Fiscal Deficit as % of GDP

Status in 1990-91 General government Fiscal Deficit 9.4% Revenue deficit 3.3% Primary deficit 2.8%
Monetization of budget deficit Control on interest rate on government securities

Status in 2005-06 General government Fiscal Deficit 7.3% Revenue deficit 3.1% Primary deficit 1.2%
No automatic monetization Govt securities are auctioned and sold at market prices

4.4 Progress of Fiscal Reforms

Status in June 1991 Public debt as percentage of GDP (a) Central govt 61% - Internal 50% - External 12% (b) States 19% - Internal 19% (c )General govt 68% - Internal 56% - External 12% Status in March 2006 Public debt as percentage of GDP (a) Central govt 66%

- Internal 60% - External 6% (b) States 33% - Internal 33% (c )General govt 99% - Internal 93% - External 6%

4.5 Progress of Fiscal Reforms

Status in June 1991 Fiscal Deficit was financed by: (a) RBI Ad Hoc TBs at 4.6% interest (b) Banks through SLR holdings at 38.5% and CRR 25% (c ) Market borrowings (d) Public funds (e) External debt
Status in January 2007 (a) Ad hocs replaced by WMAs at market rate (b) SLR reduced to 25% and CRR 5% (c)Govt. securities are sold at market rates (d) Reduction of interest

rates for public funds (e) Less dependence on External debt

4.6 Progress of Fiscal Reforms

Status in June 1991 High duty & tax rates Maximum rates Excise duty 110% Import duty 400% Income tax 54% Corporate taxes: Domestic COs. 49% and 54% Foreign COs. 65%
Status in January 2007 Duties & taxes reduced Maximum rates
Excise duty 16% Cenvat + 16% SED Import duty 12.5% Income tax 30%

Corporate taxes: Domestic COs. 30% + 10% surcharge Foreign COs. 40%+2.5% surcharge

4.7 Progress of Fiscal Reforms

Status in June 1991

No service tax No MinAlternativeTax No transactions tax No tariff value Dividend tax on both individuals & Cos. Existence of gift tax Limited cases of taxholidays No fringe benefit tax (FBT)
Status in January 2007

Service tax @12% MAT introduced Trans. tax @0.02%+25% increase in 2006-07 Tariff value introduced Dividend tax on only companies Gift tax abolished Tax holidays widened to many infrastructure FBT imposed

4.8 Progress of Fiscal Reforms

Status in June 1991 No MRP linked excise duties No estimated income scheme for

retail traders No presumptive tax No state level VAT

Status in January 2007 Concept of MRP introduced for consumer goods Estimated income scheme introduced for retail traders. Presumptive income tax scheme introduced State level VAT introduced wef April 05

4.9 Related Financial Reforms

Status in June 1991 CRR 25% SLR 38.5% Bank Rate 12% PLR above 21% Deposit and interest rates are controlled Capital issues and prices determined by the CCI in MOF
Status in January 2007 CRR 5% SLR 25% Bank rate 6% PLR 11% to 11.5% Deposit and interest

rates are liberalised The office of CCI abolished and SEBI established

4.10 Related Financial Reforms

Status in June 1991 Indian firms not allowed to raise funds from foreign stock exchanges Portfolio investment by foreign investors in Indian companies not allowed Foreigners not allowed to buy G-secsStatus in January 2007
Indian firms allowed to raise foreign funds by GDR, ADR, FCCBs & offshore funds FIIs, NRIs and OCBs allowed to buy stocks in Indian markets s.t. overall limit of 49% FIIs/ NRIs/ OCBs allowed to buy G-secs

5.1 Second Generation Fiscal

Reforms
Coordinating state level reforms Accelerated privatisation Development of debt and bond markets Reforms in Insurance, Provident and Pension funds Thrust on state provision of basic needs Rationalisation of user charges for public utilities Rationalisation of subsidies

6. Concluding Remarks
Transparency and accountability of budget formulation Multi-year budget and macro-economic forecast Adequacy and sustainability of policies Willingness to pay by stakeholders Strengthening institutional set up
Fiscal Reforms in India since1991
Why reforms were needed? Large fiscal deficits and automatic monetization of deficitsleading to high inflation and high interest rates and crowdingout private investment . High and irrational tax rates, high tariff walls led to industrialinefficiency

Complicated tax structure, legal laws, rules and procedures Change in the role of the government from operator toregulator, supplier of goods and services to facilitator Liberalization of trade, industry, investment Globalization and Regionalization of economic activities

Characteristics of Reforms Gradual and Step by Step Approach Democratic and political constraint Least sacrifice made by people No write-off or rescheduling of external debt Agency constraint and No backtracking Nationality constraint Ownership of reforms

Broad View on the Outcome of Fiscal Reforms Deficit indicators While there was some reduction in fiscal deficit inthe first half of the 1990s, progress was reversed inthe late 1990s mainly due to the impact of implementation of the Fifth Pay Commissionsawards. fiscal consolidation underway has been somequalitative progress, as reflected in the reduction inthe proportion of revenue deficit to gross fiscaldeficit. Outstanding Liabilities The high level of fiscal deficits both at the Centre and theStates led to debt accumulation over the period resulting ina rise in the debt to GDP ratio.

 Contingent liabilities witnessed some decline in the recentyearsunder the FRBM Act,the annual increase in the stock of contingent liabilities of the Central Government is limitedto a ceiling of 0.5 per cent of GDP

The Fiscal Responsibility andBudgetManagement (FRBM)Act, 2003 Targeting long term development by achieving sufficient revenue surplusand removing fiscal impediments The central government should take appropriate measures to reduce thefiscal deficit and revenue deficit so as to eliminate revenue deficit by 31stof March, 2008 and thereafter build up adequate revenue surplus The revenue deficit as a ratio of GDP should be brought down by 0.5 per cent every year and eliminated by 2007-08; The fiscal deficit as a ratio of GDP should be reduced by 0.3 per cent everyyear and brought down to 3 per cent by 2007-08; The Union Government shall not give guarantee to loans raised by PSUsand State governments for more than 0.5 per cent of GDP in the aggregate; The Union Government should place three documents along with thebudget, namely, the Macroeconomic Framework Statement, the MediumTerm Fiscal Policy Statement and the Fiscal Policy Strategy Statement

Deficit and Growth A high level of fiscal deficit tends to have a negativeimpact on real GDP growth through crowding out effects and/or rise in interest rates in the economy. Low fiscal deficits also enable more effectivemonetary policy. Tax-GDP Ratio Decline in the gross tax-GDP ratio of the Central Govt. from 10.3 per cent in 1991-92 to 9.4 per cent in 1996-97 and further to a low of 8.2 per cent in 2001-02,attributed to the initial effects of the reduction in taxrates. The distorting impact of high and varied indirect taxeson overall resource allocation has been reducedconsiderably, enabling increased economy wideeconomic efficiency Improved corporate results during years have led tosignificant rise in collection of corporate income tax Fiscal Deficit and Public Sector Savings The reduction in fiscal deficits has helped inturning around savings and investments in recentyears. Implementation of rule-based fiscal reforms hashelped in enabling the turnaround in the publicsector savings, in turn, gross domestic savingsalong with the substantial increase in privatecorporate sector savings
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.[1] The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy.

Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing.[2]

Overview
Monetary policy rests on the relationship between the rates of interest in an economy, that is, the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard. A policy is referred to as contractionary if it reduces the size of the money supply or increases it only slowly, or if it raises the interest rate. An expansionary policy increases the size of the money supply more rapidly, or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation. There are several monetary policy tools available to achieve these ends: increasing interest rates by fiat; reducing the monetary base; and increasing reserve requirements. All have the effect of contracting the money supply; and, if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two policies separately. Within almost all modern nations, special institutions (such as the Federal Reserve System in the United States, the Bank of England, the European Central Bank, the People's Bank of China, and the Bank of Japan) exist which have the task of executing the monetary policy and often independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various financial

instruments, such as treasury bills, company bonds, or foreign currencies. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight; however, the monetary policy of China is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies. The other primary means of conducting monetary policy include: (i) Discount window lending (lender of last resort); (ii) Fractional deposit lending (changes in the reserve requirement); (iii) Moral suasion (cajoling certain market players to achieve specified outcomes); (iv) "Open mouth operations" (talking monetary policy with the market).
Theory

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.[1] Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals). It is important for policymakers to make credible announcements. If private agents (consumers and firms) believe that policymakers are committed to lowering inflation, they will anticipate future prices to be lower than otherwise (how those expectations are formed is an entirely different matter; compare for instance rational expectations with adaptive expectations). If an employee expects prices to be high in the future, he or she will draw up a wage contract with a high wage to match these prices. Hence, the expectation of lower wages is reflected in wage-setting behavior between employees and employers (lower wages since prices are expected to be lower) and since wages are in fact lower there is no demand pull inflation because employees are receiving a smaller wage and there is no cost push inflation because employers are paying out less in wages. To achieve this low level of inflation, policymakers must have credible announcements; that is, private agents must believe that these announcements will reflect actual future policy. If an announcement about low-level inflation targets is made but not believed by private agents, wage-setting will anticipate high-level inflation and so wages will be higher and inflation will rise. A high wage will increase a consumer's demand (demand pull inflation) and a firm's costs (cost push inflation), so inflation rises. Hence, if a policymaker's announcements regarding monetary policy are not credible, policy will not have the desired effect.

If policymakers believe that private agents anticipate low inflation, they have an incentive to adopt an expansionist monetary policy (where the marginal benefit of increasing economic output outweighs the marginal cost of inflation); however, assuming private agents have rational expectations, they know that policymakers have this incentive. Hence, private agents know that if they anticipate low inflation, an expansionist policy will be adopted that causes a rise in inflation. Consequently, (unless policymakers can make their announcement of low inflation credible), private agents expect high inflation. This anticipation is fulfilled through adaptive expectation (wage-setting behavior);so, there is higher inflation (without the benefit of increased output). Hence, unless credible announcements can be made, expansionary monetary policy will fail. Announcements can be made credible in various ways. One is to establish an independent central bank with low inflation targets (but no output targets). Hence, private agents know that inflation will be low because it is set by an independent body. Central banks can be given incentives to meet targets (for example, larger budgets, a wage bonus for the head of the bank) to increase their reputation and signal a strong commitment to a policy goal. Reputation is an important element in monetary policy implementation. But the idea of reputation should not be confused with commitment. While a central bank might have a favorable reputation due to good performance in conducting monetary policy, the same central bank might not have chosen any particular form of commitment (such as targeting a certain range for inflation). Reputation plays a crucial role in determining how much would markets believe the announcement of a particular commitment to a policy goal but both concepts should not be assimilated. Also, note that under rational expectations, it is not necessary for the policymaker to have established its reputation through past policy actions; as an example, the reputation of the head of the central bank might be derived entirely from his or her ideology, professional background, public statements, etc. In fact it has been argued[3] that to prevent some pathologies related to the time inconsistency of monetary policy implementation (in particular excessive inflation), the head of a central bank should have a larger distaste for inflation than the rest of the economy on average. Hence the reputation of a particular central bank is not necessary tied to past performance, but rather to particular institutional arrangements that the markets can use to form inflation expectations. Despite the frequent discussion of credibility as it relates to monetary policy, the exact meaning of credibility is rarely defined. Such lack of clarity can serve to lead policy away from what is believed to be the most beneficial. For example, capability to serve the public interest is one definition of credibility often associated with central banks. The reliability with which a central bank keeps its promises is also a common definition. While everyone most likely agrees a central bank should not lie to the public, wide disagreement exists on how a central bank can best serve the public interest. Therefore, lack of definition can lead people to believe they are supporting one particular policy of credibility when they are really supporting another. [4]

History of monetary policy

Monetary policy is associated with interest rates and availabilility of credit. Instruments of monetary policy have included short-term interest rates and bank reserves through the

monetary base.[5] For many centuries there were only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of monetary policy during this time. Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seigniorage, or the power to coin. With the advent of larger trading networks came the ability to set the price between gold and silver, and the price of the local currency to foreign currencies. This official price could be enforced by law, even if it varied from the market price. Paper money called "jiaozi" originated from promissory notes in 7th century China. Jiaozi did not replace metallic currency, and were used alongside the copper coins. The successive Yuan Dynasty was the first government to use paper currency as the predominant circulating medium. In the later course of the dynasty, facing massive shortages of specie to fund war and their rule in China, they began printing paper money without restrictions, resulting in hyperinflation. With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with gold, the idea of monetary policy as independent of executive action began to be established.[6] The goal of monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold-backed currencies. To accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both their own borrowers, and other banks who required liquidity. The maintenance of a gold standard required almost monthly adjustments of interest rates. During the 1870-1920 period, the industrialized nations set up central banking systems, with one of the last being the Federal Reserve in 1913.[7] By this point the role of the central bank as the "lender of last resort" was understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no small part because of the marginal revolution in economics, which demonstrated how people would change a decision based on a change in the economic trade-offs. Monetarist macroeconomists have sometimes advocated simply increasing the monetary supply at a low, constant rate, as the best way of maintaining low inflation and stable output growth.[8] However, when U.S. Federal Reserve Chairman Paul Volcker tried this policy, starting in October 1979, it was found to be impractical, because of the highly unstable relationship between monetary aggregates and other macroeconomic variables.[9] Even Milton Friedman acknowledged that money supply targeting was less successful than he had hoped, in an interview with the Financial Times on June 7, 2003. [10][11][12] Therefore, monetary decisions today take into account a wider range of factors, such as:
y y y y y y y

short term interest rates; long term interest rates; velocity of money through the economy; exchange rates; credit quality; bonds and equities (corporate ownership and debt); government versus private sector spending/savings;

y y

international capital flows of money on large scales; financial derivatives such as options, swaps, futures contracts, etc.

A small but vocal group of people, primarily libertarians and Constitutionalists[13], advocate for a return to the gold standard (the elimination of the dollar's fiat currency status and even of the Federal Reserve Bank). Their argument is basically that monetary policy is fraught with risk and these risks will result in drastic harm to the populace should monetary policy fail. Others[who?] see another problem with our current monetary policy. The problem for them is not that our money has nothing physical to define its value, but that fractional reserve lending of that money as a debt to the recipient, rather than a credit, causes all but a small proportion of society (including all governments) to be perpetually in debt. In fact, many economists[who?] disagree with returning to a gold standard. They argue that doing so would drastically limit the money supply, and throw away 100 years of advancement in monetary policy. The sometimes complex financial transactions that make big business (especially international business) easier and safer would be much more difficult if not impossible. Moreover, shifting risk to different people/companies that specialize in monitoring and using risk can turn any financial risk into a known dollar amount and therefore make business predictable and more profitable for everyone involved. Some have claimed that these arguments lost credibility in the global financial crisis of 2008-2009.
Trends in central banking

The central bank influences interest rates by expanding or contracting the monetary base, which consists of currency in circulation and banks' reserves on deposit at the central bank. The primary way that the central bank can affect the monetary base is by open market operations or sales and purchases of second hand government debt, or by changing the reserve requirements. If the central bank wishes to lower interest rates, it purchases government debt, thereby increasing the amount of cash in circulation or crediting banks' reserve accounts. Alternatively, it can lower the interest rate on discounts or overdrafts (loans to banks secured by suitable collateral, specified by the central bank). If the interest rate on such transactions is sufficiently low, commercial banks can borrow from the central bank to meet reserve requirements and use the additional liquidity to expand their balance sheets, increasing the credit available to the economy. Lowering reserve requirements has a similar effect, freeing up funds for banks to increase loans or buy other profitable assets. A central bank can only operate a truly independent monetary policy when the exchange rate is floating.[14] If the exchange rate is pegged or managed in any way, the central bank will have to purchase or sell foreign exchange. These transactions in foreign exchange will have an effect on the monetary base analogous to open market purchases and sales of government debt; if the central bank buys foreign exchange, the monetary base expands, and vice versa. But even in the case of a pure floating exchange rate, central banks and monetary authorities can at best "lean against the wind" in a world where capital is mobile. Accordingly, the management of the exchange rate will influence domestic monetary conditions. To maintain its monetary policy target, the central bank will have to sterilize or offset its foreign exchange operations. For example, if a central bank buys foreign exchange (to counteract appreciation of the exchange rate), base money will increase. Therefore, to sterilize that increase, the central bank must also sell government debt to contract the monetary base by an equal amount. It follows that turbulent activity in foreign exchange

markets can cause a central bank to lose control of domestic monetary policy when it is also managing the exchange rate. In the 1980s, many economists [who?] began to believe that making a nation's central bank independent of the rest of executive government is the best way to ensure an optimal monetary policy, and those central banks which did not have independence began to gain it. This is to avoid overt manipulation of the tools of monetary policies to effect political goals, such as re-electing the current government. Independence typically means that the members of the committee which conducts monetary policy have long, fixed terms. Obviously, this is a somewhat limited independence. In the 1990s, central banks began adopting formal, public inflation targets with the goal of making the outcomes, if not the process, of monetary policy more transparent. In other words, a central bank may have an inflation target of 2% for a given year, and if inflation turns out to be 5%, then the central bank will typically have to submit an explanation. The Bank of England exemplifies both these trends. It became independent of government through the Bank of England Act 1998 and adopted an inflation target of 2.5% RPI (now 2% of CPI). The debate rages on about whether monetary policy can smooth business cycles or not. A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a significant number of prices in the economy are fixed in the short run and firms will produce as many goods and services as are demanded (in the long run, however, money is neutral, as in the neoclassical model). There is also the Austrian school of economics, which includes Friedrich von Hayek and Ludwig von Mises's arguments,[15] but most economists fall into either the Keynesian or neoclassical camps on this issue.
Developing countries

Developing countries may have problems establishing an effective operating monetary policy. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is often because the monetary authority in a developing country is not independent of government, so good monetary policy takes a backseat to the political desires of the government or are used to pursue other non-monetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarization. Such forms of monetary institutions thus essentially tie the hands of the government from interference and, it is hoped, that such policies will import the monetary policy of the anchor nation. Recent attempts at liberalizing and reforming financial markets (particularly the recapitalization of banks and other financial institutions in Nigeria and elsewhere) are gradually providing the latitude required to implement monetary policy frameworks by the relevant central banks.

Types of monetary policy

In practice, to implement any type of monetary policy the main tool used is modifying the amount of base money in circulation. The monetary authority does this by buying or selling financial assets (usually government obligations). These open market operations change either the amount of money or its liquidity (if less liquid forms of money are bought or sold). The multiplier effect of fractional reserve banking amplifies the effects of these actions. Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate. The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.

Monetary Policy: Inflation Targeting

Target Market Variable: Interest rate on overnight debt Interest rate on overnight debt

Long Term Objective: A given rate of change in the CPI

Price Level Targeting Monetary Aggregates Fixed Exchange Rate

A specific CPI number

The growth in money supply A given rate of change in the CPI The spot price of the currency The spot price of gold Usually interest rates The spot price of the currency Low inflation as measured by the gold price Usually unemployment + CPI change

Gold Standard Mixed Policy

The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking exactly the same variables (such as a harmonized consumer price index).
Inflation targeting

Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range.

The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar. The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee. Changes to the interest rate target are made in response to various market indicators in an attempt to forecast economic trends and in so doing keep the market on track towards achieving the defined inflation target. For example, one simple method of inflation targeting called the Taylor rule adjusts the interest rate in response to changes in the inflation rate and the output gap. The rule was proposed by John B. Taylor of Stanford University.[16] The inflation targeting approach to monetary policy approach was pioneered in New Zealand. It is currently used in Australia, Brazil, Canada, Chile, Colombia, the Czech Republic, New Zealand, Norway, Iceland, Philippines, Poland, Sweden, South Africa, Turkey, and the United Kingdom.
Price level targeting

Price level targeting is similar to inflation targeting except that CPI growth in one year over or under the long term price level target is offset in subsequent years such that a targeted price-level is reached over time, e.g. five years, giving more certainty about future price increases to consumers. Under inflation targeting what happened in the immediate past years is not taken into account or adjusted for in the current and future years.
Monetary aggregates

In the 1980s, several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc.). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. This approach is also sometimes called monetarism. While most monetary policy focuses on a price signal of one form or another, this approach is focused on monetary quantities.
Fixed exchange rate

This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation. Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export

licenses, etc.). In this case there is a black market exchange rate where the currency trades at its market/unofficial rate. Under a system of fixed-convertibility, currency is bought and sold by the central bank or monetary authority on a daily basis to achieve the target exchange rate. This target rate may be a fixed level or a fixed band within which the exchange rate may fluctuate until the monetary authority intervenes to buy or sell as necessary to maintain the exchange rate within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a special case of the fixed exchange rate with bands where the bands are set to zero.) Under a system of fixed exchange rates maintained by a currency board every unit of local currency must be backed by a unit of foreign currency (correcting for the exchange rate). This ensures that the local monetary base does not inflate without being backed by hard currency and eliminates any worries about a run on the local currency by those wishing to convert the local currency to the hard (anchor) currency. Under dollarization, foreign currency (usually the US dollar, hence the term "dollarization") is used freely as the medium of exchange either exclusively or in parallel with local currency. This outcome can come about because the local population has lost all faith in the local currency, or it may also be a policy of the government (usually to rein in inflation and import credible monetary policy). These policies often abdicate monetary policy to the foreign monetary authority or government as monetary policy in the pegging nation must align with monetary policy in the anchor nation to maintain the exchange rate. The degree to which local monetary policy becomes dependent on the anchor nation depends on factors such as capital mobility, openness, credit channels and other economic factors.

old standard

The gold standard is a system under which the price of the national currency is measured in units of gold bars and is kept constant by the government's promise to buy or sell gold at a fixed price in terms of the base currency. The gold standard might be regarded as a special case of "fixed exchange rate" policy, or as a special type of commodity price level targeting. The minimal gold standard would be a long-term commitment to tighten monetary policy enough to prevent the price of gold from permanently rising above parity. A full gold standard would be a commitment to sell unlimited amounts of gold at parity and maintain a reserve of gold sufficient to redeem the entire monetary base. Today this type of monetary policy is no longer used by any country, although the gold standard was widely used across the world between the mid-19th century through 1971.[17] Its major advantages were simplicity and transparency. The gold standard was abandoned during the Great Depression, as countries sought to reinvigorate their economies by increasing their money supply. [18] The Bretton Woods system, which was a modified gold standard, replaced it in the aftermath of World War II. However, this system too broke down during the Nixon shock of 1971. The gold standard induces deflation, as the economy usually grows faster than the supply of gold. When an economy grows faster than its money supply, the same amount of money is

used to execute a larger number of transactions. The only way to make this possible is to lower the nominal cost of each transaction, which means that prices of goods and services fall, and each unit of money increases in value. Absent precautionary measures, deflation would tend to increase the ratio of the real value of nominal debts to physical assets over time. For example, during deflation, nominal debt and the monthly nominal cost of a fixedrate home mortgage stays the same, even while the dollar value of the house falls, and the value of the dollars required to pay the mortgage goes up. Mainstream economics considers such deflation to be a major disadvantage of the gold standard. Unsustainable (i.e. excessive) deflation can cause problems during recessions and financial crisis lengthening the amount of time a economy spends in recession. William Jennings Bryan rose to national prominence when he built his historic (though unsuccessful) 1896 presidential campaign around the argument that deflation caused by the gold standard made it harder for everyday citizens to start new businesses, expand their farms, or build new homes.
Policy of various nations
y y y y y y y y y y y y y y y y y

Australia - Inflation targeting Brazil - Inflation targeting Canada - Inflation targeting Chile - Inflation targeting China - Monetary targeting and targets a currency basket Czech Republic - Inflation targeting Colombia - Inflation targeting Hong Kong - Currency board (fixed to US dollar) India - Multiple indicator approach New Zealand - Inflation targeting Norway - Inflation targeting Singapore - Exchange rate targeting South Africa - Inflation targeting Switzerland - Inflation targeting [19] Turkey - Inflation targeting United Kingdom[20] - Inflation targeting, alongside secondary targets on 'output and employment'. United States[21] - Mixed policy (and since the 1980s it is well described by the "Taylor rule," which maintains that the Fed funds rate responds to shocks in inflation and output)

Monetary policy tools

Monetary base

Monetary policy can be implemented by changing the size of the monetary base. Central banks use open market operations to change the monetary base. The central bank buys or sells reserve assets (usually financial instruments such as bonds) in exchange for money on deposit at the central bank. Those deposits are convertible to currency. Together such currency and deposits constitute the monetary base which is the general liabilities of the central bank in its own monetary unit. Usually other banks can use base money as a fractional reserve and expand the circulating money supply by a larger amount.

Reserve requirements

The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in the money supply. Central banks typically do not change the reserve requirements often because it creates very volatile changes in the money supply due to the lending multiplier.
Discount window lending

Discount window lending is where the commercial banks, and other depository institutions, are able to borrow reserves from the Central Bank at a discount rate. This rate is usually set below short term market rates (T-bills). This enables the institutions to vary credit conditions (i.e., the amount of money they have to loan out), thereby affecting the money supply. It is of note that the Discount Window is the only instrument which the Central Banks do not have total control over. By affecting the money supply, it is theorized, that monetary policy can establish ranges for inflation, unemployment, interest rates ,and economic growth. A stable financial environment is created in which savings and investment can occur, allowing for the growth of the economy as a whole.
Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market. One cannot set independent targets for both the monetary base and the interest rate because they are both modified by a single tool open market operations; one must choose which one to control. In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the money supply.
Currency board

A currency board is a monetary arrangement that pegs the monetary base of one country to another, the anchor nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local

monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are threefold:
1. To import monetary credibility of the anchor nation; 2. To maintain a fixed exchange rate with the anchor nation; 3. To establish credibility with the exchange rate (the currency board arrangement is the hardest form of fixed exchange rates outside of dollarization).

In theory, it is possible that a country may peg the local currency to more than one foreign currency; although, in practice this has never happened (and it would be a more complicated to run than a simple single-currency currency board). A gold standard is a special case of a currency board where the value of the national currency is linked to the value of gold instead of a foreign currency. The currency board in question will no longer issue fiat money but instead will only issue a set number of units of local currency for each unit of foreign currency it has in its vault. The surplus on the balance of payments of that country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the (net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the hands of the central bank. The virtue of this system is that questions of currency stability no longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade, irrespective of economic differences between it and its trading partners. Hong Kong operates a currency board, as does Bulgaria. Estonia established a currency board pegged to the Deutschmark in 1992 after gaining independence, and this policy is seen as a mainstay of that country's subsequent economic success (see Economy of Estonia for a detailed description of the Estonian currency board). Argentina abandoned its currency board in January 2002 after a severe recession. This emphasized the fact that currency boards are not irrevocable, and hence may be abandoned in the face of speculation by foreign exchange traders. Following the signing of the Dayton Peace Agreement in 1995, Bosnia and Herzegovina established a currency board pegged to the Deutschmark (since 2002 replaced by the Euro). Currency boards have advantages for small, open economies that would find independent monetary policy difficult to sustain. They can also form a credible commitment to low inflation.

Unconventional monetary policy at the zero bound

Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns about deflation or deflation is occurring, are referred to as unconventional monetary policy. These include credit easing, quantitative easing, and signaling. In credit easing, a central bank purchases private sector assets, in order to improve liquidity and improve access to credit. Signaling can be used to lower market expectations for future interest rates. For example, during the credit crisis of 2008, the US Federal Reserve indicated rates would be low for an extended period , and the Bank of Canada made a conditional commitment to keep rates at the lower bound of 25 basis points (0.25%) until the end of the second quarter of 2010.

Reforms in the Indian Monetary Policy During 1990s

The Monetary policy of the RBI has undergone massive changes during the economic reform period. After 1991 the Monetary policy is disassociated from the fiscal policy. Under the reform period an emphasis was given to the stable macro economic situation and low inflation policy. The major changes in the Indian Monetary policy during the decade of 1990. 1. Reduced Reserve Requirements : During 1990s both the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) were reduced to considerable extent. The CRR was at its highest 15% plus and additional CRR of 10% was levied, however it is now reduced by 4%. The SLR is reduced form 38.5% to a minimum of 25%. 2. Increased Micro Finance : In order to strengthen the rural finance the RBI has focused more on the Self Help Group (SHG). It comprises small and marginal farmers, agriculture and non-agriculture labour, artisans and rural sections of the society. However still only 30% of the target population has been benefited. 3. Fiscal Monetary Separation : In 1994, the Government and the RBI signed an agreement through which the RBI has stopped financing the deficit in the government budget. Thus it has seperated the Monetary policy from the fiscal policy. 4. Changed Interest Rate Structure : During the 1990s, the interest rate structure was changed from its earlier administrated rates to the market oriented or liberal rate of interest. Interest rate slabs are now reduced up to 2 and minimum lending rates are abolished. Similarly, lending rates above Rs. Two lakh are freed. 5. Changes in Accordance to the External Reforms : During the 1990, the external sector has undergone major changes. It comprises lifting various controls on imports, reduced tariffs, etc. The Monetary policy has shown the impact of liberal inflow of the foreign capital and its implication on domestic money supply. 6. Higher Market Orientation for Banking : The banking sector got more autonomy and operational flexibility. More freedom to banks for methods of assessing working funds and other functioning has empowered and assured market orientation.

Evaluation of the Monetary Policy in India

During the reforms though the Monetary policy has achieved higher success in the Monetary policy, it is not free from limitation or demerits. It needs to be evaluated on a proper scale. 1. 2. 3. Failed in Tackling Budgetary Deficit : The higher level of the budget deficit has made the Monetary policy ineffective. The automatic monetization of the deficit has led to high Monetary expansion. Limited Coverage : The Monetary policy covers only commercial banking system leaving other non -bank institutions untouched. It limits the effectiveness of the monitor policy in India. Unorganized Money Market : In our country there is a huge size of the unorganized money market. It dose not come under the control of the RBI. Thus any tools of the Monetary policy dose not affect the unorganized money market making Monetary policy less affective. 4. Predominance of Cash Transaction : In India still there is huge dominance of the cash in total money supply. It is one of the main obstacles in the effective implementation of the Monetary policy. Because Monetary policy operates on the bank credit rather on cash. 5. Increase Volatility : As the Monetary policy has adopted changes in accordance to the changes in the external sector in India, it could lead to a high amount of the volatility. There are certain drawbacks in the working of the Monetary Policy in India. However, during the economic reforms it has got different dimensions.

How do you evaluate monetary policy?

By Amol Agrawal

Suppose you are made a consultant to a central bank to evaluate their monetary policy. How does one go about it? Lars Svensson has a paper on the same. Urbanomics also has some comments on the paper. Evaluating inflation-targeting monetary policy is more complicated than checking whether inflation has been on target, because inflation control is imperfect and flexible inflation targeting means that deviations from target may be deliberate in order to stabilize the real economy. A modified Taylor curve, the forecast Taylor curve, showing the tradeoff between the variability of the inflation-gap and output-gap forecasts can be used to evaluate policy ex ante, that is, taking into account the information available at the time of the policy decisions, and even evaluate policy in real time. In particular, by plotting mean squared gaps of inflation and output-gap forecasts for alternative policy-rate paths, it may be examined whether policy has achieved an efficient stabilization of both inflation and the real economy and what relative weight on the stability of inflation and the real economy has effectively been applied. Ex ante evaluation may be more relevant than evaluation ex post, after the fact. Publication of the interest-rate path also allows the evaluation of its credibility and the effectiveness of the implementation of monetary policy. Pretty interesting paper and much of it is in English. Gives you some ideas on evaluating monetary policy and takes you to economics textbooks where we evaluated choices given a frontier (production, consumption etc).

Insider trading
Insider trading is the trading of a corporation's stock or other securities (e.g. bonds or stock options) by individuals with potential access to non-public information about the company. In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise in breach of a fiduciary or other relationship of trust and confidence or where the non-public information was misappropriated from the company.[1] In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders (in the U.S., defined as beneficial owners of ten percent or more of the firm's equity securities) must be reported to the regulator or publicly disclosed, usually within a few business days of the trade. Many investors follow the summaries of these insider trades in the hope that mimicking these trades will be profitable. While "legal" insider trading cannot be based on material non-public information, some investors believe corporate insiders nonetheless may have better insights into the health of a corporation (broadly speaking) and that their trades otherwise convey important information (e.g., about the pending retirement of an important officer selling shares, greater commitment to the corporation by officers purchasing shares, etc.) Illegal insider trading is believed to raise the cost of capital for securities issuers, thus decreasing overall economic growth. [2]

[edit]Legal insider trading

Legal trades by insiders are common, as employees of publicly-traded corporations often have stock or stock options. These trades are made public in the US through SEC filings, mainly Form 4. Prior to 2001, US law restricted trading such that insiders mainly traded during windows when their inside information was public, such as soon after earnings releases.[3] SEC Rule 10b5-1 clarified that the U.S. prohibition against insider trading does not require proof that an insider actually used material nonpublic information when conducting a trade; possession of such information alone is sufficient to violate the provision, and the SEC would impute an insider in possession of material nonpublic information uses this information when conducting a trade. However, Rule 10b5-1 also created for insiders an affirmative defense if the insider can demonstrate that the trades conducted on behalf of the insider were conducted as part of a preexisting contract or written, binding plan for trading in the future.[3] For example, if a corporate insider plans on retiring after a period of time and, as part of his or her retirement planning, adopts a written, binding plan to sell a specific amount of the company's stock every month for the next two years, and during this period the insider comes into possession of material nonpublic information about the company, any subsequent trades based on the original plan might not constitute prohibited insider trading.

[edit]Illegal insider trading

Rules against insider trading on material non-public information exist in most jurisdictions around the world, though the details and the efforts to enforce them vary considerably. The United States is generally viewed as having the strictest laws against illegal insider trading, and makes the most serious efforts to enforce them.[4]
[edit]Definition of "insider"

In the United States and Germany, for mandatory reporting purposes, corporate insiders are defined as a company's officers, directors and any beneficial owners of more than ten percent of a class of the company's equity securities. Trades made by these types of insiders in the company's own stock, based on material non-public information, are considered to be fraudulent since the insiders are violating the fiduciary duty that they owe to the shareholders. The corporate insider, simply by accepting employment, has undertaken a legal obligation to the shareholders to put the shareholders' interests before their own, in matters related to the corporation. When the insider buys or sells based upon company owned information, he is violating his obligation to the shareholders. For example, illegal insider trading would occur if the chief executive officer of Company A learned (prior to a public announcement) that Company A will be taken over, and bought shares in Company A knowing that the share price would likely rise. In the United States and many other jurisdictions, however, "insiders" are not just limited to corporate officials and major shareholders where illegal insider trading is concerned, but can include any individual who trades shares based on material non-public information in violation of some duty of trust. This duty may be imputed; for example, in many jurisdictions, in cases of where a corporate insider "tips" a friend about non-public information likely to have an effect on the company's share price, the duty the corporate insider owes the company is now imputed to the friend and the friend violates a duty to the company if he or she trades on the basis of this information.
[edit]Liability for insider trading

Liability for insider trading violations cannot be avoided by passing on the information in an "I scratch your back, you scratch mine" or quid pro quo arrangement, as long as the person receiving the information knew or should have known that the information was company property. It should be noted that when allegations of a potential inside deal occur, all parties that may have been involved are at risk of being found guilty. For example, if Company A's CEO did not trade on the undisclosed takeover news, but instead passed the information on to his brother-in-law who traded on it, illegal insider trading would still have occurred.[5]
[edit]Misappropriation theory

A newer view of insider trading, the "misappropriation theory" is now part of US law. It states that anyone who misappropriates (steals) information from their employer and trades on that information in any stock (not just the employer's stock) is guilty of insider trading.

For example, if a journalist who worked for Company B learned about the takeover of Company A while performing his work duties, and bought stock in Company A, illegal insider trading might still have occurred. Even though the journalist did not violate a fiduciary duty to Company A's shareholders, he might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering).[6]
[edit]Proof of responsibility

Proving that someone has been responsible for a trade can be difficult, because traders may try to hide behind nominees, offshore companies, and other proxies. Nevertheless, the U.S. Securities and Exchange Commission prosecutes over 50 cases each year, with many being settled administratively out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity.
[edit]Trading on information in general

Not all trading on information is illegal inside trading, however. For example, while dining at a restaurant, you hear the CEO of Company A at the next table telling the CFO that the company's profits will be higher than expected, and then you buy the stock, you are not guilty of insider trading unless there was some closer connection between you, the company, or the company officers. However, information about a tender offer (usually regarding a merger or acquisition) is held to a higher standard. If this type of information is obtained (directly or indirectly) and there is reason to believe it is non-public, there is a duty to disclose it or abstain from trading.[7]
[edit]Tracking insider trades

Since insiders are required to report their trades, others often track these traders, and there is a school of investing which follows the lead of insiders. This is of course subject to the risk that an insider is making a buy specifically to increase investor confidence, or making a sell for reasons unrelated to the health of the company (e.g. a desire to diversify or pay a personal expense). As of December 2005 companies are required to announce times to their employees as to when they can safely trade without being accused of trading on inside information.
[edit]Insider Trading vs. Insider Information

In the industry of investing, there is a difference between insider trading and insider information. For example, there was information released about Continental and United Airlines merging in late 2009. At the turn of the year, it was believed that the merger was going to fall through and that the two companies were not going to act upon the merger. By summer of 2010 and the final signing of the legal details (a), the deal went through officially. The acquisition of the added resources, capital, and infrastructure for the two companies would easily drive up the stock price of the new company under UAL on the New York Stock Exchange. With this done, insider traders could have acted back when there were rumors assuming the price would have gone up. However, insider informants said that the merger fell through and nothing was going to happen. This creates gossip in the trading world

and information that an insider can be giving out to friends and family may not be completely accurate since they do not know the full story. Generally, insider traders act upon information that they believe to be true that is not available to the public giving them the upper hand in making profits. Insider informants pass along information in the form of gossip and do not personally buy or sell stock based on projections. Whether or not either party is acting illegally is solely in the hands of the SEC