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CENTRAL BANKING AND FUNCTIONS OF CENTRAL BANK

Introduction
The primary goal of central banks is to provide their countries currencies with price stability by controlling inflation. It is responsible for providing its economy with funds when commercial banks cannot cover a supply shortage. A central bank also acts as the regulatory authority of a country's monetary policy . Provider and printer of notes and coins in circulation. The central bank adjusts the volume of currency.

History of central bank


Starts with the establishment of the Bank of England in 1694. . The central bank at early stages was primarily responsible for maintaining the convertibility of gold into currency. The central bank's independence from the political machine after WW1. Changed scenario afterWWII.

How the Bank Influences an Economy

Macroeconomic Influences

Microeconomic Influences

Transitional Economies

Macroeconomic Influences
The central bank must regulate the level of inflation by controlling money supplies by means of monetary policy. Open market operations are the key means by which a central bank controls inflation, money supply, and price stability.

Microeconomic Influences

Enforcing a policy of commercial bank reserves. Central banks will hold commercialbank reserves that are based on a ratio of each commercial bank's deposits. Controls open market transactions by giving funds to commercial banks.

Transitional Economies
Issue of transition from managed to free market economies. The main concern is controlling inflation.

Government intervention, whether direct or indirect through fiscal policy, can stunt central bank development.
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Central Banking Systems

While new functions were acquired as central banks evolved into public policy agencies, the accompanying change in underlying objectives was rarely explicitly stated.

Given the context, one could infer that the objective underlying all functions was-for the economic interests of the nation, consistent with government economic policy.
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Contemporary Thinking on Central Bank Objectives For most contemporary commentators, central bank objectives should include: Macroeconomic stability, relating to domestic inflation and the foreign exchange rate

Longer term considerations of financial sector development Immediate issues of the sound management and financial health of financial institution
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Monetary Policy Objectives

Price stability is usually the dominant monetary policy objective specified in legislation.

Stability in the domestic purchasing power of the currency.


These are superior to other macroeconomic objectives specified in the law for example, in mandates such as those requiring central bank support for the governments general economic policy without prejudice to the central banks primary price stability objective.

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Financial Stability Objectives

The great majority of central banks operate under the presumption that they have a policy responsibility for financial stability.
They act as lender of last resort. Low stable inflations. Stable Interest and Exchange rates.
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Payment System Objective

To supervise the smooth operation of the clearing and payment system and satisfy itself that they are efficient and sound .

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Differences Between Central Banking & Commercial Banking System

The central bank is the apex monetary institution, which has been specially empowered to exercise control over the banking system of the country. The commercial bank, on the contrary, is a constituent unit of the banking system.

The central bank does not operate with a profit motive. The commercial banks, on the other hand, have profit earning as their primary objective.

The central bank is generally a state-owned institution, while the commercial banks are normally privately owned institutions.

The central bank does not deal directly with the Public. The 15

Differences Between Central Banking & Commercial Banking System

The central bank does not compete with the commercial banks. Rather it helps them by acting as the lender of the last resort.

The central bank has the monopoly of note-issue, whereas the commercial banks do not enjoy such right.

The central bank is the custodian of the foreign exchange reserves of the country. The commercial banks are only the dealers in foreign exchange.

The central bank acts as the banker to the government, the commercial banks act as bankers to the general public.
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Differences Between Central Banking & Commercial Banking System

Differences Based on Deposits

Differences Based on Loans

Differences Based on Services

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FUNCTIONS OF CENTRAL BANK

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Monetary Management
Regulation of the issue of Bank notes and the keeping of reserves with a view to securing monetary stability . Deals with the use of various policy instruments for influencing the cost and availability of money in the economy to promote economic growth and ensure price stability.

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Monetary Management Policy in India

Maintaining price stability, ensuring adequate flow of credit to productive sectors The Governor of the Reserve Bank announces the Monetary Policy in April every year for the financial year that ends in the following March. This is followed by three quarterly reviews in July, October and January.

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. The Monetary Policy in April and its Second Quarter Review in October consist of two parts:
Part A
provides a review of the macroeconomic and monetary developments

Part B
provides a synopsis of the action taken and the status of past policy announcements together with fresh policy measures. It also deals with important topics, such as, financial stability, financial markets, interest rates, credit delivery, regulatory norms, financial inclusion and institutional developments.
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Issuer of currency
The central bank has the sole monopoly of note issue in almost every country. unlimited legal tender throughout the country ADVANTAGES

brings uniformity in the monetary system The central bank can exercise better control over the money supply in the country. Monetary management of the paper currency becomes easier. Can change the quantity of currency in accordance with the monetary requirement of the economy
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Enables the central bank to exercise control over the creation of credit by the commercial banks. The central bank also earns profit from the issue of paper currency. avoids the political interference in the matter of note issue. Issue and Management of Currency in India Paper Currency Act of 1861 - monopoly of note issue 1861 1935 - Govt. of India
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From 1935 RBI RBI carries out the currency management function through its Department of Currency Management , central office Mumbai 19 Issue Offices located across the country. Reserve Bank has authorized selected branches of banks to establish currency chests There is a network of 4,281 Currency Chests and 4,044 Small Coin Depots .

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Banker, Agent and Adviser to the Government


same functions for the government as a commercial bank performs for its customers maintains the accounts of the central as well as state government receives deposits , collects cheques and drafts foreign exchange resources to the government for repaying external debt or purchasing foreign goods floats loan to which the public can subscribe

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As an agent
collects taxes and other payments on behalf of the government manages public debt by raising loans from the public represents the government in the international financial institutions and conferences

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As a financial adviser
gives advise to the government on economic, monetary, financial matters such as deficit financing, devaluation, trade policy, foreign exchange policy, etc.

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RBI As Banker to the Central Government


Central Government is required to maintain a minimum cash balance with the Reserve Bank RBI does not handle governments day-to-day transaction RBI works out the overall funds position and sends daily advice showing the balances The daily advices are followed up with monthly statements

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Banker's bank

CB acts as a friend, philosopher and guide to the commercial banks


As a custodian of the cash reserves As a lender of last resort

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As a custodian of the cash reserves


central bank maintains the cash reserves of the commercial bank Every bank has to keep a certain percentage of its cash balances as deposits with the CB in India, the Reserve Bank provides the facility of opening accounts with itself provides short-term loans and advances to select banks, when

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As a lender of last resort


A lender of last resort is an institution which is willing to offer loans as a last resort preserve the stability of the banking and financial system by protecting individuals deposited funds avoid great depressions by acting as lenders of last resort in times of financial crisis

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Financial regulation and supervision


The objective of this function is to protect the interests of depositors through an effective prudential regulatory frame work for orderly development and conduct of banking operations. The financial system of a country includes commercial banks, regional rural banks, local area banks, cooperative banks, financial institutions and non-banking financial companies.

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Regulatory functions of RBI Licensing For commencing banking operations in India, whether by an Indian or a foreign bank, a license from the Reserve Bank is required. The opening of new branches by banks and change in the location of existing branches are also regulated as per the Branch Authorization Policy.

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Corporate governance The Reserve Banks policy objective is to ensure high-quality corporate governance in banks It has issued guidelines stipulating fit and proper criteria for directors of banks Statutory pre-emptions Interest rate Reserve bank regulates the interest rates on savings bank accounts
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Prudential norms RBI keeps a close watch on developing trends in the financial markets and fine tunes the prudential policies. Risk management The reserve bank requires banks to have effective risk management to cover credit risk, material risk, operational risk

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Disclosure norms Banks are required to make disclosures in their annual report about capital adequacy, asset quality, liquidity etc. Know your customer norms To prevent money laundering through the banking system, the Reserve Bank has issued (KYC), (AML) and (CFT) guidelines. Protection of small depositors The Reserve Bank has set up Deposit Insurance and Credit Guarantee Corporation (DICGC) to protect the interest of small depositors, in case of bank failure.

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Para banking activities The banking sector reforms and the gradual deregulation of the sector inspired many banks to undertake non-traditional banking activities, also known as Parabanking. Supervisory functions The Reserve Bank undertakes supervision of banks to monitor and ensure compliance by them with its regulatory policy framework. This is achieved through on-site inspection, off-site surveillance and periodic meetings with top management of banks.

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On site inspection The Reserve Bank undertakes annual onsite inspection of banks to assess their financial health and to evaluate their performance in terms of quality of management, capital adequacy, asset quality, earnings, liquidity position as well as internal control systems.

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Off-site surveillance The Reserve Bank requires banks to submit detailed and structured information periodically under its Off Site Surveillance and Monitoring System (OSMOS). Periodic meetings The Reserve Bank periodically meets the top management of banks to discuss the findings of its inspections.

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Monitoring of frauds The Reserve Bank regularly sensitizes banks about common fraud-prone areas, the modus operandi and the measures necessary to prevent frauds.

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MONEY MARKET
REPO Sale of securities together with an agreement for the seller to buy back the securities at a later date.
Commercial

Banks borrow money from Central Bank to meet short term needs.
They

have to sell securities, usually bonds to Central Bank with an agreement to repurchase them at a predetermined rate and date.
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MONEY MARKET

Reserve bank charges some interest rate on the cash borrowed by banks. This rate is usually less than the interest rate on bonds. This interest rate is called repo rate

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MONEY MARKET

Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as security in a repo transaction. Legal title to the securities passes from the seller to the buyer

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Types of repo
1)

Overnight repo: One day maturity transaction Term repo : Repo with specified end date : Repo with no end date

2)

3)

Open repo

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Types of repo
1)

Specified delivery: Requires the delivery of a pre specified bond at the onset, and at maturity of the contractual period Tri party repo : A custodian bank or international clearing organization, the tri-party agent, acts as an intermediary between the two parties to the repo. Held in custody : The collateral pledged by the borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ("held in custody") by the borrower, for the lender, throughout the duration of the trade Whole loan repo: Transaction is collateralized by a loan rather than a security.
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2)

3)

4)

Types of repo

Equity repo: Equity repos are simply repos on equity securities such as common shares. Sell/buyback repo: A sell/buy back is the spot sale and a forward repurchase of a security. Reverse repo: A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. The seller executing the transaction would describe it as a "repo", while the buyer in the same transaction would describe it a "reverse repo. 46

Foreign Exchange Management


Foreign Exchange reserves: Foreign currency deposits and bonds held by monetary authorities including Central Bank. Central Bank: A custodian of countrys Foreign Exchange reserves.

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Major Focus on:

Adding to the comfort of market participants by demonstrating the backing of domestic currency by external assets. Maintaining foreign currency liquidity to absorb shocks in terms of crisis. Maintaining markets confidence in exchange rate policies.

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Investment of Reserves
Majority foreign currency assets deposited can be converted into cash at short notice. Counterparties with whom deals are completed are subjected to rigorous selection.

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1.Payment and Settlement Systems


core responsibility of central banks Important for the financial system and the transmission of monetary policy Initiating reforms to ensure efficient and faster flow of funds among various constituents of the financial sector increasing monetization in the economy, the countrys large geographic expanse, preference for paper-based instruments

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The Payment and Settlement Systems Act, 2007 for regulation and supervision of payment systems in India. Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), 2005 Department of Payment and Settlement Systems (DPSS) to assist BPSS

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a) Development, Consolidation and Integration


three-pronged strategy to establish a modern and robust payment and settlement system Consolidation- expanding the reach of the existing products by introducing clearing process in new locations. facilitated by the use of latest technology

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a) Development, Consolidation and Integration


Integrating- payment system with the settlement systems for government securities and foreign exchange. Negotiated Dealing System (NDS) to facilitate settlement of Government securities transactions. Clearing Corporation of India Limited (CCIL) for settlement of trade in various sectors.

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2. Developmental Role
supporting developmental activities includes

ensuring credit to productive sectors of the economy creating institutions to build financial infrastructure expanding access to affordable financial services encouraging efficient customer service extension of banking service to all
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a) Rural Credit
agrarian character of the Indian economy ensured timely and adequate credit to the agricultural sector at affordable cost conduct special studies in areas necessary promoting integrated rural development Priority Sector Lending, Lead Bank

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b) Micro, Small and Medium Enterprises Development


Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 to modify the definition of micro, small and medium enterprises engaged in production measures by RBI/ GOI to improve the credit flow to these sectors are Collateral Free Loans, Credit Guarantee Scheme for Small Industries by SIDBI, Specialized MSE Branch in every District etc.

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c) Export Credit
Export Import Bank of India (EXIM Bank), 1982, to ensure adequate availability of concessional bank credit to exporters interest rates on export credit have been rationalized RB prescribed the banks to lent adjusted net bank credit to exporters by foreign banks

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d) Financial Inclusion
need for the RBI to develop Financial Inclusion for inclusive growth banks not reaching and bringing vast segments of the population mainly underprivileged sections of society causes basic banking services not reaching the desired extent

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e) Customer Service

focuses on
protection of customers rights enhancing the quality of customer service strengthening the grievance redressal mechanism in banks

the Reserve Banks initiatives for this are


- setting up of a Customer Redressal Cell - creation of a Customer Service Department and the setting up of the Banking Codes and Standards Board of India (BCSBI)
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3. Policy Research and Data Dissemination


rich tradition of policy-oriented research and an effective mechanism for disseminating data its own research capabilities in economics, finance and statistics better understanding of the functioning of the economy and changes in the policy transmission mechanism

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a) Internal Research
research undertaken on issues in the current environment having implications on Indian economy disseminates data in the form of several publications and through its website India among Special Data Dissemination Standards (SDDS) defined by the IMF for releasing data

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b) Data and Research Dissemination


periodical publications about its operations, trends and developments in economy also periodicals on monetary policy, official press releases, speeches and interviews on RBs assessment of economy the Annual Report and the Report on Trend and Progress of Banking in India every year

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larger database on the Indian economy through the Reserve Banks website The Handbook of Statistics on the Indian Economy since 1996 two research departments Department of Economic Analysis and Policy and Department of Statistics and Information Management provide research on economy

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Case Study 1: Reserve bank of India

The Reserve Bank of India (RBI) is the central banking institution of India and controls the monetary policy of the Indian rupee example for semi autonomous type of banks. central bank that depends on the political echelons and, especially, on the Ministry of Finance. RBI plays an important part in the development strategy of the government. This dependence could be through its budget which is allocated to it by the Ministry or by a Parliament
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Structure of RBI
The organization of RBI can be divided into three parts:

Central Board of Directors. Local Boards Offices of RBI


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1.Central Board of Directors


One Governor: it is the highest authority of RBI. He is appointed by the Government of India for a term of 5 years. He can be re-appointed for another term. Four Deputy Governors: Four deputy Governors are nominated by Central Govt. for a term of 5 years Fifteen Directors : fifteen members of the Central Board are appointed by the Central Government. Out of these , four directors,one each from the four local Boards are nominated by the Government separately by the Central Government

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2.Local Boards

local boards for four regional areas of the country with their head-quarters at Mumbai, Kolkata, Chennai, and New Delhi. consist of five members each, appointed by the central Government for a term of 4 years to represent territorial and economic interests and the interests of co-operatives and indigenous banks.
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3. Offices of RBI

The Head office of the bank is situated in Mumbai The offices of local boards are situated in Delhi, Kolkata and Chennai. In order to maintain the smooth working of banking system, RBI has opened local offices or branches in Ahmedabad, Bangalore, Bhopal, Bhubaneshwar, Chandigarh, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Nagpur, Patna, Thiruvananthpuram, Kochi, Lucknow and Byculla (Mumbai).
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Functions of RBI
Monopoly of note issue: This function helps the Central Bank to control money supply in the economy. All currency notes except one rupee note and coins are issued by the Issue Department of the central bank Banks to the Government: The RBI is the Banker's agent and adviser to the government It accepts deposits and make payments on behalf of the Government

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Banker's Bank: RBI acts as a banker for all the commercial banks All scheduled banks come under the direct control of RBI The RBI helps the member banks: (a) It acts as the lender of the last resort. (b) It is the custodian of cash reserves of commercial banks. (c) It clears, transfers the transaction. It acts as the central clearing house.
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Management of foreign exchange reserves: RBI is the custodian of the foreign exchange reserves of the country It is the responsibility of the RBI to stabilize external value of rupee and carry out transactions in foreign currencies. Credit control: The central bank uses the quantitative and qualitative tools to control credit. It is one of the principal functions of RBI. It helps the bank to ensure exchange rate stability and price stability

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CASE STUDY 2: FEDERAL RESERVE SYSTEM(FED)


Central Banking system of US Created on 23rd December 1913 Autonomous bank, Politically and financially independent Self sustaining and runs itself

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PURPOSE OF ESTABLISHING
Primary motivation was to address banking panics Other purposes are stated in Federal reserve act Severe crisis in 1907 in US led the congress to enact the Federal Reserve Act in 1913

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STRUCTURE
Fed has both private and public components Can make decisions without the permission of Congress or the President of the U.S The System does not require public funding Fed has four main components

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The Board of Governors


Seven board of governors is a federal agency Regulates and supervises the US banking sysytem Governors are appointed by the president and confirmed by the senate

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FEDERAL OPEN MARKET COMMITTEE(FOMC)


Consists of 12 members 7 from the Board of Governors and 5 of the regional Federal Reserve Bank presidents Oversees open market operations Directs operations undertaken by the Federal Reserve in foreign exchange markets

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12 FEDERAL RESERVE BANKS


Each reserve Bank is responsible for member banks located in its district Each regional Bank has a president, who is the CEO of their Bank

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MEMBER BANKS
A member bank is a private institution and owns stock in its regional Federal Reserve Bank More than one-third of U.S commercial banks are members of the Federal Reserve System

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Current Objectives
To address the problem of banking panics To serve as the central bank for the United States To strike a balance between private interests of banks and the centralized responsibility of government To manage the nation's money supply through monetary policy to achieve the sometimes-conflicting goals

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To provide financial services to depository institutions, the U.S government, and foreign official institutions, including playing a major role in operating the nation's payments system To strengthen U.S standing in the world economy

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THANK YOU

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