Indian Economy and issues related to planning, mobilization of resources, growth,

development and employment

Economics

Presently the policy of RBI aims at moderating inflation that is the overriding objective of its monetary policy, even
as some growth is eroded in the process. Thus a bit of growth is traded off for price stability.

Similarly, fiscal prudence (foresight) may be traded off to some extent in pursuit of welfare.

Three branches of economics

 Micro Economics: It examines the economic behavior of individual actors such as consumers, businesses,
households etc.
 Macro Economics: It studies the economy as a whole and its features like national income, employment,
poverty, balance of payments and inflation
 Meso Economics: It studies the intermediate level of economic organization like institutional arrangements.
Study of a sector of economics like auto, infrastructure etc. may fall under this category.

Approaches in mainstream economics

 Keynesian macro economics

It is based on the theories of John Maynard Keynes. According to this theory, the state can stimulate economic
growth and restore stability in the economy through expansionary policies. The intervention of the state is only
when the economic cycle turns down and growth slows down or is negative. In normal times, it is the market that
drives growth through the forces of supply and demand.

 Neo Liberalism

It refers to the advocacy of policies such as individual liberty, free markets and free trade.

 Socialist Economics

It is based on the State ownership of means of production to achieve greater equality and give the workers greater
control of the means of production.

o Nehruvian Socialism is based on co-existence of both public and private sector in a mixed economy
o Communist model establishes a fully centrally planned economy also called as Command Economy
 Development Economics

It is a branch of economics which deals with not only promoting economic growth and structural change, but also
improving the well being of the population as a whole through focus on health, education, work place conditions etc.

Economic Growth

Economic growth is generally shown as the increase in percentage terms of real GDP (GDP adjusted to inflation)

National income Accounting refers to a set of rules and techniques that are used to measure the output of a country.
Gross Domestic Product (GDP)

Gross Domestic Product (GDP) is defined as the total market value of all goods and services produced in a country in
a given period of time (usually one year)

 Nominal GDP (current prices): It refers to the current year production of final goods and services valued at
the current year prices. ($2.6 trillion and 5th largest economy; surpassed UK recently)
 Real GDP (constant prices): It refers to the current year production of goods and services valued at base year
prices or constant prices.
 GDP (PPP) = $9.45 trillion and 3rd largest economy after China and USA
 GDP per capita is $6430 and falls under lower middle income group

Real GDP growth or inflation adjusted GDP growth allows us to determine if production increased or decreased
regardless of changes in the inflation and purchasing power of the currency.

Output expressed as GDP at constant prices (Factor Cost) makes genuine sense as inflation/ deflation is factored out
and distortions of subsidies and indirect taxes are also deducted.

The data from the current prices is adjusted to the constant prices by using deflators. It helps take out the
contribution of inflation value of the output. CPI/ WPI are used as GDP deflators.

In estimating GDP, only final marketable goods and services are considered. Gains from resale are excluded but the
services provided by the agents are counted. That is when a used car or house is sold; no new goods or services are
produced. But the agent makes a sales commission which adds to the service economy. Similarly, transfer payments
such as pensions and scholarships are excluded from the GDP.

Not all goods and services from productive activities enter into the market transactions. Hence, imputations
(attribute) are made for these non-marketed but productive activities. Eg: imputed rental for owner occupied
housing.

The value of intermediate goods and services is a part of the final goods and services and so are not counted
separately as it amounts to double counting and exaggerates the value of the output.

GDP (PPP) is the sum of value of all goods and services produced in the country valued at prices prevailing in the US
in the year noted.

Market Price refers to the actual transacted price and includes indirect taxes such as sales tax, customs duty, excise
duty, service tax etc.

Factor Cost refers to the actual cost of various factors of production and it includes government grants and subsidies
but it excludes indirect taxes.

Factor Costs are the actual production costs at which goods and services are produced by the firms and industries in
an economy. They are the actual costs of land, production, labor, capital, energy, and raw materials etc. that are
used to produce a given quantity of output. They are also called farm gate or factory gate costs as all the costs
incurred take place behind the factory gate.

Transfer payments refer to payments made by the government to individuals for which there is no economic
activity produced in return by these individuals

GDP (Factor Cost) = GDP (Market Price) – Indirect taxes + Subsidies

GNP (Factor Cost) = GNP (Market Price) – Indirect Taxes + Subsidies

Indian Economy
Financial Year GDP Growth %
 India GDP (Nominal) = $2.601 trillion (Rank 9 worldwide; April 2019) FY 12 5.2%
 India GDP (PPP) = $9.45 trillion (Rank 3 Worldwide; April 2019) FY 13 5.5%
 Contribution to GDP: Agriculture= 17%; Industry=29% (17% FY 14 6.4%
manufacturing); Services = 54% (PIB, 2018 in GVA terms) FY 15 7.4%
FY 16 8%
 Contribution to Employment: Agriculture= 49%; Industry=20%;
FY 17 8.2%
Services = 31% (2013-14)
FY 18 7.2%
GDP Deflator FY 19 estimates 7%

GDP deflator is a comprehensive measure of inflation, implicitly derived from national accounts data as a ratio of GDP
at current prices to constant prices. It is available on a quarterly basis with a lag of two months since 1996. Given the
delay involved in obtaining the GDP deflator, national income aggregates extensively use WPI for deflating the
nominal price estimates to derive real price estimates.

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 ∗ 100

𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟 =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃

A price deflator of 200 means that the current year price is twice the base year price and a price deflator of 50
means that the current year price is half the base year price

Unlike some price indices, GDP deflator is not based on a fixed basket of goods and services. It covers the entire
economy.

The central bank RBI had adopted the new Consumer Price Index (CPI) (combined) as the key measure of inflation
recently.

GDP vs GNP

GDP refers to how much is produced within the boundaries of the country by both Indians and foreigners

GNP refers to the value of output produced by the nationals of a country both within and outside the country

The profits of foreign firms earned in India are included in India’s GDP but not in India’s GNP.

GDP is essentially about where it is produced while GNP is about who produces it.

 If an economy is an open economy with great levels of foreign investment and lesser levels of outbound FDI,
its GDP is likely to be greater than GNP (GDP>GNP)
 If an economy is open but more of its nationals tend to move economic activity abroad and earn more from
investing abroad compared to non-nationals doing business and earning incomes within its borders, its GNP
will be greater than GDP (GDP<GNP)
 If an economy is a closed economy where nobody leaves its shore and nobody invests abroad and nobody
invests in the country from abroad, then GDP will be equal to GNP (GDP=GNP)

Japan used to belong to the third category but now its GNP tends to be 2% larger than the GDP.

Ireland’s GDP is greater than its GNP by 20%. This is typical of a small and very open economy. When such a country
manages to attract a lot of FDI, domestic economic activity expands quite quickly. But all the earnings from that
economic activity if sent home by the companies may not leave the country richer at all.
GDP is a better measure than GNP as it involves domestic production where employment is created, inflation is
moderated and tax revenues are more.

Estimating GDP

Three approaches of estimating GDP are

 Expenditure Approach:

GDP = Consumption (C) + Investment (I) + Government Spending (G) + (Exports- Imports)

A Firm (Nation) can make the final expenditure on the following accounts

(a) the final consumption expenditure (C) on the goods and services produced by the firm. Mostly it is the
households which undertake consumption expenditure. There may be exceptions when the firms buy consumables
to treat their guests or for their employees

(b) the final investment expenditure (I) incurred by other firms on the capital goods produced by a firm. Unlike the
expenditure on intermediate goods which is not included in the calculation of GDP, expenditure on investments is
included. The reason is that investment goods remain with the firm, whereas intermediate goods are consumed in
the process of production

(c) the expenditure that the government makes (G) on the final goods and services produced by a firm. We may
point out that the final expenditure incurred by the government includes both the consumption and investment
expenditure

(d) the export revenues that a firm earns by selling its goods and services abroad minus the import payments for
goods imported. This will be denoted by NX (Net of Exports and Imports)

 Income Approach:

Wages + Profits + Rents + Interest Earnings

There may fundamentally be four kinds of contributions that can be made during the production of goods and services

(a) Contribution made by human labour, remuneration for which is called wage

(b) Contribution made by capital, remuneration for which is called interest

(c) Contribution made by entrepreneurship, remuneration of which is profit

(d) Contribution made by fixed natural resources (called ‘land’), remuneration for which is called rent.

Revenues earned by all the firms put together must be distributed among the factors of production as salaries, wages,
profits, interest earnings and rents.

 Output Approach:

Market value of all final goods and services

Only newly produced final goods are included.

GDP considers only marketed goods and services. If a cleaner is hired, his pay is included in GDP but if one does the
work himself, it does not add to the GDP. Thus, much of the work done by women at home taking care of children,
chores etc. which is called Care Economy is outside the GDP.
Net = Gross – Depreciation

A part of the capital gets consumed during the year due to wear and tear. This wear and tear is called depreciation.
Naturally, depreciation does not become part of anybody’s income.

Net National Product

The expenses incurred for repair and replacing the machinery are called depreciation expenditure.

 Net Domestic Product (NDP) = GDP (market price) – Depreciation

 Net National product (NNP) = GNP – Depreciation

National Income

It is calculated by deducting indirect taxes from NNP and adding subsidies. It is NNP at factor cost.

It is to be noted that all the variables in NNP are evaluated at market prices. Through the expression given above, we
get the value of NNP evaluated at market prices. But market price includes indirect taxes. When indirect taxes are
imposed on goods and services, their prices go up. Indirect taxes accrue to the government. We have to deduct them
from NNP evaluated at market prices in order to calculate that part of NNP which actually accrues to the factors of
production. Similarly, there may be subsidies granted by the government on the prices of some commodities. So we
need to add subsidies to the NNP evaluated at market prices. The measure that we obtain by doing so is called Net
National Product at factor cost or National Income.

NI = (GNP – Depreciation) – Indirect Taxes + Subsidies

NI = NNP – Indirect Taxes + Subsidies

NI = NNP (Factor Cost)

Per Capita GDP = GDP/ Mid Year population for the corresponding year

The real GDP per capita income of an economy is often used as an indicator of the average standard of living of
individuals in a country. India’s per capita income is Rs. 93293.

Personal Income

Personal Income (PI) is the part of NI which is received by households. First, let us note that out of NI, which is earned
by the firms and government enterprises, a part of profit is not distributed among the factors of production. This is
called Undistributed Profits (UP). We have to deduct UP from NI to arrive at PI, since UP does not accrue to the
households. Similarly, Corporate Tax, which is imposed on the earnings made by the firms, will also have to be
deducted from the NI, since it does not accrue to the households. On the other hand, the households do receive
interest payments from private firms or the government on past loans advanced by them. And households may have
to pay interests to the firms and the government as well, in case they had borrowed money from either. So we have
to deduct the net interests paid by the households to the firms and government. The households receive transfer
payments from government and firms (pensions, scholarship, prizes, for example) which have to be added to
calculate the Personal Income of the households.

Personal Income (PI) = National Income (NI) – Undistributed Profits (UP) – Corporate Taxes - Net Interest Payments
made by households + Transfer Payments

If we deduct the Personal Tax Payments (income tax, for example) and Non-tax Payments (such as fines) from PI,
we obtain what is known as the Personal Disposable Income (PDI)
Personal Disposable Income (PDI) = Personal Income (PI) – Personal Taxes – Non Tax Payments

National Disposable Income

National Disposable Income (NDI) = NNP (at market prices) + Other Current Transfers from rest of the World

It gives an idea of what is the maximum amount of goods and services in the domestic economy at its disposal.
Current transfers from the rest of the world include items such as gifts, aid, etc.

Private Income = Factor Income (income derived from selling the services of factors of production) from NDP accruing
to Private Sector + National Debt Interest (money borrowed by government) + Net Factor Income from Abroad +
Current Transfers from Government + Other Net Transfers from the Rest of the World

Base Year

Base year is a specific year from which the economic growth is measured. It is allocated a value of 100 in an index.
The base year of the national accounts is changed periodically to take into account structural changes in the
economy.

The first official estimates of national income were prepared by the Central Statistical Organization (CSO) with base
year 1948-49 for the estimates at constant prices. Currently 2011-12 base year is being used.

A base year has to be a normal year without large fluctuations in production, trade and prices of commodities in
general. Reliable price data should be available and should be as recent as possible. The National Statistical
Commission wants the base year to be revised every 5 years.

Problems in calculating National Income

 Black Money: Illegal activities such as smuggling and unreported incomes due to tax evasion and corruption
are outside the GDP estimates
 Non Monetization: In most of the rural economy, considerable portion of transactions occur informally and
they are called as non-monetized economy
 Household Services: The national income accounts do not include the Care economy – domestic work and
housekeeping
 Social Services: It ignores voluntary and charitable work as it is unpaid
 Environmental Costs: National Income estimation does not account for environmental costs incurred in
production of goods

Business Cycles

Alternating periods of expansion and decline in economic activity is called business cycle. There are 4 stages in a
business cycle: Expansion, Growth, slowdown and decline.

 Economic slowdown: gradual deflationary situation, lack of demand etc.

 Recession: Decline in GDP for 2 or more consecutive quarters
 Depression: Recession that lasts longer; has a larger decline in business activity. Real GDP declines by > 10%
 Meltdown: financial assets losing in value in a tail spin, often resulting in liquidity crisis and collapse
 Recovery: Steady rise in general level of prices, income, output and employment
 Boom: Business activity at high level with increasing income, output and employment at macro level

Recession may end with governmental measures such as stimulus. However, if it does not end after stimulus and
relapses due to any reason, then it is called double dip recession. Eg: UK in 2012
Reliability of GDP as a measure of progress

Disadvantages of GDP

 GDP does not value intangibles like leisure, quality of life etc.
 Impact on environment may be harmful
 It only gives average figures that hide stratification and economic inequality is not revealed
 Condition of poor is not indicated
 Gender disparities are not indicated
 It does not matter how the increase in wealth takes place- whether by civilian demand or by war
 GDP does not measure sustainability of growth
 It is not strictly speaking a measure of standard of living

It is not an exact measure of standard of living. For example, a country which exported 100% of its production would
still have a high GDP but a very poor standard of living.

The argument in favor of using GDP is that standard of living tends to increase when GDP per capita increases. This
makes GDP a proxy for standard of living rather than a direct measure of it.

The major advantages to using GDP as an indicator of standard of living are that it is measured frequently, widely and
consistently.

Alternatives to GDP

Human Development Index, 1993

UN HDI is a standard means of measuring well being. It was developed in 1990 by Pakistani economist Mahbub ul
Haq and has been used by UNDP since 1993.

HDI measures the average achievements in a country in 3 dimensions

 Health measured by life expectancy at birth (68.8 years)

 Education measured by expected years of schooling (12.3 years) and mean years of schooling (6.4 years)
 Standard of living measured by GDP (PPP) per capita ($6353)

All the above parameters have equal weights

India ranks at 130/189 (131 in 2017) as per the UNDP HDR report of 2018 based on 2017 data with HDI of 0.64

The 2010 Human Development Report came up with Inequality adjusted Human Development Index which factors
the inequalities in the three dimensions of human development: Life Expectancy, Education and Income

Inequality adjusted HDI in 2018 is 0.468

Gender Development Index (GDI) is the ratio of the HDIs calculated separately for females and males using the same
methodology as in the HDI.

Human Poverty Index (HPI), 1997 (replaced by Multidimensional Poverty Index)

HPI is an indication of the standard of living in a country developed by the UN and was first reported in the Human
Development Report, 1997. It was considered to better reflect the extent of deprivation in developed countries
compared to the HDI. Indicators used are
  Life Span
 Functional Literacy Skills
 Long term Unemployment
 Relative Poverty

A Kuznets curve graphs the hypothesis that as an economy develops, market forces first increase and then decrease
economic inequality

Multi dimensional Poverty Index (MPI), 2010

It is made up of several factors that constitute poor people’s experience of deprivation- such as poor health, lack of
education, inadequate living standards, lack of income, disempowerment, poor quality of work and threat from
violence. It captures the multiple aspects that contribute to poverty. It was developed by Oxford Poverty and Human
Development Initiative and the UNDP

Dimensions of MPI Indicators

Child Mortality (48/1000)
Health
Nutrition
Years of school
Education
Children enrolled (92%, 69%, 25%)
Cooking fuel
Toilet
Water
Living Standards
Electricity
Floor
Assets

Genuine Progress Indicator (GPI)

It is a concept in green economics and welfare economics. It distinguished uneconomic growth- harmful economic
growth under which inequalities pile up and environmental damage is huge.

GPI is an attempt to measure whether or not a country’s growth, increased production of goods and expanding
services have actually resulted in the improvement of the welfare of the people in the country.

Gross National Happiness (GNH)

It is an attempt to define the quality of life in more holistic and psychological terms than GDP.

It was coined by Bhutan’s former King Jigme Singye Wangchuk in 1972. The concept of GNH is based on the premise
that true development takes place when material and spiritual development occur side by side to complement and
reinforce each other.

The 9 domains of GNH are psychological wellbeing, health, time use, education, cultural diversity and resilience, good
governance, community vitality, ecological diversity and resilience, living standard
World Happiness Report

The World Happiness Report, published by the United Nations Sustainable Development Solutions Network (SDSN).
Finland>Denmark>Norway>Iceland>Netherlands are the top 5 countries in 2018.

India was ranked 140/156 countries (133 in 2018) in 2019

The report is based on six factors – levels of GDP, life expectancy, generosity, social support, freedom, and
corruption as indicators of happiness.

Natural Resources Accounting and Green GDP

By failing to account for reductions in the stock of natural resources, standard measures of national income do not
represent economic growth genuinely.

National Biodiversity Action Plan in 2008 highlighted as an action point the valuation of goods and services provided
by bio diversity. In Nagoya meet in 2010, India declared that it will adopt Natural Resource Accounting.

Green GDP

It is an index of economic growth with the environmental consequences of that growth factored in. From the final
value of goods and services produced, the cost of ecological degradation is deducted to arrive at Green GDP.

In 2004, Wen Jiabao, the Chinese Premier announced that green GDP index would replace the Chinese GDP. But the
effort was dropped in 2007 as green GDP figures shrank the size of the GDP to unimpressive levels

In the calculation of Green GDP, there are methodological concerns about how to monetize the loss of bio diversity,
how to measure the economic impacts of climate change due to green house gas emissions etc.

Stiglitz Report

The Commission on the measurement of economic performance and social progress was set up in 2008 on the French
Government’s initiative. Its aim is to identify the limits of GDP as an indicator of economic performance and social
progress and to consider additional information required for the production of a more relevant picture.

The Stiglitz report recommends that

 economic indicators should stress well being instead of production and for non-market activities such as
domestic and charity work to be taken into account
 Indexes should integrate complex realities such as crime, environment and the efficiency of the health
system as well as income inequality.

Types of Economies

Moral Economy

It is the interplay between economic activity and cultural mores. It describes the various ways in which custom and
social pressure coerce economic actors in a society to conform to traditional norms even at the expense of profit. If
moral economy breaks down, industrial unrest may result.

It is an economy in which stakeholders like workers expect respect and dignity along with salary and working
conditions.
Laissez Faire

A market economy is an economic system in which goods and services are traded with the price being determined by
demand and supply.

It is generally understood to be a doctrine opposing economic interventionism by the government beyond the extent
which is perceived to be necessary to maintain peace and property rights

By pursuing his own interest, an individual frequently promotes that of the society more effectually than when he
really intends to promote it. Adam Smith calls it the invisible hand- the force that combines the individual self
interest into a collective self interest.

Social Market

It seeks an alternative economic system other than laissez faire and socialism by combining private sector enterprise
with measures of state to establish fair competition, low inflation and low level of unemployment, good working
conditions and social welfare.

Most modern industrialized nations today are not typically representatives of Laissez Faire principles, as they usually
involve significant amounts of government intervention. This intervention includes

 minimum wages to increase standard of living

 anti-monopoly regulation to prevent monopolies
 progressive income taxes
 welfare programs to provide safety net for the needy
 disability assistance
 subsidy programs for business and agricultural products
 government ownership of some industries
 regulation of market competition to ensure fair standards and practices
 economic trade barriers

Market Failure: It is the inability of an unregulated market to achieve allocation efficiency. The main types of market
failure are monopoly, steep inequality and pollution

Government failure occurs when the government does not efficiently allocate goods and resources to the
consumers. Inefficient use of resources, wastage, retarded economic growth due to monopolies and regulation are the
results of governmental failure Eg: Air India

Structural Composition of the Economy

 The primary sector of the economy involves changing natural resources into primary products
 The secondary sector includes those economic sectors that create a finished usable product: Manufacturing
and construction
 The tertiary sector involves the provision of services to businesses as well as final consumers
 The quaternary sector is an extension of the three sector hypothesis and concerns the intellectual services:
information generation, information sharing, consulting, R&D
 Quinary sector comprises health, education, culture, police, fire service and other government services not
intended to make profit. It also includes the domestic activities such as those performed by stay at home
parents or homemakers.
Structure of Global Economy

Countries with more advanced economies than developing nations but which have not yet fully demonstrated the
signs of developed economies are called newly industrialized countries.

A high income country is defined by the World Bank as a country with a GNI per capita income of USD 12055 in 2017.
Some high income countries may also be developing countries, Eg: Gulf Countries are rich but not developed. They
have deep pockets of export economy based on oil and gas and the rest of the economy is under developed.
Second world was the communist countries with command economies but they do not exist today.

As per World Bank Atlas Method, For the current 2019 fiscal, lending groups are defined based on GNI per capita in
2017

 Low income Economies: GNI Per capita<=$995

 Lower Middle Income Countries: $996<=GNI Per capita <=$3895
 Upper Middle Income Countries: $3896<=GNI Per capita<=$12055
 High Income Countries: GNI Per capita >=$12056

Third World was made of developing countries

Least Developed Countries (LDCs) or Fourth World Countries are countries that exhibit lowest indicators of socio-
economic development. A country is classified as LDC if it meets the following conditions

 Low income ( 3 year average per capita < $995)

 Human Resource Weakness (nutrition, health, education and adult literacy)
 Economic Vulnerability (based on instability in agricultural production, export of goods and services and
percentage of people displaced by natural disasters)
Socio-Economic Planning

In a planned economy, State owns partly or wholly the economy. If the State owns the whole economy, it is called a
Command Economy (China, North Korea, Cuba, Laos and Vietnam). If there is room for private market forces, it is
called Mixed Economy.

Characteristics of centrally planned economies

 Important role for government in the management of the economy

 Goals are set by the government and private investors together
 Investment is shared by the two according to their capacity
 There is largely a welfare orientation to the economy

In a market economy, state has minimal role in the management of the economy; Production, consumption and
distribution decisions are predominantly left to the market. State plays a certain role in redistribution.

Indicative Planning is one where there is a mixed economy with State and Market playing significant roles to
achieve targets for growth that they together set. It is operated under a planned economy and not under a command
economy.

Command economies were set up in China and Russia for faster economic growth but they have been dismantled in
the last two decades as they do not create wealth sustainably and are not conducive for innovation and efficiency.
Cuba and North Korea are still Command Economies.

History of Economic Planning in India

 Visweswarayya Plan, 1934

Visweswarayya pointed to the success of Japan and insisted that “industries and trade do not grow of themselves,
but have to be willed, planned and systematically developed”. Expert economists and businessmen were to do the
planning and the goal was poverty eradication through growth.

 National Planning Committee Plan, 1938

INC established the NPC under the chairmanship of Nehru in 1938. It stated the objective of planning for
development was to ensure adequate living standards for the masses. It advocated heavy industries that were
essential both to build other industries and for India’s self defence. Heavy industries had to be under public
ownership for both redistributive and security purposes.

 Bombay Plan, 1944

In 1944, leading industrialists (Purushottam Das Thakur Das, JRD Tata, GD Birla and Others) put forward a plan for
economic development popularly known as the Bombay Plan. It saw India’s future progress based on further
expansion of the textile and consumer industries already flourishing in cities like Bombay and Ahmedabad. It saw an
important role for the state in providing infrastructure, invest in basic industries like steel and protect Indian
industry from foreign competition.

 People’s Plan

During the 1940s, the Indian Federation of Labor published its People’s Plan by MN Roy that stressed on employment
and wage goods (final goods specifically intended for mass market)
  Gandhian Plan

SN Agarwala, follower of Mahatma Gandhi published the Gandhian Plan that emphasized on decentralization,
agriculture development, employment and cottage industries.

Long term goals of Planning

 Growth

Economic growth is the increase in the value of goods and services produced in an economy. It is conventionally
measured by increase in rate of real GDP.

Economic Development refers to growth that includes redistributive aspects and social justice. Economic growth is
necessary for development but not sufficient

 Modernization

Modernization is improvement in technology. It is driven by innovation and investment in R&D.

 Self Reliance

It means relying on the resources of the country and not depending on other countries and MNCs for investment and
growth. Long term development is not possible unless there is a large degree of self reliance. Nehru Mahalanobis
growth model that closed Indian economy and relied on basic industries is the main plank for self reliance.

 Social Justice

It means inclusive and equitable growth where inequalities are not steep and benefits of growth reach all rural-
urban, man-woman; caste divides and inter regional divides are reduced

Five Year Plans

 1st 5 Year Plan (1951-56)

Stressed more on agriculture in view of large scale import of food grains and inflationary pressures on the economy

 2nd 5 Year Plan (1956-61)

Major stress was on establishment of heavy industries. It was based on Nehru-Mahalanobis self reliance and basic
industry driven growth

 3rd 5 Year Plan (1961-66)

The aim was to establish a self sustaining economy. Rupee was devalued for the first time in 1966. India’s conflict
with Pakistan and repeated droughts contributed to the failure of this plan

 Plan Holiday (1966-69)

As the third plan experienced difficulties on the external front and the economic troubles mounted on the domestic
front due to inflation, floods and food crisis, the fourth plan could not be started from 1966. There were three annual
plans till 1969.

 4th 5 Year Plan (1969-74)

The main objective of this plan was growth with stability. It laid special emphasis on improving the condition of the
under privileged and weaker sections through provision of education and employment. It introduced the concept of
import substitution (replacing foreign imports with domestic production) as a strategy for industrialization

 5th 5 Year Plan (1974-79)

The main objective of the plan was Growth for Social Justice.

 Plan Holiday (1979-80)

Nil

 6th 5 Year Plan (1980-85)

Removal of poverty was the foremost objective of this plan. Another area of emphasis was on the development of
infrastructure. Direct attack on poverty was the main stress on the Plan unlike the earlier strategy of trickledown
effect where the growth of economy was expected to benefit all in course of time.

 7th 5 Year Plan (1985-90)

It stressed on rapid growth of food grains production and increase in employment opportunities. This plan saw the
beginning of liberalization of Indian economy

 Plan Holiday (1990-92)

The 8th five year plan could not be started in 1990 due to the economic crisis and political instability.

 8th 5 Year Plan (1992-97)

The main emphasis of the plan was

 To stabilize the adverse BoP scenario sustainably

 Improvement in trade and CAD
 Human Development as main focus of planning
 Shift in pattern of industrialization with lower emphasis on heavy industries and higher focus on
infrastructure

It was the first indicative plan and was formulated in a way so as to manage the transition from centrally planned
economy to market led economy. It was based on Rao-Manmohan Singh model of liberalization.

 9th 5 Year Plan (1997-02)

A growth rate of 6.5% was targeted with 3.9% for agriculture. The key strategies to realize the set target rested on
attaining a high investment rate of 28.2% of GDP at market prices and domestic saving rate which determines
sustainable level of investment.

 10th 5 Year Plan (2002-07)

The main objectives of the Tenth Five-Year Plan were:

 Attain 8% GDP growth per year

 Reduction of poverty rate by 5% by 2007
 Providing gainful and high-quality employment at least to the addition to the labour force
 Reduction in gender gaps in literacy and wage rates by at least 50% by 2007
  20-point program was introduced

 11th 5 Year Plan (2007-12)

The main objectives of the Eleventh Five-Year Plan were:

 Rapid and inclusive growth(Poverty reduction)

 Emphasis on social sector and delivery of service therein
 Empowerment through education and skill development
 Reduction of gender inequality
 Environmental sustainability
 To increase the growth rate in agriculture, industry and services to 4%,10% and 9% respectively
 Reduce Total Fertility Rate to 2.1
 Provide clean drinking water for all by 2009
 increase agriculture growth to 4%

 12th 5 Year Plan (2012-17)

 The theme of the Approach Paper is “faster, sustainable and more inclusive growth”.
 Average growth target has been set at 8.2 percent
 Areas of main thrust are-infrastructure, health and education
 The 12th Plan seeks to achieve 4 percent agriculture sector growth during the five-year period
 On poverty alleviation, the commission plans to bring down the poverty ratio by 10 percent. At present,
the poverty is around 30 per cent of the population.

Relevance of Planning

 Federal cooperation and coordination

 Equitable Growth
 Environment Friendly Development
 Defending National interest in the age of globalization
 Inter-sectoral balance of growth

Planning Commission to Niti Aayog

The planning commission was replaced by National Institution for Transforming India Aayog which means a sharp
break from National Development Plans to Policy and Institutional change for transforming India.

Need for Niti Aayog

 Today our aspirations have soared and we seek elimination of poverty and not alleviation
 People require institutional reforms in governance and dynamic policy shifts that can seed and nurture large
scale change
 India needs an administration paradigm in which the government is an enabler rather than a provider of first
and last resort

Role of Niti

The primary role is to serve as a think tank for the government to give strategic and technological advice across the
spectrum of key elements of policy.
Specific objectives of Niti

 To design strategic and long term policy and programme frameworks and initiatives
 Monitor their progress and their efficacy
 Use lessons learnt from feedback to make innovative improvements including necessary mid-course
corrections
 To provide advice and encourage partnerships between key stakeholders and national and international
like-minded think tanks as well as educational and policy research institutions
 To create knowledge, innovation and entrepreneurial support system through a collaborative community of
national and international experts, practitioners and other partners
 To maintain state of the art resource center, be a repository of research on good governance and best
practice in sustainable and equitable development
 Focus on technology building and capacity building for implementation of programmes and initiatives

The NITI Aayog could throw light on long-term issues, with solutions that
are not just economic or technological but also social and political — of
strengthening democracy, building institutions and regaining policy space

Structure of Niti Aayog

Designation Name

Chairperson Shri Narendra Modi

Vice Chairperson Arvind Panagariya

Full-Time Member Prof. Ramesh Chand

Full-Time Member Shri V.K. Saraswat

Full-Time Member Shri Bibek Debroy

Chief Executive Officer Shri Amitabh Kant

National Development Council

NDC is neither a constitutional body nor a statutory body and was set up in 1952

 To prescribe guidelines for the formation of the national plan

 To consider the national plans formulated by the planning commission
 To assess the resources for the plan and recommend a strategy for mobilizing the resources
 To consider important questions of socio-economic policy affecting development of the nation
 To review the progress of the five year plan mid-course and suggest measures for achieving the original
targets

NDC comprises the PM, All Union Cabinet Ministers; State CMs, UT Administrators, Members of Planning Commission
and Invited Ministers of State (MoS) with independent charge.

It is the apex body for decision making and deliberations on development matters.

Financial Resources for plans

Financial resources for the plan come from

  Central Budget
 State Budgets
 PSEs
 Domestic Private Sector
 FDI

Gross Budgetary Support is the amount from the central budget that goes to fund the plan investments during the
plan period.

Resources of the centre consist of both budgetary resources including external assistance routed through the
budget and Internal and Extra Budgetary Resources (IEBR) of CPSEs.

The quantum of overall budgetary support is divided into budgetary support for Central Plan and Central Assistance
for States’ Plans.

Indicative Planning

It is characterized by an economy where the private sector is given substantial role with State as a facilitator and not
as a regulator.

The need to have market as a collaborator rather than subordinate arises from the fact that the market investment
is more than 50% for the plan goals and therefore cooperation is the only viable way. Together, markets and state
would set the goals, make investments and achieve goals. The role of the government pertains to

 Providing strategic direction to the economy

 Make its own share of investments
 Ensure consistent, irreversible, predictable and growth oriented policies

Since the government did not contribute the majority of financial resources, it had to indicate the policy direction to
the corporate sector and encourage them to contribute to the plan targets. Government should create the right
policy climate- predictable, irreversible and transparent- to help the corporate sector contribute resources for the
plan.

Indicative planning is to assist the private sector with information that is essential for its operations regarding
priorities and plan targets. Government and the Corporate Sector are both responsible for the accomplishment of
planning goals.

It gives the private sector encouragement to achieve growth in areas where the country has inherent strengths-
pharma, IT, engineering goods etc.

Rolling Plan

In this type of planning, every year three new plans are made and implemented- annual plan, 5 year plan and
perspective plan.

Perspective plan is made for 10-15 years into which the other two plans are dovetailed annually

Financial Planning

In this planning, physical targets are set in line with available financial resources. Mobilization and setting
expenditure pattern of financial resources is the focus of this type.
Physical Planning

Output targets are prioritized with inter-sectoral balance. Having set output targets, finances are raised later.

Nehru-Mahalanobis Growth model

“If industrialization is to be rapid enough, the country must aim at developing basic industries and industries which
make machines to make the machines needed for further development”

It is based on the predominance of basic goods as it would attract all round investment and result in higher growth
rate and output which will further develop small scale and ancillary industry to boost employment generation,
alleviate poverty and improve exports. Other elements include

 Import substitution by using protective barriers

 Sizeable public sector active in vital areas such as railways and atomic energy
 Vibrant small scale sector driving consumer goods

The strategy is criticized for the imbalances between the growth of heavy industry sector and other spheres like
agriculture and consumer goods. It is further criticized as it relied on the trickledown effect- benefits of growth will
flow to all sections in course of time.

Rao-Manmohan Singh Model of Growth

Its essence is contained in the New Industrial Policy 1991 and extends beyond it too.

The major components of the model are

 Reorient the role of the State in economic management and focus on social and infrastructural development
 Dismantle selective controls and permits to allow private investment liberally
 Open up the economy and create competition for PSEs
 External sector liberalization to integrate Indian economy with the global economy to benefit from resource
flows and competition

Positive results of reforms

 Rates of growth went up

 BoP crisis has been solved in the first few years after 1990
 Services sector allowed India to become a global player
 Exports recovered well
 Consumer choice has increased
 FIIs and FDIs have picked up
 Establishment of Indian firms in the Global Market

Deficiencies of reforms

 Poverty is still a challenge

 Increased inequalities
 Jobless growth (an economic phenomenon in which a macro economy experiences growth while
maintaining or decreasing its level of employment)
 Pressure on food security despite sufficient production
 Farmers feeling directionless in the WTO regime
  Globalization threatens to destabilize agriculture with cheaper imports
 PSU reforms have not made progress
 Globalization exposed India to imported inflation due to commodity price rise

The industries requiring compulsory licensing are:

 Distillation and brewing of alcoholic drinks

 Cigars and cigarettes of tobacco and manufactured tobacco substitutes
 Electronics
 Aerospace and defense equipment
 Industrial explosives -including detonating fuses, safety fuses, gun powder, nitrocellulose and matches
 Hazardous chemicals – including items hazardous to human safety and health and thus fall for mandatory
licensing

At present only three industries are reserved for the public sector. They are:

 Atomic energy,
 minerals specified in the schedule to the atomic energy (control of production and use) order 1953,
 railway transport

Global Recession, 2008

The financial crisis is linked to the reckless lending practices by financial institutions and the growing trend of
securitization of real estate mortgages in the US. Money was lent to people with high risk credit record. Money was
lent for any number of houses on the assumption that the prices would always go up and there was no risk. The
papers associated with the lending were securitized and sold as assets. When the loaned did not return the money
as they could not due to their bad economic condition, the pack of cards fell, investment banks lost money,
commercial banks from whom they borrowed money and lent went sick and some bankrupt.

Some trace the genesis to the Chinese buying US treasuries with their export earnings thus supplying the US cheap
money that they could lend recklessly.

HUNGaMA report, 2012 (Naandi Foundation)

The HUNGaMA (Hunger and Malnutrition) Survey conducted across 112 rural districts of India in 2011 provides
reliable estimates of child nutrition covering nearly 20% of Indian children.

The HUNGaMA Survey shows that positive change for child nutrition in India is happening, including in the 100 Focus
Districts. However rates of child malnutrition are still unacceptably high particularly in these Focus Districts where
over 40 per cent of children are underweight and almost 60 per cent are stunted

The 100 Focus Districts are located across Bihar, Jharkhand, Madhya Pradesh, Orissa, Rajasthan and Uttar Pradesh –
states which perform the worst on child nutrition.

The survey notes that the prevalence of malnutrition is significantly higher among children from low-income
families. It found that children from Muslim or SC/ST households generally had worse nutrition indicators.

The survey further found that awareness among mothers about nutrition is low — “92 per cent mothers had never
heard the word malnutrition.”

The report says the nutrition advantage girls have over boys in the first months of life seems to be reversed over
time as they grow older.
Areas of development

 More emphasis should be laid on quality of implementation rather than on new programmes
 Focus on family based feeding and caring behavior rather than distributing food
 Emphasis on breast feeding in first 6 months
 Involving communities and citizen groups
 More resources to anganwadi centres targeting both children and adolescent women
 Discouraging early marriage
 Monitoring and evaluation
Fiscal System

The part of government policy which is concerned with raising revenue through taxation and with deciding on the
amounts and purposes of government spending programs

Fiscal receipts: taxes, user charges, disinvestment proceeds, borrowings from internal and external sources

All receipts are not earned and some are borrowed. Fiscal policy deals with not only quantity but also quality of
public finance.

Fiscal policy can achieve important public policy goals like growth, equity, promotion of small scale industries,
encouragement to agriculture, location of industries in rural areas, labor intensive growth, export promotion,
development of sound social and physical infrastructure etc.

Non Plan expenditure is not a constitutional term but is in use to emphasize on the point that government spends
financial resources for consumption (maintenance) as well as asset creation. It includes expenditure on interest
payments, defence, subsidies, salaries, all expenditures related to previous plan periods, maintenance expenditure
for infrastructure created in previous plan periods and public administration.

Break up of finances

Revenue Receipts are recurrent receipts and includes taxes and non tax sources. Taxes are income tax, corporation
tax, excise duty, customs duty etc. Non tax sources are user charges, interest receipts, dividends, profits etc.

Revenue Receipts

 Taxes
o Corporation Tax
o Income Tax
o Excise Duty
o Service Tax; now GST
o Customs Duty
 Non Tax Sources
o Interest Receipts
o Dividends
o Profits
o User Charges

Revenue Expenditure is essentially the non-plan expenditure that does not create assets. It is synonymous with
maintenance and consumption expenditure or welfare expenditure. It includes interest payments, defence, subsidies
and public administration

Revenue Expenditure or Non-Plan Expenditure

 Interest Payments
 Defence
 Public Administration
 Subsidies
Capital Account Receipts are recoveries of loans and advances made by the Union Government to States, UTs and
PSUs, fresh borrowing from inside the country as well as abroad, investment proceeds etc. Some of them are debt
and some of them are non-debt.

Capital Receipts

 Non debt creating receipts

o Recoveries of loans given to states
o Disinvestments
 Debt creating receipts
o Internal borrowing
o External borrowing

Capital Account Expenditure is loans made to States, UTs and PSUs, expenditure for asset creation in infrastructure
and social areas.

Capital Expenditure or Plan Expenditure

 Asset Creation in Infrastructure

 Asset Creation in Social investment

Types of Deficit

 Revenue Deficit (Target of 1.9% in 2017-18 from 2.3% of GDP in 2016-17)

It is the difference between revenue receipts and revenue expenditure.

FRBMA 2003 says that Revenue Deficit should be ZERO by the end of 2008-09. The objective is to fund for
consumption from government’s own resources and not borrowing. However, the recession of 2008 made it
necessary for the government to borrow more to stimulate the economy thus disrupting the FRBM targets.

 Effective Revenue Deficit (1.2% in 2016-17)

Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets.

The present accounting system includes all grants from the Union Government to the state governments/Union
territories/other bodies as revenue expenditure, even if they are used to create assets. Such revenue expenditures
contribute to the growth in the economy and therefore, should not be treated as unproductive in nature. Hence
Effective Revenue Deficit was introduced.

Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption
expenditure of the Government.

 Fiscal Deficit (Target of 3.3% in 2018-19)

Fiscal deficit is the difference between what the government earns and its total expenditure. It is the difference
between what is received by the government on revenue account and all the non debt creating capital receipts like
recovered loans and disinvestment proceeds and the total expenditure.

Gross Fiscal Deficit = Total Expenditure – (non debt creating capital receipts + Revenue receipts)

Net Fiscal Deficit = Gross Fiscal Deficit – Financial assistance from centre to states (loans and grants)
Fiscal deficit mirrors the health of government finances more accurately than budget deficit (borrowing from RBI)

Fiscal Deficit = Borrowing from RBI + Other liabilities of Government to meet its expenditure

 Budget Deficit

It considers only the difference between total budgeted receipts and expenditure (not actual). It was abolished in
1997. It covers only borrowings from RBI for funding the gap.

Fiscal Deficit is greater than Budgetary Deficit.

Fiscal Deficit = Budgetary Deficit + Net Increase in internal and external borrowings

 Monetized Deficit

It is the borrowings made from RBI through printing fresh currency. It is resorted to when the government cannot
borrow from the market any longer due to pressure on interest rates or when fresh money injection is necessary to
induce growth.

 Primary Deficit (0.3% of GDP in 2016-17)

It is the difference between Fiscal Deficit and the interest payments. It helps in assessing the progress of
government’s efforts towards fiscal control.

Primary Deficit = Fiscal Deficit – Interest Payments

It indicates how much of the government borrowings are going to meet expenses other than the interest payments.

A low or zero primary deficit indicates that interest commitments (on earlier loans) have forced the government to
borrow.

 Deficit Financing

It is the use of freshly printed currency to bridge the budget deficit or the gap between government revenues and
expenditure.

When the resources from taxes, user charges, public sector enterprises, public borrowings, small scale borrowings and
others are not enough, RBI prints and gives to the government and is called deficit financing.

The money printed by the RBI is called high powered money or reserve money.

The concept of budget deficit was dropped from 1997 budget and as a result deficit financing was also stopped.
FRBM disallows RBI printing money to finance government deficit in normal conditions.

Deficit financing was needed in the early stages of Independent India because

 In 1950s our domestic savings ratio was <9% of GDP (31% currently) and constrained the investment and
welfare activity of the government
 Capacity to raise non inflationary sources of financing was highly limited
 External aid could supplement domestic funding only to a limited extent and it is better to source debt from
inside than outside
 FDI was discouraged as a source of investment and thus scarcity of investment resulted
Deficit financing if done prudently and if the borrowed money is used well, it is healthy. However, if the borrowed
money is wasted for consumption, it is against good economics

The viability and desirability of deficit financing therefore depends on

 Extent of borrowing
 End use of money borrowed

Trends in Fiscal Deficit

Period Fiscal Deficit as % of GDP

2014-15 4.1%
2015-16 3.9%
2016-17 3.5%
2017-18 3.5%
2018-19 Target of 3.3%

Ways and Means Advances

Prior to 1997, RBI lent to central government against ad hoc treasury bills (short-term debt obligation backed by the
government with a maturity of less than one year). This provision for extending short term financing was created to
bridge temporary mismatches in receipts and payments. However, the central government’s practice of rolling over
this facility resulted in automatic monetization of the government’s deficit. Automaticity refers to RBI having to print
money if the government’s cash balance with the RBI went below threshold fixed. It had no choice but to print the
money and lend to the government. The process of creating 91 day bills and subsequently funding them into non
marketable special securities at very low interest rate emerged as a principal source of funding. The interest rate was
not market driven and was very concessional.

In case of state governments, RBI provides two types of WMAs. Normal WMAs are clean or unsecured advances
extended at the bank rate, while special WMAs are extended against government securities.

If the state government borrows over and above the WMA allowed for it by the RBI, it is called overdraft and there
is a limit on overdraft too.

Union Government replaced ad hoc treasury bills with WMAs in 1997. WMAs given by RBI to GOI do not require any
collateral. Its amount is limited and arrived at the beginning of the year through consultation between GOI and RBI.
There are penal interest rates if the pre agreed amount is violated. WMAs are made at the repo rate. Overdraft is
charged at a penal rate 2% above the repo rate.

How much Fiscal Deficit is right?

Fiscal deficit is bridged by market borrowing and central bank printing fresh currency (monetization), if necessary. To a
limited extent, FD is important as the Government’s ability to help growth and welfare increases. Government can
always return the loans when its revenues improve due to tax buoyancy. However, FD becomes problematic and even
destabilizing when it overshoots a rational threshold.

Sovereign debt crisis in Europe and fiscal woes in USA are a result of unsustainably high debt and borrowing.

Fiscal deficits may cause macroeconomic instability by inflating the economy as money supply rises.
Corporate sector is crowded out-they are left with inadequate funds in the markets as the government borrowing
requirements increase. Added to that, interest rates will be high as there is pressure on the available money in the
market.

Crowding Out: Increased government borrowing reduces investment spending

Borrowing leads to increase in interest rates leading to reduction in

private spending.

Increased borrowing by government leads to less money available in

the economy and therefore the demand for money increases. This
leads to rise in interest rates. Therefore the private sector which is
sensitive to interest rates reduces its investment due to a lower rate
of return from investing in projects. That is the investment is
crowded out.

India’s Debt to GDP ratio in 2018 is 69% (General Government Gross Debt) in 2018 as per IMF

If the funding route is through RBI monetization, it means inflation and instability. Inflation may mean lesser savings,
less investment and eventually it hurts the sustainability of high growth.

Large deficits, even if they do not spill over into macroeconomic instability in the short run, will require higher taxes
in the long term to cover the heavy burden of internal debt. High tax rates will place India at a significant
disadvantage to other fast-growing countries. It means, as the FRBM Act says- inter generational parity is hurt if debt
mounts as future generations will have to pay higher taxes to help the government repay the debt.

Government liabilities- interest payments- increase and there is far less for development. BOP pressures may mount
if inflows drop due to the country being downgraded by rating agencies like Standard and Poor, Moody etc.
Therefore, FDs must be moderated-they are desirable within limits but hurtful beyond the limits.

But in abnormal times like since 2008-09 when the world slipped into recession impacting Indian economy negatively,
FD must be allowed to be increased for the fiscal stimuli which are necessary to arrest downturn in the economy
and kick-start growth. FRBM allows such counter-cyclical expenditure. Even then, deficit should be incurred not for
populist expenditure but to stimulate the economy.

The sovereign debt crisis in Euro zone (2010 onwards) and particularly the Greece economy are due to excessive FD.
It borrowed and spent excessively in response to the global financial crisis. But the government was not able to raise
the money at normal rates of interest. It had to pay high rates of interest. That means it will be debt-trapped.

The lesson from Greek crisis is that FD may be incurred only for productive reasons and ensure good returns.

Up to 3% of GDP for FD as laid down by FRBM Act is desirable as the Government can borrow and spend for welfare
and growth.

The level of FD should be determined keeping in consideration the following

 whether the debt can be put to productive deployment

 The rate of return on the borrowed funds’ use is adequate
 the impact on private sector investment by way of crowding out effect etc

Even more important is not to cut social spending in a move to reduce deficit.
Introduction of GST, the DTC amendments, selective disinvestment, broadening of tax base, tax buoyancy (changes
in tax revenues with change in GDP) etc. will yield enough to moderate borrowings.

Global crisis and FD in India

Global recession impacted India and our growth rate slipped. Tax revenues were hit. There was a massive fall in
demand. Corporate sectors postponed investment Threat to employment was real.

 Firstly, the Government responded by providing three focused fiscal stimulus packages in the form of tax relief
to boost demand and increased expenditure on public projects to create employment and public assets.
 Secondly, the RBI took a number of monetary easing and liquidity enhancing measures to facilitate flow of
funds from the financial system to meet the needs of productive sectors.

This fiscal accommodation led to an increase in fiscal deficit from 2.7% in 2007-08 to 6.2% of GDP in 2008-09. These
measures were effective in arresting the fall in growth rate of GDP in 2008-09 and we achieved a growth of 6.7%

Stimulus package measures included

 CENVAT rate cut

 Higher public spending
 Lower interest rates
 Cutting excise duty and service tax

The deficit was financed by raising Internal Debt, External Assistance, and from Public Account surplus cash.

Fiscal Responsibility and Budget Management (FRBM) Act 2003

FRBM Act 2003 (Fiscal Responsibility and Budget Management (FRBM) Act 2003) was notified in 2004 with the
following salient features.

 annual targets of reduction in deficits, government borrowing and debt

 Government to annually reduce the revenue deficit by 0.5 per cent and the fiscal deficit by 0.3 per cent
beginning fiscal 2004-05
 elimination of revenue deficit and reduction of fiscal deficit to 3 % of GDP by March 31, 2009
 a cap on the level of guarantees and total liabilities of the Government
 Prohibits Government to borrow from the RBI (primary borrowing) after April 1, 2006. RBI cannot print money
to lend to the government
 On a quarterly basis that Government shall place before both the Houses of Parliament an assessment of
trends in receipts and expenditure.
 Annually present the macro-economic framework statement, medium term fiscal policy statement and
fiscal policy strategy statement. The three statements would provide the macro-economic background and
assessment relating to the achievement of FRBM goals
 Under exceptional circumstances, Government may be compelled to breach targets. In case of deviations,
the Government would not only be required to take corrective measures, but the Finance Minister shall also
make a statement in both the Houses of Parliament

FRBM was brought in for fiscal discipline; increase plan expenditure; reduce the amount of borrowings; meet
consumption from government’s own fiscal resources; leave the RBI with autonomy as far as money creation goes etc.
Fiscal consolidation is necessary particularly in the era of globalization when the penalty for irresponsibility is high.
Fiscal Consolidation

Fiscal consolidation means strengthening government finances. Fiscal consolidation is critical as it provides
macroeconomic stability; cuts wasteful expenditure and can enable government to spend more on infrastructure and
social sectors.

Tax reforms, disinvestment, better targeting of subsidies and so on are the hallmarks of fiscal consolidation.

There is a need to involve states to effect overall fiscal consolidation and strengthen the growth momentum.

GST and revised DTC are an important federal effort toward fiscal reforms and consolidation.

Fiscal consolidation in India includes the following reforms:

 revenue reforms include tax reforms on both direct and indirect tax front; rationalization of tax exemptions,
improving efficiency of tax collection, and tax stability
 On the expenditure side, reform areas include cutting out non-essential and unproductive activities, schemes
and projects, allocation of resources to priority areas, reducing cost of services, rationalizing subsidies;
reduction of time and cost overruns on projects, getting proper ‘outcome’ from output

Plan and Non Plan expenditure classification and its un-sustainability

In the Budget, expenditure is shown both as revenue and capital and also as plan and non-plan. ‘Plan’ expenditures, as
the name implies, relate to expenditures on annual plan projects contributing to five-year plan; these include
projects like dams, roads, power plants etc. Non-Plan expenditure relates to maintenance, consumption and welfare.
Non-plan expenditure does not create assets.

When a project is being built, it is plan item of expenditure. When completed and being maintained, it is a non-plan
item of expenditure.

It is important to mention that not only that maintenance expenditures subsequent to the completion of plan
programmes are non-plan, but even “expenditures on research projects and operating expenses of power stations
are classified as non-plan.

The distinction between plan and non-plan expenditure items has become simplistic and is artificial and untenable.
The building of a new school or a primary health centre is considered a Plan investment but its running and
maintenance is considered non-Plan spending. Thus, very often it had led to Government allocation being reduced
for maintenance as it is classified as non-plan item and will be criticized. Thus, assets are neglected. New projects are
allotted money while the completed projects are neglected.

Kelkar Task Force to implement FRBMA 2003 recommends reexamination of the distinction between Plan and Non-
Plan expenditure.

The Plan Non-Plan expenditure distinction was ended in Budget 2017-18.

Rangarajan panel on public expenditure, 2010

An 18-member high-level expert committee has been set up under the Chairmanship of Dr. C. Rangarajan to suggest
measures for efficient management of public expenditure. This committee will see whether the classification of
expenditure into Plan and Non-Plan is rational and can be continued.

 The government should do away with the distinction between plan and non plan expenditure
  While the planning commission should be responsible for formulation of five year plan, the task of firming
up annual budgets should be entrusted to the Finance Ministry based on inputs from the panel
 Suggested a basic shift in budgeting approach from input based budget to outputs and outcomes
 Modification in accounting classification with a view to strengthen the framework for transfer of funds from
centre to states
 Strengthening the Central plan monitoring system and empowering the citizens to seek information on flow
of resources and utilization with a view to promoting transparency and accountability

Public Debt and Other Liabilities

Public Debt includes internal debt and external debt.

Internal Debt = Borrowings inside the country such as market loans, borrowing from RBI on treasury bills

Internal debt includes loans raised by the government in the open market through treasury bills and government
securities, special securities issued to the RBI and most importantly, various bonds like the oil bonds, fertilizer bonds
etc.

The money sucked in by the Market Stabilization Scheme (MSS) is also shown in the government’s statement of
liabilities. Introduced in 2004, MSS envisages the issue of treasury bills and/or dated securities to absorb excess
liquidity arising out of the excessive foreign exchange inflows.

External Debt = Borrowings from outside India such as loans from foreign countries, international financial
institutions, NRI deposits etc.

External debt (2.9% of GDP) consists of

 long-term external debt which is the bulk part

 NRI deposits and multilateral loans
 External commercial borrowings (borrowed from foreign sources for financing the commercial activities)
 bilateral loans
 Trade Credits (credit extended to you by suppliers who let you buy now and pay later)

Other Liabilities: Outstanding against various small saving schemes, provident funds, private borrowings etc.

Zero Base Budgeting

Tenth Plan Approach Paper says that ZBB will be followed for rationalization of expenditure. The Maharashtra
Government renamed it ‘Development based budget’.

Under the ZBB, a close and critical examination is made of the existing government programmes, projects and other
activities to ensure that funds are made available to high priority items by eliminating outdated programmes and
reducing funds to the low priority items. Governmental programmes and projects are appraised every year as if they
are new and funding for the existing items is not continued merely because a part of the project cost has already been
incurred. Programmes are discarded if the cost-benefit ratio is below the prescribed norms. The objective of the ZBB
is to overhaul the functioning of the government departments and PSUs so that productivity can be increased and
wastage can be minimized. Scarce government resources can be deployed efficiently.

However, the use of ZBB to human development programmes and poverty alleviation and employment generation
programmes is limited and the results are cumulative and cannot be assessed annually.
Other terms

Fringe Benefit Tax

The benefits that are usually enjoyed collectively by the employees and cannot be attributed to individual
employees are called FBTs. They are taxed in the hands of the employer. Examples are transport services for workers
and staff, gym, club, etc. The rationale for levying a FBT on the employer lies in the inherent difficulty in isolating the
‘personal element’ where there is collective enjoyment of such benefits and attributing the same directly to the
employee. It is abolished in the Union Budget 2009-10. It is a direct tax.

Perquisites

Perquisites are benefits in addition to normal salary to which employee has a right by virtue of his employment. Perks
are taxable as a part of salary as per the India income tax laws and includes

 Value of rent free accommodation

 Value of any concession in matter of rent
 Car
 Club membership
 travel

Fiscal Drag

Fiscal Drag is a situation where inflation pushes income into higher tax brackets- bracket creep. The result is
increase in income taxes but no increase in real purchasing power. This is a problem during periods of high inflation.
Government gains due to higher tax collections and the economy suffers as growth is dragged down due to less
demand. In high-growth and high inflation economies (‘overheated’), fiscal drag acts as an automatic stabilizer, as it
acts naturally to keep demand stable.

Fiscal Neutrality

When the net effect of taxation and public spending is neutral- neither stimulating nor dampening demand- a
balanced budget. It is neutral, as total tax revenue equals total public spending.

Crowding out and crowding in effects

Excessive government borrowing can lead to shrinkage of the liquidity in the market; forces the interest rates to go
up; private investment is crowded out for two reasons: liquidity availability is less and the rates are high.
Investment suffers and growth decelerates. The Government also may not spend the borrowed funds well to generate
returns.

If the government deploys the funds well, it may have a crowding in effect: the infrastructure built can have a
multiplier effect on investment, tax collections and growth.

Pump Priming

It means deficit financing and spending by a government on public works in an attempt to revive economy during
recession- countercyclical measures. It can raise the purchasing power of the people and thus stimulate and revive
economic activity to the point that deficit spending will no longer be considered necessary to maintain the desired
economic activity.
Small savings

Small savings instruments are Post Office Monthly Income Schemes and Time Deposits; National Savings Scheme;
Indira Vikas Patra; Kisan Vikas Patra; Public Provident Fund and so on. They are aimed at promoting safe and long-
term savings by individuals.

They are initiated by the central Government but mobilized by the State Governments; and are deposited with and
managed by the central government. As a reward State Governments receive all such savings as loan.

Public goods, merit goods and demerit goods

For public goods, consumption by some does not diminish them for others. That is, they are non-rivalrous. Common
examples include law, parks, street-lighting, defence etc. They are goods meant for the entire public.

Merit goods are goods like education, health care etc. that are important for the society as a whole-that is, they
have positive externalities. Market may not supply them in adequate quantities. Government supplements the
market.

Demerit Goods are those whose consumption should be discouraged. They have negative externalities. Examples of
Demerit Goods include: tobacco, alcohol etc. (Thirteenth Finance Commission calls them sin goods and wants them
to be harshly taxed.)

Giffen Goods

They include goods whose demand goes up when the price increases. They are the status markers and exclusivist in
nature. The idea is that if you are very poor and the price of your basic foodstuff (e.g bread) increases, then you can’t
afford the more expensive alternative food (meat) therefore, you end up buying more bread because it is the only
thing you can afford. Giffen Goods are part of inferior goods

Twin Deficits

Budget deficit (fiscal deficit) and current account deficit the former fuelling the latter as the borrowings increase are
known as twin deficits. USA is a prime example.
Monetary and Credit Policy

It is a macroeconomic policy tool used to influence interest rates, inflation and credit availability through changes in
the supply of money available in the economy.

The use by the Central Bank of interest rate and other instruments to influence money supply to achieve certain
macroeconomic goals is known as monetary policy. Credit policy is a part of monetary policy as it deals with how
much and at what rate credit is advanced by the banks.

Objectives of monetary policy are:

 accelerating growth of economy

 price stability
 exchange rate stabilization
 balancing savings and investment
 Generating employment

Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy:
expansionary policy increases the total supply of money in the economy as in 2008-09 all over the world including
India to beat recession/slowdown; and a contractionary policy decreases the total money supply by tightening credit
conditions as 2005-07 in India.

Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while
contractionary policy has the goal of raising interest rates to combat inflation.

Historically, the Monetary Policy was announced twice a year – a slack season policy (April-September) and a busy
season policy (October-March) in accordance with agricultural cycles.

However, since monetary Policy has become dynamic in nature as RBI reserves its right to alter it from time to time,
depending on the state of the economy. A review of the policy takes place every quarter (now bi monthly- every 2
months).

Monetary Policy Committee

Now, meetings of the Monetary Policy Committee are held at least 4 times a year and decided benchmark interest
rates

 MPC was setup after a MoU between the GOI and the RBI about the conduct of the new inflation targeting
monetary policy framework in February 2015
 MPC replaced the previous Technical Advisory committee
 Total of 6 members with RBI Governor as Chairman, Deputy Governor and one officer of RBI + 3 members
appointed by the Centre based on recommendations of a search cum selection committee headed by the
Cabinet Secretary
 RBI governor has a casting vote and doesn’t enjoy veto power

The tools available for the central bank to achieve the monetary policy ends are the following

 Bank Rate
 Reserve ratios
 Open Market Operations
 Intervention in the forex market
  Moral suasion

Bank Rate

Bank Rate is the rate at which RBI lends long term to commercial banks. Any revision in Bank Rate by RBI is a signal
to banks to revise deposit rates as well as prime lending rate (PLR is the rate at which banks lend to the best
customers). PLR is not in use any more.

Today Bank rate stands at 6.25% (17th April 2019).

Bank rate is aligned with Marginal Standing Facility Rate which in turn is linked to the policy repo rate. It is a one-
time technical adjustment to align Bank rate with MSF rate.

The Bank rate acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements.

Bank Rate = MSF Rate (6.25%)

Ready Forward Contracts- Repo and Reverse Repo Rates

It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the
seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a
price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed
date in future at a predetermined price.

Repo Rate is the rate at which banks borrow from RBI on the security of government bonds (on a short term basis).
Banks undertake to repurchase the security at a later date – over night or few days. (6% on 17th April 2019)

Reverse repo is when RBI borrows from the market (absorbs excess liquidity) with the sale of securities and
repurchases them the next day or after a few days. The rate at which it borrows is called reverse repo rate as it is the
reverse of the repo operation. (5.75% on 17th April 2019)

100 Basis points = 1%

The Repo/Reverse Repo transaction can only be done at Mumbai and in securities as approved by RBI such as
Treasury Bills, Central/State Govt. securities. RBI uses Repo and Reverse repo as instruments for liquidity adjustment
in the system. Repo and reverse repo rates are known as policy rates and are used as signals to the financial system
to adjust their lending and borrowing operations.

Liquidity Adjustment Facility (LAF)

 It was introduced by RBI in 2000. Funds under LAF are used by the banks for their day to day mismatches in
liquidity. It covers credit at repo and reverse repo rates.

Marginal Standing Facility

In 2011, RBI introduced the MSF as a window through which the commercial banks can borrow up to 1% of their Net
Demand and Time Liabilities (NDTL) overnight. It is meant to ease liquidity in the market. MSF is 6.25% on 17th April
2019. Whenever there is an adjustment of the MSF rate, the Reserve Bank will consider and align the Bank Rate
with the revised MSF rate.

RBI uses Marginal standing facility to control and manage the money supply in the financial system. With the
increase in the rate, the borrowing becomes expensive for the commercial banks and in return the loans become
dearer for the individual or corporate borrowers, which will result in less flow of money in the market.
Also, the MSF rate is often increased by RBI to curb the excessive availability of rupee and to avoid further rupee
depreciation against a dollar.

Banks can use the repo route over and above the mandatory SLR holdings of 19% of bank deposits which means banks
can borrow using the repo route only if they maintain SLR holdings above the prescribed norms. MSF can be availed
with securities above the 19% SLR holdings or even below it. MSF is open to banks that want to borrow from the RBI
even if credit is costlier by a percentage point.

The current MSF has two components:

 Excess SLR: Banks can borrow under MSF in lieu of whatever excessive SLR they have. There is no limit here.
So say a bank has SLR of 24% and needs funds, it can borrow from RBI funds worth 5% (of its NDTL assuming
RBI fixed SLR=19%).
 Below SLR: What if a bank does not have excess SLR? Can it borrow? Yes it can. Currently RBI allows banks to
borrow 2% of NDTL below SLR under MSF and funds worth 0.5% of NDTL for providing assistance to Mutual
Funds.

MSF is the penal rate because the repo route is exhausted and also because the SLR limit is breached.

Bank rate is also a penal rate as SLR and CRR limits are breached. Therefore bank rate was brought on par with MSF
rate in 2012.

Reserve Requirements

In economics, (fractional-reserve banking is the near-universal practice of banks in which banks keep a fraction of
the total deposits managed by a bank as reserves and are not to be lent). These reserves are designed to satisfy
various needs like providing loans to the Government (SLR) and inflation management (CRR). They are in the form of
RBI approved securities (SLR) kept with themselves or cash that is kept with the RBI (CRR).

Statutory Liquidity Ratio (SLR)

It is the portion of time (fixed deposits) and demand liabilities (savings bank and current accounts) of banks that
they should keep in the form of designated liquid assets like government securities and other RBI approved
securities like public sector bonds; current account balances with other banks and gold. SLR aims at ensuring that the
need for government funds is partly but surely met by the banks. SLR was progressively brought down from 38.5% in
1991 to 19% (17th April 2019).

The Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 fixed the floor and cap on SLR at 25% and
40% respectively. But the amendments made in these statues in 2007 removed the lower limit but retained the cap
at 40%.

Cash Reserve Ratio (CRR)

It is the portion of the bank deposits that a bank should keep with the RBI in cash form. CRR deposits earn no
interest.

The Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 fixed the floor and cap on CRR at 3% and
20% respectively. But the amendment made in these statutes in 2007 removed the limits- lower and upper.

CRR is adjusted to manage liquidity and inflation. More is the CRR less is the money available for lending by the
banks to players in the economy. CRR was 15% in 1991 and today it is 4% (17th April 2019). If inflation is high, money
supply needs to be taken out and so CRR is generally increased. But in a regime of moderate inflation, low CRR is in
place.

RBI increases CRR to tighten credit and lowers CRR to expand credit. During the downturn after the global Great
Recession 2008 October onwards, CRR was reduced but as growth and inflation returned since 2009, CRR was
gradually increased.

CRR as a tool of monetary policy is used when there is a relatively serious need to manage credit and inflation.
Otherwise, normally, RBI relies on signaling its intent through the policy rates of repo. Based on these rates, RBI
conducts open market operations for liquidity management.

Open Market Operations

OMOs of the RBI can be described as purchase and sale of government securities in the open market (essentially
means banks and financial institutions) by the RBI in order to influence the volume of money and credit in the
economy. Purchases of government securities by RBI inject money into the market and thus expand credit; sales
have the opposite effect- absorb excess liquidity and shrink credit. Open market operations are RBI’s most important
and flexible monetary policy tool. Open market operations do not change the total stock of government securities
but change the proportion held by the RBI, commercial and cooperative banks.

Qualitative Controls or Selective Credit Controls are also exercised by RBI. Certain businesses can be given more and
certain others may get less credit from banks on the orders of the RBI. Thus, selective credit controls can be imposed
for meeting various goals like discouraging hoarding and black-marketing of certain essential commodities by
traders etc. by giving them less credit. Either credit can be rationed or interest rate can be hiked by RBI for certain
sectors.

 Margin Requirements: difference between securities offered and amount borrowed by Banks
 Consumer Credit Regulation: Issuing rules regarding down payment and maximum maturities of installment
credit for purchase of goods
 Guidelines: oral, written statements, appeals, warnings etc.
 Rationing of credit: control of credit granted/allocated by commercial banks
 Direct Action: against banks that don’t fulfill conditions and requirements by refusing to rediscount their
papers or charge a penal interest over bank rate etc.
 Moral Suasion: It is a persuasion measure used by Central bank to influence and pressure, but not force,
banks into adhering to policy. Measures used are closed-door meetings with bank directors, increased
severity of inspections, discussions, appeals to community spirit etc.

Growing importance of monetary policy

Generally, democratically elected governments resist use of fiscal policy to fight inflation as it requires government
to take unpopular actions like reducing spending or raising taxes. The option of cutting indirect taxes is a limited one
and is used rarely as it was done in 2009. Political realities favor a bigger role for monetary policy during times of
inflation and deflation/disinflation.

Fiscal policy may be more suited to fighting unemployment as the government can step up spending to create public
works and in the process jobs; while monetary policy may be more effective in fighting inflation/deflation.

The monetary policy remedy to economic decline is to increase the amount of money in circulation by cutting
interest rates and increasing the money supply. But once interest rates reach zero or near zero, the central bank can
do no more-economists call it the “liquidity trap,” what Japan did during the late 1990s.
Liquidity is trapped in banks- banks do not want to lend as credit may turn into bad asset. Businesses do not want to
borrow as demand has slumped.

Liquidity Trap: A liquidity trap is a situation described in Keynesian economics in which injections of cash into the
private banking system by a central bank fail to lower interest rates and hence make monetary policy ineffective.

Liquidity trap visualized in an IS–LM diagram shows that a monetary expansion (the shift from LM to LM') has no
effect on equilibrium interest rates or output. However, fiscal expansion (the shift from IS to IS") leads to a higher level
of output with no change in interest rates: Since interest rates are unchanged, there is no crowding out.

When reduced rates do not help, unconventional steps are taken as in the USA where the Federal Reserve (its central
bank) resorted to quantitative easing.

Monetary policy has grown from simply increasing the money supply to keep up with both population growth and
economic activity. It must now take into account such diverse factors as:

 Signals to the economy by way of rate and reserve adjustment

 Exchange rates
 Credit quality
 International capital flows of money on large scale

The Market Stabilization Bond Scheme in India was started as a sterilization attempt in 2004. Under the MSS, RBI
generates government securities to sterilize excess liquidity in the market to prevent inflation. Such sterilization can
be expensive as the money so sucked out costs by way of the interest paid on it. Thus, the purpose of stemming rupee
appreciation leads to excess of money supply which could inflate the economy unless sterilized with the direct
intervention (selling MSBs) which is a costly process. Hike in interest rates and CRR may also become necessary- it
hurts growth even as it reduces inflation. The latter was seen in India in the 2006-08 periods.

Developing Countries and Monetary Policy

Developing countries have problems operating monetary policy effectively. The primary difficulty is that fiscal policy
of the Government sets priorities and the Central bank is not actively involved in decisions related to money supply
through borrowings. The welfare schemes; foreign trade policy, tax policy etc. are the privilege of the central
government and the central bank largely acts to support the same. Further, few developing countries have deep
markets in government debt. Thus, the OMOs have limited value.

In India, situation is improving with RBI being given importance after economic reforms started early in the 1990’s.
The introduction of WMAs for the central government; FRBM Act 2003 etc. gave autonomy to the RBI and a
consultative role to it; so does the FSDC set up in 2010- Financial Stability and Development Council

FSDC focuses on financial stability, financial sector development, inter regulatory coordination, financial literacy,
financial inclusion, macro prudential supervision etc. It is headed by Finance Minister as Chairman and heads of SEBI,
IRDA, RBI, PFRDA and FMC, Finance Secretary, Secretary of DEA, Secretary of DFS and CEA as members. Additional
Secretary in the Ministry of Finance is the secretary of the council.

Now MoS for Economic Affairs, Revenue Secretary, Chairperson of Insolvency Board and Secretary of Deity are also
included as members

Interest rates and their significance

The determinants of interest rates are:

 Inflation- the higher the inflation, the higher the interest rates because the same money invested in
commodities and other assets should not fetch more, because of the inflation
 Need for growth- lower interest rates reduce cost of credit and facilitate investment for growth
 Promotion of savings
 Government’s need to borrow: the magnitude of government’s borrowing programme also determines
interest rates. The more the borrowing, the higher the interest rates
 Need to generate demand: as interest rates come down, consumer demand for credit goes up and there will
be a stimulus for growth
 Global trends as we need to retain foreign funds

As a part of banking sector reforms, interest rates have been deregulated. The rationale is that banks can adjust rates
quickly according to market conditions; financial innovations should be facilitated; populism through regulation can
be prevented; competitive rates can be good for savers and investors; global alignment is possible dynamically; etc.
RBI however, uses repo rates and CRR adjustments to influence interest rates.

Floating and Flexible rates of interest

There are two types of interest rate- fixed and floating. If they are offered together (when they co-exist), it is called
flexible interest rate regime.

Floating interest rates are linked to an underlying benchmark rate. The interest rate offered ‘floats’ in relation to the
interest rate of a government security instrument of similar maturity (5 years or 10 years maturity etc.) as
determined by the market. The effective rate is adjusted on a quarterly basis or semi-annually or annually.

Inflation Targeting

Under this policy approach the target is to keep inflation in a particular range or at a particular level. Government
and the RBI agree on convergence between the fiscal and the monetary policies to achieve the common goal. RBI is
given autonomy to manage inflation while the government agrees to have a fiscal policy that will contribute to price
stability- for example, not borrow excessively etc. India does not follow it. This monetary policy approach was
pioneered in New Zealand.

Target of 4% CPI Inflation from August 5 2016 to March 31 2021 with +-2% tolerance limits

Reserve Bank of India

The central bank of the country is the Reserve Bank of India (RBI). It was established in 1935 with a share capital of Rs.
5 crores on the basis of the recommendations of the Hilton Young Commission. The share capital was entirely owned
by private shareholders in the beginning.

Reserve Bank of India was nationalized in the year 1949. The general superintendence and direction of the Bank is
entrusted to Central Board of Directors of 20 members: the Governor and four Deputy Governors, one Government
official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important
elements in the economic life of the country, and four nominated Directors by the Central Government to represent
the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi.

The Reserve Bank of India Act of 1934 entrusts all the important functions of a central bank to the Reserve Bank of
India.

Bank of Issue

 Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all
denominations.
 The distribution of one rupee notes and coins and small coins all over the country is undertaken by the
Reserve Bank as agent of the Government.
 The amount of currency that the RBI can print depends upon the need of the economy. The only restriction
is the systemic one- it should not create instability with too much or too less of money supply.

Banker to government

 The second important function of the Reserve Bank of India is to act as Government banker, agent and
adviser.
 The Reserve Bank has the obligation to transact Government business, to receive and to make payments on
behalf of the Government and to carry out their other banking operations.
 The Reserve Bank of India helps the Government- both the Union and the States to raise loans.
 The Bank makes ways and means advances to the Governments. It acts as adviser to the Government on all
monetary and banking matters.

The Finance Ministry, in October 2016 has decided to set up a public debt management cell (under DEA) with
advisory functions only that will transform into Public Debt Management Agency in 2 years. This will help in
providing a comprehensive picture of liabilities and prevent conflict of interest of RBI in selling bonds and setting
interest rates

Banker’s bank and lender of last resort

 The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities by
rediscounting bills of exchange. CRR deposits of banks are kept with the RBI.
 Since commercial banks can always expect the Reserve Bank of India to come to their help in times of
banking crises, the Reserve Bank is the lender of the last resort.

Controller of Credit

 RBI has the power to influence the volume of credit created by banks in India. It can do so through changing
the instruments available to it. According to the Banking Regulation Act of 1949, the Reserve Bank of India can
ask any particular bank or the whole banking system not to lend to particular groups or persons.

Agent and Adviser of the government

 As an agent to the government, it accepts loans and manages public debt on behalf of the government (The
public debt is defined as how much a country owes to lenders outside of itself. These can include individuals,
businesses and even other governments.)
 It issues government bonds, treasury bills etc.
 Acts as the financial adviser to the government in all important economic and financial matters
Functions as the National Clearing House

 RBI acts as the national clearing house for settlement of banking transactions. It enables the other banks to
settle their inter-bank claims easily. Inter-bank cheque clearing settlement is done twice a day.

Custodian of foreign reserves

 The Reserve Bank of India has the responsibility to act as the custodian of India’s reserve of international
currencies.
 It takes up operations in the forex market to stabilize the exchange rate of rupee and ensure that there is no
speculation and there is order.

To be able to do so effectively, it holds forex reserves which it acquires from the market (purchases). It has about
$404billion of forex reserves (April 2019) which includes foreign currency assets, gold and IMF’s SDRs.

Supervisory Functions

In addition to its traditional central banking functions, the Reserve bank has certain non-monetary functions of the
nature of supervision of banks and promotion of sound banking in India.

 The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of
supervision and control over commercial and co-operative banks, relating to licensing and establishments,
branch expansion, setting reserve ratios etc.

Promotional Functions

The Bank now performs a variety of developmental and promotional functions.

 The Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban
areas, and establish and promote new specialized financing agencies.

Accordingly, the Reserve Bank has helped in the setting up of the IFCI and the SFC; the Industrial Development Bank
of India (IDBI) in 1964, the Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction
Corporation of India in 1972.

NABARD was set up in 1982. It has an important role in facilitating microfinance for financial inclusion. Further, its
innovations include banking correspondent model for rural banking. It does not lend directly to customers.

The central bank’s main responsibility is the making of monetary policy to ensure a stable economy, including a
stable currency. It aims to manage inflation (rising average prices) as well as deflation (falling prices).

RBI holds foreign exchange reserves and official gold reserves, and has influence over exchange rates. Some exchange
rates are managed, some are market based (free float) and many are somewhere in between (“managed float” or
“dirty float”).

RBI Act amended in 2006

Government made amendments to RBI Act 1934 and Banking Regulation Act for allowing the apex bank to have more
flexibility to fix the SLR and Cash Reserve Ratio (CRR). It removed the floor and cap on CRR and floor on statutory
liquidity ratio (SLR) to provide flexibility to RBI to manage liquidity. This would result in better liquidity management
in the system.
RBI autonomy

The arguments in favor of autonomy are:

 monetary stability which is essential for the efficient functioning of the modern economic system can be best
achieved if professional Central bankers with the long term perspective are given charge. Otherwise, political
leadership may be tempted to populism.
 without such autonomy, government tends to be profligate with its policies of automatic monetization
 monetary credibility is high in public perception if professionals manage it

Arguments against autonomy are

 democratic systems are run with Parliament and Cabinet making all important policies
 monetary policy is an integral policy of the overall economic policy and so RBI has to subordinate itself to
the larger objective.

The best course is to have a middle path where autonomy should be linked to performance like in the policy of
‘inflation targeting’ where the central bank should justify its autonomy with performance in the field of management
of prices at reasonable levels.

Money Supply

This refers to the total volume of money circulating in the economy. Money supply can be estimated as narrow or
broad money.

Monetary base is also called the reserve money. It is the sum of the currency in the hands of the public and the
currency commercial banks keep as reserves with the central bank (RBI). It is also known as High-powered Money.

M0 = Currency with Public + Reserves with RBI = High powered Money or Reserve Money or Monetary Base

M1 equals the sum of currency with the public and demand deposits with the banks. It is the narrow money.

M1 = Currency with public + Demand Deposits in Banks (savings and current account deposits)

M2 = M1 + Short term time deposits

M3 or the broad money concept includes time deposits (fixed deposits), savings deposits with post office saving
banks and all the components of M1

M3 = M2 + Long Term Time Deposits + Savings Deposits with post offices

The monetary policy aims to maintain price stability, exchange rate stability, full employment and economic growth.

Reserve Bank of India can increase or decrease the supply of money as well as interest rate, carry out open market
operations, control credit and vary the reserve requirements to achieve these objectives.

Supply side economics is resorted to boost economy- it means cutting taxes to boost consumption and investment.
It is also called Reaganomics. Its focus is on the producer. Supply-side economics is a macroeconomic theory which
argues that economic growth can be most effectively created by investing in capital and by lowering barriers on the
production of goods and services.

Monetary policy also has same goals as fiscal policy- growth, employment, price stability etc. The two policies need
to work for convergence as their objectives are the same. The 1997 initiative to replace ad hoc treasury bills with
WMAs is an example of the harmonization of the two policies. Another example is the FRBM Act. FSDC set up in
2010 is a prime example as in this institution, the government of India and the RBI, among others, are represented for
macro prudential regulation. If the fiscal policy borrows excessively, the resultant higher interest rates and inflation
cannot be managed by the RBI. Therefore, the need is for convergence.

Quantitative Easing

The term quantitative easing describes an extreme form of monetary easing used to stimulate an economy where
interest rates are either at, or close to zero and are still not working to revive the economy.

In practical terms, the central bank purchases financial assets including treasuries and corporate bonds from
financial institutions (such as banks) using money it has created.

Credit/Liquidity crunch/ Liquidity Crisis

It refers to a state in which there is a short supply of money to lend to businesses and consumers and interest rates
are high. It may happen when the government borrows heavily and there is crowding out of the corporate sector.

It may also refer to a serious crisis of confidence in the financial system (as in 2008) when banks refuse to lend to
even genuine businesses fearing default and credit turning into bad debt.

Other terms

Long Term Refinancing Operations

European Central Bank lends money at very low interest rate to Euro Zone Banks. The injection of cheap money
means that banks can use it to buy higher yielding assets and make profits or to lend more money to business and
consumers which could help the real economy return to high growth as well as potentially yield higher returns.

Prime Lending Rate

Prime Lending Rate is the rate at which banks lend to the best customers. It is replaced with base rate in 2010

National Payments Corporation of India (NPCI)

 Umbrella organization for operating retail payments and settlement systems in India
 Set up with guidance and support of RBI and Indian Banks Association (IBA) under the provisions of the
Payment and Settlement Systems Act, 2007
 Not for Profit Company under section 25 of the Companies Act, 1956 (now section 8 of Companies Act 2013)
 Operates RuPay, National Common Mobility Card (NCMC) and National Electronic Toll Collection (NETC),
Immediate Payment Service (IMPS)
 National Financial Switch (NFS) and Cheque Truncation System (CTS) are flagship products of NPCI

NCMC is an inter-operable transport card conceived by the Ministry of Housing and Urban Affairs and launched on
4th March 2019

NETC or FASTag is a simple to use, reloadable tag which enables automatic deduction of toll charges and lets you pass
through the toll plaza without stopping for the cash transaction

NFS is the largest network of shared automated teller machines (ATMs)

CTS is a cheque clearing system undertaken by the RBI for quicker cheque clearance
Taxation System in India

Separate heads of taxation are provided under lists I and II of Seventh Schedule of Indian Constitution. There is no
head of taxation in the Concurrent List (Union and the States have no concurrent power of taxation).

The thirteen heads in List-I of Seventh Schedule of Constitution of India covered under Union taxation, on which
Parliament enacts the taxation law, are as under:

 Taxes on income other than agricultural income;

 Duties of customs including export duties;
 Duties of excise on tobacco and other goods manufactured or produced in India except (i) alcoholic liquor
for human consumption, and (ii) opium, Indian hemp and other narcotic drugs and narcotics, but including
medicinal and toilet preparations containing alcohol or any substance included in (ii);
 Corporation Tax;
 Taxes on capital value of assets (exclusive of agricultural land) of individuals and companies, taxes on
capital of companies;
 Estate duty in respect of property other than agricultural land;
 Duties in respect of succession to property other than agricultural land;
 Terminal taxes on goods or passengers, carried by railway, sea or air; taxes on railway fares and freight;
 Taxes (other than stamp duties) on transactions in stock exchanges and futures markets;
 Taxes on the sale or purchase of newspapers and on advertisements published therein;
 Taxes on sale or purchase of goods other than newspapers, where such sale or purchase takes place in the
course of inter-State trade or commerce;
 Taxes on the consignment (delivery) of goods in the course of inter-State trade or commerce
 All residuary types of taxes not listed in any of the three lists of Seventh Schedule of Indian Constitution

Clarifications

Union government would be the regulating authority for the imposition of excise duty on medicinal and toilet
preparations consisting of alcohol, opium, Indian hemp and narcotic substances.

Stamp duties are taxed by State as per the Constitution. Stamp duties are not taxed by Union Government. Only
transactions in stock exchanges and future markets are taxed by Union government. However, under the Stamp Act,
the Central Government can levy stamp duty on some instruments like bills of exchange, cheques, promissory notes,
transfer of shares etc.

The nineteen heads in List-II of Seventh Schedule of the Indian Constitution covered under State taxation, on which
State Legislative enacts the taxation law, are as under:

 Land revenue, including the assessment and collection of revenue, the maintenance of land records, survey
for revenue purposes and records of rights, and alienation of revenues;
 Taxes on agricultural income;
 Duties in respect of succession to agricultural income;
 Estate Duty in respect of agricultural income;
 Taxes on lands and buildings;
 Taxes on mineral rights;
 Duties of excise for following goods manufactured or produced within the State (i) alcoholic liquors for human
consumption, and (ii) opium, Indian hemp and other narcotic drugs and narcotics;
 Taxes on entry of goods into a local area for consumption (Octroi), use or sale therein;
  Taxes on the consumption or sale of electricity;
 Taxes on the sale or purchase of goods other than newspapers;
 Taxes on advertisements other than (advertisements published in newspapers and advertisements
broadcast by radio or television);
 Taxes on goods and passengers carried by roads or on inland waterways;
 Taxes on vehicles suitable for use on roads;
 Taxes on animals and boats;
 Tolls;
 Taxes on profession, trades, callings and employments (limit of Rs. 2500 annually);
 Capitation taxes;
 Taxes on luxuries, including taxes on entertainments, amusements, betting and gambling;
 Stamp duty

Clarifications

Taxes on Newspapers, radio and television broadcasting advertisements are in the power of Union government

Capitation Tax is one which is levied upon the person simply, without any reference to his property, real or personal,
or to any business in which he may be engaged, or to any employment which he may follow. Eg: Poll Tax

Direct Taxes

A direct tax is levied on the income or profits of an individual or company. It is used to denote the fact that the
burden of tax falls on the individual or the company paying the tax and cannot be passed on to anyone else.

Eg: Income tax, corporate tax, wealth tax etc.

Property Tax: Property tax or 'house tax' is a local tax on buildings, along with appurtenant land, and imposed on
owners. The tax power is vested in the states and it is delegated by law to the local bodies, specifying the valuation
method, rate band, and collection procedures.

Inheritance (Estate) Tax: An inheritance tax (also known as an estate tax or death duty) is a tax which arises on the
death of an individual. It is a tax on the estate, or total value of the money and property, of a person who has died.
The levy of Estate Duty in respect of property (other than agricultural land) passing on death occurring on or after
16th March, 1985, has also been abolished under the Estate Duty (Amendment) Act, 1985.

Gift Tax: Gift tax in India is regulated by the Gift Tax Act which was constituted on 1st April, 1958. As per the Gift Act
1958, all gifts in excess of Rs. 25,000, in the form of cash, draft, cheque or others, received from one who doesn't
have blood relations with the recipient, were taxable. It was later abolished. As per a new provision introduced in
the Income Tax Act 1961 under section 56 (2), gifts received by any individual or Hindu Undivided Family (HUF) in
excess of Rs. 50,000 in a year would be taxable.

Indirect Taxes

An indirect tax is levied on manufacturing and sale of goods or services. The real burden of such tax is not borne by
the individual or the firm but is passed on to the consumer.

Eg: Excise duty, customs duty, sales tax etc.

Customs Duty: Duties of customs are levied on goods imported or exported from India

Under the custom laws, the various types of duties are levied.
  Basic Duty: This duty is levied on imported goods
 Additional Duty (Countervailing Duty CVD): It is equal to excise duty levied on a like product manufactured or
produced in India. Countervailing duties (CVDs), also known as anti-subsidy duties, are trade import duties
imposed under World Trade Organization (WTO) rules to neutralize the negative effects of subsidies
 Anti-dumping Duty: Sometimes, foreign sellers abroad may export into India goods at prices below the
amounts charged by them in their domestic markets in order to capture Indian markets to the detriment of
Indian industry. This is known as dumping. In order to prevent dumping, the Central Government may levy
additional duty equal to the margin of dumping on such articles.
 Protective Duty: If the Tariff Commission set up by law recommends that in order to protect the interests of
Indian industry, the Central Government may levy protective anti-dumping duties at the rate recommended
on specified goods.
 Export Duty: Such duty is levied on export of goods. At present very few articles such as skins and leather are
subject to export duty. The main purpose of this duty is to restrict exports of certain goods
 Cess: additional levy on the basic tax liability to meet a specific expenditure
 National Calamity Contingent Duty: This duty was imposed under Section 134 of the Finance Act, 2003 on
imported petroleum crude oil. This tax was also leviable on motor cars, imported multi-utility vehicles, two
wheelers and mobile phones
 Education Cess: Education Cess is leviable @ 2% on the aggregate of duties of Customs
 Secondary and Higher Education Cess: Leviable @1% on the aggregate of duties of Customs
 Road Cess: Additional Duty of Excise commonly known as Road Cess is levied on Petrol and High Speed Diesel
 Surcharge on Motor Spirit: Special Additional Duty of Customs (Surcharge) on Motor Spirit is leviable by the
Finance Act, 2002. Surcharge goes to consolidated fund of India and can be used for any purpose; a cess is
earmarked for a particular purpose only.

Central Excise Duty: Central excise duty is tax which is charged on such excisable goods that are manufactured in India
and are meant for domestic consumption.

Excises are inland taxes, whereas customs duties are border taxes.

An excise is distinguished from a sales tax or VAT in three ways:

 an excise typically applies to a narrower range of products;

 an excise is typically heavier, accounting for a higher fraction of the retail price of the targeted products; and
 an excise is typically a per unit tax, costing a specific amount for a volume or unit of the item purchased (Eg:
excise duty hike of Rs. 2 per litre), whereas a sales tax or VAT is an ad valorem tax and proportional to the
price of the good.

Sales Tax: Sales Tax in India is a form of tax that is imposed by the Government on the sale or purchase of a particular
commodity within the country. Sales Tax is imposed under both, Central Government (Central Sales Tax) and State
Government (Sales Tax) Legislation.

Service Tax: It is an indirect tax levied on services. As per the negative list approach, all services except the 38
activities under the negative list are taxed at 12.36%. The switch over to the negative list based approach is aimed at
aligning the indirect taxation system to the proposed GST regime, which is sought to be introduced to unify the levies
of the Centre and the States into a composite system

Since service tax (levied by union) was not there in any of the lists, it was levied as per the power under entry 97 of
the Union List which states that any tax not mentioned in either list can be levied by the Union. Later Article 270
was amended to include Entry 92c to levy service tax under the Union List. However, this amendment was not
notified. It becomes redundant with the coming of the GST.

Negative list includes metered taxis, auto rickshaws, transport of goods and passengers and transmission and
distribution of electricity by discoms, solemn activities such as funerals, burial, transport of deceased, school and
university courses, approved vocational courses, auxiliary education services and renting of immovable property by
educational institutions, services provided to government or local authorities for repair and maintenance of
aircrafts, services provided to advocates by other advocates, business entities with a turnover of up to 10 lakhs in
the preceding financial year, services provided by way of public convenience such as bathroom, washroom, urinals,
toilets, services related to work contracts under the JnNURM, Rajiv Awas Yojana etc.

Value Added Tax (VAT): The practice of VAT executed by State Governments is applied on each stage of sale, with a
particular apparatus of credit for the input VAT paid. VAT in India (classified under the tax slabs) is 0% for essential
commodities, 1% on gold ingots and expensive stones, 4% on industrial inputs, capital merchandise and
commodities of mass consumption, and 12.5% on other items. Variable rates (State-dependent) are applicable for
petroleum products, tobacco, liquor, etc.

Securities Transaction Tax (STT): STT is a tax being levied on all transactions done on the stock exchanges. STT is
applicable on purchase or sale of equity shares, derivatives, equity oriented funds and equity oriented Mutual Funds.
Current STT on purchase or sale of an equity share is 0.075%. Selling the shares after 12 months comes under long
term capital gains and one need not have to pay any tax on that gain. In the case of selling the shares before 12
months, one has to pay short term capital gains @10% flat on the gain.

The overall control for administration of Direct Taxes lies with the Union Finance Ministry which functions through
Income Tax Department with the Central Board of Direct Taxes (CBDT) at its apex.

Taxation policy in a developing country like India can play a significant role in raising resources for growth: to bring
reductions in inequalities, to direct growth in backward regions; to reduce consumption of luxury goods, to direct
investment into small scale sector etc.

In the wake of economic reforms of 1991, the tax system has been rationalized and simplified. Some of the changes
that have taken place are

 Broadening the tax base to include services, fringe benefits, stock market transactions etc
 Reduction in customs and excise duties
 Lowering of corporate tax rates
 Rationalizing personal income tax rates and slabs
 Sales tax reforms at the state level
 Introduction of VAT in 2005 at the state level
 Simplifying income tax filing procedures

Measures for broadening tax base, strengthening compliance and simplification

 Rates and slabs are rationalized

 Negative list of services for taxation from 2012 at 12%
 Adoption of VAT by almost all states
 GST introduction
 Tax to be deducted at source on various items like interest on bank deposits and dividend distribution
 Quoting of PAN made compulsory for many transactions
 Securities Transactions Tax
Direct taxes help in income redistribution. Decline in relative share of indirect taxes is also seen as good because it
promotes the competitive nature of Indian economy and attracts investment.

In developed countries, direct taxes contribute more to the tax collections.

Income tax department spends 54 paisa for every Rs. 100 tax collected.

Goods and Services Tax (GST)

GST is a multi point taxation system under which tax is levied on value added and on consumption only. There is no
cascading of taxes as there is deduction or credit mechanism for taxes paid for the inputs. Total burden of tax is
borne by the domestic consumer. Exports are not subject to GST.

Need for GST

World over, goods and services are integrated and taxed as a comprehensive domestic indirect taxation system
based on value addition. They attract the same rate of tax.

GST is proposed to be a comprehensive indirect tax levy on manufacture and sale of goods as well as services at the
national level.

 Integration of goods and services taxation would give India a world class tax system and improve tax
collections.
 It would end the long standing distortions of differential treatments of manufacturing and service sector.
 The introduction of GST will lead to the abolition of taxes such as Octroi, central sales tax, state level sales
tax, entry tax etc and eliminate the cascading effects of tax on tax.

It is aimed at forging a common domestic market, removing multiplicity of taxes, eliminating the cascading effect of
tax on tax, making the prices of Indian products competitive and above all benefiting the end consumers

FAQ on GST

GST is an indirect tax that will lead to the abolition of all other taxes such as Octroi, central sales tax, state-level
sales tax, excise duty, service tax, and value-added tax (VAT). Both the state and the central governments will impose
GST on almost all goods and services produced in India or imported into the country. Exports will not be subject to
GST. Direct taxes, such as income tax, corporate tax and capital gains tax will not be affected.
For the first two years the proposal is for two rates both at the Federal and the State levels, converging to a single
rate in the third year. Producers would receive credits for tax paid earlier which would eliminate multiple taxes on
the same product or service.

What is the Rationale for GST?

Eliminating a multiplicity of existing indirect taxes would simplify the tax structure, broaden the tax base, and create
a common market across states and federally administrated districts. Increased compliance and fewer exemptions to
GST would lift India's federal tax-to-GDP ratio from 16.6 percent. At the same time GST would lower the average tax
burden for companies that now pay "cascading" taxes on top of taxes through the production process. By lowering
business costs it would boost economic growth and increase exports, proponents argue, and bring India in line with
practices in many developed economies. Reducing production costs would make exporters more competitive. The
GST may usher in the possibility of a collective gain for industry, trade, agriculture and common consumers as well as
for the central Government and the state Governments.

What Are The GST Rates?

For the first year, 10% of CGST of Centre and 10% of SGST of States for goods and 6% each for essential items, 8%
each for services. The higher rate would come down to 9% in the second year and the two rates would converge to
8% in the third year.

Are There Exemptions?

Goods deemed necessary or of basic importance would be taxed at a lower rate, while precious metals would be
taxed at a separate rate.

Petroleum products such as crude oil, motor spirit and diesel would be exempted from the GST but would still be
subject to sales tax and other duties now levied.

Alcoholic beverages would receive similar treatment.

Will The States Lose Out?

In order to compensate states for potential lost revenue, a government panel has proposed to create a 500 billion
rupee ($10.8 billion) fund as incentive for states to buy into GST.

What Happens Next?

The legislation to make constitutional amendments needs to be finalized and the mechanism for administering the
tax needs to be created. The government also needs to set up the technology infrastructure to manage the tax.

What is The Revenue Impact?

The GST is initially intended to be revenue-neutral but is eventually expected to increase the tax take thanks to
more efficient collection and increased compliance. It will smooth the tax process, reduce transaction costs and
raise the tax-to-GDP ratio.

What about the Economic Impact?

Implementation of a comprehensive GST would lift India's roughly $2.3 trillion (GDP Nominal) economy by between
0.9 percent and 1.7 percent, on top of whatever growth would otherwise be achieved. Exports would rise by
between 3.2 percent and 6.3 percent, while imports would increase from 2.4 percent to 4.7 percent.
GST Act: 122nd Constitutional Amendment Bill and 101st Constitutional Amendment Act

The Constitution (One Hundred and Twenty-Second Amendment) Bill, 2014 was introduced in the Lok Sabha on
December 19, 2014 by the Minister of Finance, Mr. Arun Jaitley.

The Bill seeks to amend the Constitution to introduce the goods and services tax (GST). Consequently, the GST
subsumes various central indirect taxes including the Central Excise Duty, Countervailing Duty (CVDs also known as
anti-subsidy duties, are trade import duties imposed under World Trade Organization (WTO.) rules to neutralize the
negative effects of subsidies), Service Tax, etc. It also subsumes state value added tax, Octroi and entry tax, luxury
tax, etc.

 Concurrent powers for GST: (Article 246A) The Act inserts a new Article in the Constitution to give the central
and state governments the concurrent power to make laws on the taxation of goods and services.
 Integrated GST (IGST): However, only the centre may levy and collect GST on supplies in the course of inter-
state trade or commerce (including imports). The tax collected would be divided between the centre and
the states in a manner to be provided by Parliament, by law, on the recommendations of the GST Council.
 GST Council: The President must constitute a Goods and Services Tax Council within sixty days of this Act
coming into force. The GST Council aims to develop a harmonized national market of goods and services.
 Composition of the GST Council: The GST Council is to consist of the following three members: (i) the Union
Finance Minister (as Chairman), (ii) the Union Minister of State in charge of Revenue or Finance, and (iii) the
Minister in charge of Finance or Taxation or any other, nominated by each state government. Vice
Chairperson is decided amongst the members for a certain period
 Functions of the GST Council: These include making recommendations on:
o taxes, cesses, and surcharges levied by the centre, states and local bodies which may be subsumed in
the GST;
o goods and services which may be subjected to or exempted from GST;
o model GST laws, principles of levy, apportionment of IGST and principles that govern the place of
supply;
o the threshold limit of turnover below which goods and services may be exempted from GST;
o rates including floor rates with bands of GST;
o special rates to raise additional resources during any natural calamity;
o special provision with respect to Arunachal Pradesh, Jammu and Kashmir, Manipur, Meghalaya,
Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand; and
o any other matter
 Goods and Services Tax Council shall recommend the date on which the goods and services tax be levied on
petroleum crude, high speed diesel, motor spirit (petrol), natural gas and aviation turbine fuel.
 One-half of the total number of Members of the Goods and Services Tax Council shall constitute the quorum
 Decisions by a majority of not less than three-fourths of the weighted votes of the members present and
voting based on the following principles
o Weightage of central government = 1/3rd of the total votes cast
o Weightage for all state governments combined = 2/3rd of the total votes cast
 Resolution of disputes: The GST Council may decide upon the modalities for the resolution of disputes arising
out of its recommendations.
 Restrictions on imposition of tax: The Constitution imposes certain restrictions on states on the imposition of
tax on the sale or purchase of goods. The Bill amends this provision to restrict the imposition of tax on the
supply of goods and services and not on its sale.
  Compensation to states: Parliament may, by law, provide for compensation to states for revenue losses
arising out of the implementation of the GST, on the GST Council’s recommendations. This would be up to a
five year period.
 Goods exempt: Alcoholic liquor for human consumption is exempted from the purview of the GST. Further,
the GST Council is to decide when GST would be levied on: (i) petroleum crude, (ii) high speed diesel, (iii)
motor spirit (petrol), (iv) Natural Gas, and (v) aviation turbine fuel.

GST Exemption List: https://quickbooks.intuit.com/in/resources/gst-center/gst-exempted-goods-list-of-goods-exempt-

under-gst/

Fiscal Autonomy Issues

States feel that their fiscal autonomy is being eroded because

 They are surrendering the power to tax sales

 They cannot change rates according to their fiscal needs
 All states cannot have the same rates
 Centre may not compensate states fully

The position of states is rejected on other points because

 Centre is also surrendering and sharing powers regarding service tax and union excise duties
 States are free to tax sin goods like liquor, tobacco and also petroleum products

Challenges to address

 Integration of a large number of central and state taxes

 Multiplicity of taxes and tax rates to be unified
 Necessary constitutional amendments
 Rationalization of thresholds and exemption limits
 Standardization of systems and procedures
 Broad based computerization across the Nation
 Dispute settlement procedure and machinery
 Training of tax administrators and assesses
 Protection and balancing the present and future revenues of the Centre and the States
 Safeguarding the interests of less developed states with lower revenue potential
 Taxing of alcohol, tobacco, petroleum products which are out of GST regime

GST and tax efficiency

In the system existing now, the rates, tax imposition and collection are inefficient. Rates are not efficient as they
depend on lobbying and there is no transparent basis. GST is expected to lead to efficient allocation of factors of
production thus leading to gains in GDP and exports.

Also, GST is expected to remove the cascading effect of taxation system.

Before VAT, states had sales taxes with multiple rates. States were often seen in a sales tax war with other states. In
the war, states competed with each other offering lower tax rates to certain industries to set units in their states. This
resulted in revenue loss for both states.
Tax reforms in India

The need for tax reforms arises from the fact that

 Tax resources must be maximized

 International competitiveness must be imparted to the Indian economy
 Transaction costs must be reduced
 High cost nature of Indian economy needs to be corrected to increase compliance, improve equity and
improve investment flows

Reforms in direct taxes

 Reduction and rationalization of rates

 Simplification of procedures
 Strengthening of administration
 Widening of tax base to include more tax payers
 Withdrawal of exemptions gradually
 Introduction of MAT for zero tax companies
 DTC, 2010 was meant to replace the Income tax code of 1961

Indirect tax reforms

 Reduction in peak tariff rates

 Reduction in number of slabs
 Progressive change from specific duty to ad valorem
 VAT introduction
 GST roll out
 Negative list of service tax from 2012

Tax Expenditure

It refers to the expenditure foregone as a result of exemptions and concessions in personal, corporate and indirect
taxes. It was introduced for the first time in 2006-07 budget.

Such exemptions have been justified for promoting balanced regional growth, dispersal of industries, neutralization of
disadvantages on account of location and incentives to priority sectors including infrastructure. These should be
subject to sunset clause as tax exemptions often create pressure groups for their perpetuation.

Such exemptions can distort resource allocation and stunt productivity. They also result in multiplicity of rates, legal
complexities and litigations.

If these exemptions are rationalized, they can help the government spend more on social and infrastructure and help
reduce the fiscal deficit.

Tax Havens

A tax haven is a country or territory where certain transactions are taxed at low rate or no tax at all. Important
features of a tax haven are

 Nil or nominal taxes

 Lack of effective exchange of tax information with foreign tax authorities
 No requirement for substantial local presence
  Self promotion as an offshore financial centre

Eg: Switzerland, Singapore, Cayman Islands, and Monaco etc.

Important Taxation terms

Tax incidence: It shows the entity on which tax is imposed and is different from tax burden.

Tax Burden: It means those who actually pay taxes- from whom tax is collected

Tax Base: Tax base being broadened means wider range of goods and services being subject to tax

Tax Rate: It indicates how much tax is due from each source

Tax Shelter: Any technique which allows one to legally reduce or avoid tax liabilities

Tax Avoidance vs. Tax Evasion

There are provisions in the law that allows one to save and invest in a manner that leads to reduction in taxable
income. If these provisions are used for the benefit, it is called tax avoidance.

Tax evasion on the other hand is a punishable offence. It typically involves failing to report income or improperly
claiming deductions that are not authorized

Hidden Taxes: These are taxes that are concealed in the price of articles that one buys. They are also referred to as
implicit taxes. Eg: Import duties

Progressive tax: tax as a percentage of income rises as income rises

Regressive tax: Tax as a percentage of income falls as income rises

Specific duty: quantity is the basis of taxation

Ad Valorem: Taxes are levied on the basis of value- “according to worth” Eg: Taxes on real estate and property

Compound duties: Combination of value and other factors on which tax is imposed.

Excise duty: Excise duty is a tax on manufacture and sale of goods within the country

Customs Duty: When goods are imported or exported, customs duty is imposed and collected by the Union
Government

Negative Income Tax: It is a taxation system where income subsidies are given to persons or families that are below
the poverty line. The government will send financial aid to a person who files an income tax return reporting an
income below a certain level. Eg: Subsidy

Pigovian Tax: It is imposed on bodies that have a negative externality (negative impact of one person’s actions on
the well being of an outsider). Eg: Carbon Tax

Octroi: Entry 52 of the State List, 7th schedule specifies the tax on the entry of goods into a local area as the Octroi.
It has been the main source of revenue for most urban local bodies in India. It is criticized for the fact that it is an
obsolete method of tax collection and involves stoppage of vehicles at the check posts outside the city limits, thereby
obstructing a free flow of vehicular traffic and waste of business hours, loss of fuel etc.
Tax Buoyancy: It refers to the percentage change in tax revenue with the growth of national income. There is no
change in tax rate here

Tax elasticity: It is defined as the percentage change in tax revenue in response to the change in tax rate and the
extension of coverage

Tax Stability: It means no frequent changes and continuity of policy in a predictable and transparent manner. It is
desirable because it makes it easier for the government to build a credible spending and borrowing plan for the year
ahead.

Tobin Tax: James Tobin proposed a worldwide tax on all foreign exchange transactions when foreign capital enters a
country and when it leaves to check speculative flows.

 It would reduce exchange rate volatility and improve macro-economic performance

 It could bring in revenue to support for development efforts or exchange rate stabilization

It can be imposed only if all the countries accept the proposition. India does not prefer it as we are a CAD country
and need net foreign inflows.

In the European Monetary Union, there is a proposal to set a micro tax of 0.1% on share and bond transactions and
0.01% on deals involving complex securities such as derivatives. It is called Financial Transaction Tax (Robin Hood
tax or Tobin Tax).

India opposes the Financial Transaction Tax on the following grounds

 Regulation is the remedy

 Banks can pay the tax and not shed their reckless behavior
 It may in fact induce them to be more reckless as there are ready funds available for bail outs
 India has a well regulated banking system and so did not suffer from the same fate as banks in developed
economies
 Banks as private entities would simply push the added costs onto the consumer

Minimum Alternate Tax (MAT): Normally a company is liable to pay tax on the income computed in accordance with
the provisions of the Income Tax Act, but the profit and loss account of the company is prepared as per the
provisions of the Companies Act. There were a large number of companies who show book profits as per the P&L
account but do not pay any taxes by showing no taxable income as per provisions of income tax act. These
companies are popularly known as Zero Tax Companies. In order to bring such companies under the Income tax net,
MAT was introduced in 1996. They are required to pay 18% tax as MAT (2012)

Presumptive Tax: It involves the use of indirect means to ascertain tax liability which differs from the usual rules based
on tax-payers accounts. There is a legal presumption that the tax payers’ income is no less than the amount resulting
from the application of the indirect method. The reason for presumptive tax is that in a number of businesses,
assesses do not maintain books of accounts or are irregular if maintained.

Laffer curve: It shows the relationship between tax rates and tax revenue collected by governments.

(Lafter: Tax Revenue vs Tax Rate)

Inverted Duty Structure: Higher import duty on raw materials than on finished products is called inverted duty
structure. It puts the domestic manufacturers at disadvantage making them uncompetitive. Eg: For CFLs, import
duty on raw materials is greater than on finished CFLs.

FTAs also lead to a new type of inverted duty structure with duties for final products being lower for FTA partners
compared to non-FTA countries. This acts as a disincentive to local manufacturing which is not competitive against
FTA imports because of the inverted duty phenomenon.

Dividend Distribution Tax: Companies giving dividend have to pay tax on the amount distributed as dividend

Withholding tax: It means withholding of certain payments including interest, salaries, professional fee, payments to
contractors etc.

Capital Gains Tax: It is the tax on gains made from buying and selling assets like land or shares.

Wealth Tax: levied on specified non productive assets such as residential houses, urban land, jewelry & motor cars

Securities transaction tax: It is a tax on the value of all the transactions of purchase of securities that take place in a
recognized stock exchange. It is meant to make up for revenue loss from abolition of long term capital gains tax.

Transfer Pricing: It involves charging goods supplied to the subsidiary. The international norm in this regard is the
arms length principle which means that when two related parties deal in goods and services, pricing must be done
objectively and commercially. Transfer pricing is generally done in a way as to show high profit in countries where
the corporate tax rate is low and low profits when corporate tax rates are high. Transfer pricing norms existing today
need to be rationalized so that tax revenues that are due to the government are not eroded.

The introduction of Advance Pricing Agreement (APA) under the transfer pricing regulations is a positive step to
reduce litigation as it will be based on bilateral understanding between the two countries. It is an agreement between
the tax payer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over
a fixed period of time in the future.

Cess: It is an additional levy on a tax and is different from surcharge (general) as the former is specific. Collections
form surcharge can be used for any purpose while collections from Cess need to be used only for a specific purpose.
Eg: Education Cess

Treaty Shopping: Routing investment into India through countries with which India has a DTAA and even among
these countries, from the country that gives the best terms such as Mauritius and Cayman Islands.

Round Tripping: It refers to the practice where capital belonging to a country which leaves the country and then is
reinvested in the form of FDI. The profit out of such investment can’t be taxed in India as the fund is coming from
Mauritius, where it is not taxed.
Direct Tax Code, 2013

The direct tax code seeks to consolidate and amend the law relating to all direct taxes, namely, income-tax, dividend
distribution tax, fringe benefit tax and wealth-tax so as to establish an economically efficient, effective and
equitable direct tax system which will facilitate voluntary compliance and help increase the tax-GDP ratio. Another
objective is to reduce the scope for disputes and minimize litigation.

It is designed to provide stability in the tax regime as it is based on well accepted principles of taxation and best
international practices. It will eventually pave the way for a single unified taxpayer reporting system.

The salient features of the code are:

 Single Code for direct taxes: all the direct taxes have been brought under a single Code and compliance
procedures unified.
 Use of simple language: with the expansion of the economy, the number of taxpayers can be expected to
increase significantly. The bulk of these taxpayers will be small, paying moderate amounts of tax. Therefore, it
is necessary to keep the cost of compliance low by facilitating voluntary compliance by them.
 Reducing the scope for litigation: wherever possible, an attempt has been made to avoid ambiguity in the
provisions that invariably give rise to rival interpretations
 Flexibility: the structure of the statute has been developed in a manner which is capable of accommodating
the changes in the structure of a growing economy without resorting to frequent amendments.
 Ensure that the law can be reflected in a Form: The structure of the tax law has been designed so that it is
capable of being logically reproduced in a Form.
 Consolidation of provisions: in order to enable a better understanding of tax legislation, provisions relating to
definitions, incentives, procedure and rates of taxes have been consolidated.
 Elimination of regulatory functions: traditionally, the taxing statute has also been used as a regulatory tool.
However, with regulatory authorities being established in various sectors of the economy, the regulatory
function of the taxing statute has been withdrawn.
 Providing stability: Under the Code, all rates of taxes are proposed to be prescribed in the First to the Fourth
Schedule to the Code itself thereby obviating (removing) the need for an annual Finance Bill.

Facts of Draft DTC, 2013

 The draft tax code proposes a new tax rate of 35 per cent for individuals having income exceeding Rs 10
crore
 The draft Direct Taxes Code - 2013 proposes to reduce the age for tax exemption for senior citizens to 60
years from 65 years.
 No change in tax slabs
 The new draft tax code widens the base for levy of wealth tax. The revised code captures all assets for wealth
tax, whether physical or financial, thereby removing the distinction between physical and financial assets.
Wealth tax is proposed to be levied on individuals, Hindu Undivided Family (HUF) and private discretionary
trusts at the rate of 0.25 per cent. The threshold for levy of wealth tax in the case of individual and HUF shall
be Rs 50 Crores.
 With a view to provide parity in treatment of insurance products and mutual fund products, the new Direct
Tax Code proposes to levy income distribution tax on equity linked insurance products on the lines of equity
oriented mutual funds.
 The new tax code proposes additional tax @10 per cent on recipient of dividend (liable to dividend
distribution tax) exceeding Rs 1 Crore.
  The revised DTC says the provisions of 'Income from house property' shall not apply to the house property,
or any part of the house property, which is used for business or commercial purposes.
 The new tax code says the amount of rent received in arrears or the amount of rent which is not realized from
a tenant and is realized subsequently shall be deemed to be the income from house property of the financial
year in which such rent is received or realized.
 For the purposes of deduction in respect of interest on loan taken for self-occupied house property, the loan
given by the employer should also qualify for this concession.
 With a view to provide smooth transition from IT Act to Direct Taxes Code, the new tax code says provisions
will be made for treatment of losses remaining to be carried forward and set off as per the provisions of the
existing Income-tax Act on the date on which DTC comes into effect.

General Anti Avoidance Rules (GAAR)

The aim of GAAR provisions is to codify the doctrine of substance over form where the real intention of the parties
and purpose of an arrangement is taken into consideration for determining tax consequences irrespective of the
legal structure of the concerned transaction or arrangement.

It essentially comes into effect where an arrangement is entered into with the main objective of obtaining tax
benefit and exhibits the following features

 Results in misuse or abuse of provisions of tax laws

 Lacks commercial substance
 It is not carried out in a bona fide (genuine without intention to deceive) manner

Thus, if the GAAR panel made up of senior IT commissioners believes that the main purpose or one of the main
purposes of an arrangement is to obtain a tax benefit and any one of the above features is satisfied, he has powers to
declare it as an impermissible avoidance arrangement. Once an arrangement is ruled impermissible, then the tax
authorities can deny tax benefits.

FAQ on GAAR

What are general anti-avoidance rules?

These rules, originally proposed in the Direct Taxes Code, are targeted at arrangements or transactions made
specifically to avoid taxes. More than 30 countries have introduced GAAR provisions in their respective tax codes to
check evasion.

What were the key concerns?

GAAR is a very broad based provision and can easily be applied to most tax-saving arrangements. Many experts feel
that the provision would give unbridled powers to tax officers, allowing them to question any tax saving deal.

Foreign institutional investors are worried that their investments routed through Mauritius could be denied tax
benefits enjoyed by them under the Indo-Mauritius tax treaty.

What has the government done now?

It has postponed GAAR by 2 years. This will give a breather to tax payers and also allow the government time to frame
clear rules after consultations with stakeholders.

He has also clarified that the onus to prove that an arrangement is 'impermissible' will lie with the tax department.
The GAAR panel, the final body that will decide on the applicability of the law, will include an independent member.
Parthasarathy Shome Panel was set up to review the draft guidelines and prepare its report on GAAR
implementation roadmap.

Advance Ruling

It means written opinion or authoritative decision by an Authority empowered to render it with regard to the tax
consequences of a transaction. Under the law, the power of giving advance rulings has been entrusted to an
independent adjudicatory body headed by a retired SC judge empowered to issue rulings that are binding on both
the IT department and the individual

Double Taxation Avoidance Agreement (DTAA)

Double taxation is the levying of tax by two or more jurisdictions on the same declared income, asset or financial
transaction. It is often mitigated by tax treaties between countries. It means if investment takes place in India by a
company that is based in a country with which India has DTAA; its capital gains will be taxed only in the country
where the company is based and not in India. It encourages foreign investment and gives access to Forex for India.

The controversy arises from the abuse of the treaty whereby letter box companies without commercial substance
invest in India only for tax benefits. A large number of FIIs who trade in Indian stock markets operate from Mauritius
and Singapore. According to the tax treaty between India and Mauritius, capital gains arising from sale of shares are
taxable in the country of residence of the shareholder and not in the country of residence of company whose shares
have been sold. Therefore a company resident in Mauritius and selling shares of an Indian Company will not pay tax in
India. Since there is no capital tax in Mauritius, the gain will escape tax altogether. GAAR is meant to tackle such
misuse among other things.

The limitation of benefits clause is an anti-abuse provision which disallows tax exemptions to shell companies set up
merely to use provisions of DTAA to buy Indian assets and avoid tax payouts. India has introduced such provisions
with Singapore and UAE to prevent third party residents from misusing capital gains exemption rule by establishing
a holding company in Singapore.

Tax Planning vs. Tax Avoidance vs. Tax Evasion

If a law says that if a company invests its profits in a tax saving government bond, then it will not have to pay tax on
those profits. Thus, it can permit companies to avoid paying tax if they invest their profits in a particular financial
instrument. This is called Financial Planning.

Tax avoidance is structuring a transaction in such a way as to avoid paying tax is the primary motive. The legality is
tested on the basis of “looking through” and not “looking at”

Tax Evasion means not declaring the transaction in the books at all. It is illegal.

Type of tax Levied by Collected by Appropriated by

Corporation Tax Centre Centre Centre
Customs Tax Centre Centre Centre
Surcharge on Income Tax Centre Centre Centre
Tax on Capital value of assets of individuals and companies Centre Centre Centre
Fees on matters of Union List Centre Centre Centre
Duties on succession to property other than agricultural land Centre Centre State
Estate duty on property other than agricultural land Centre Centre State
Terminal taxes on goods and passengers carried by railways, sea Centre Centre State
and air
Taxes on railway fare and freight Centre Centre State
Tax on transaction in stock exchange and futures Centre Centre State
Tax on sale or purchase of goods in the course of interstate trade Centre Centre State
and commerce
Tax on consignment of goods in course of interstate trade or Centre Centre State
commerce
Income Tax Centre Centre State
(compulsory)
Excise duties on goods other than medicinal and toilet Centre Centre State and Centre
preparations containing alcohol and narcotics (May be)
Stamp Duties on bills of exchange, cheques, promissory notes etc. Centre State State
Excise Duties on medicinal and toilet preparations containing Centre State State
alcohol and narcotics

 Income tax is levied, collected and appropriated by the centre

 Sales tax is levied, collected and appropriated by State
 Stamp duty is levied by Centre, but collected and appropriated by State
 Service tax is levied by the Centre and collected and appropriated by the Centre and the States
Inflation

Inflation means a persistent rise in the price of goods and services. Inflation reduces the purchasing power of money.
It hurts the poor more as a greater proportion of their incomes are needed to pay for their consumption. Inflation
reduces savings; pushes up interest rates; dampens investment; leads to depreciation of currency thus making
imports costlier. (From Apr-Dec 2016, CPI = 4.9%, WPI = 3.4%); RBI’s target = <5% CPI inflation for 2017-18

Let's say a loaf of bread = Re.1 = $1

Then the Rupee experiences inflation. Now a loaf still = $1 but now costs Re.1.10. So how many $ is a Re. going to
buy now? Certainly less than one

Types of Inflation

Creeping is a rate of general price increase of 1 to 5% a year. Creeping inflation of 3 to 5 percent erodes the
purchasing power of money when continued over many years. A low creeping inflation could be good for the
economy as producers and traders make reasonable profits encouraging them to invest.

Trotting inflation is usually defined as a 5 to 10% annual rate of increase in the general level of that, if not controlled,
might accelerate into a galloping inflation of 10-20% a year.

If it aggravates, galloping inflation can worsen to “runaway” inflation which may change into a hyperinflation.
Hyperinflation is inflation that is “out of control” a condition in which prices increase rapidly as a currency loses its
value. The worst is a monetary collapse, if prices are not reined in, in time.

CreepingTrottingGallopingRunawayHyperinflation->Monetary Collapse

 Deflation: when there is a general fall in the level of prices

 Disinflation which is the reduction of the rate of inflation
 Stagflation: It is a combination of inflation and rising unemployment due to recession

Types of inflation based on causes

Demand Pull Inflation: Inflation caused by increase in demand due to increased private and government spending,
etc. It involves inflation rising as real gross domestic product rises and unemployment falls. This is commonly
described as much money chasing too few goods. For example, India in 2010 when the economy is said to have
overheated (High growth high inflation) and demand outstripped supply and prices rose. It may be referred to as
growth inflation too.

Cost-push inflation: It is also referred to as “Supply shock inflation” and is caused by reduced supplies due to
increased price of inputs

Structural inflation: A type of persistent inflation caused by deficiencies in certain conditions in the economy such as
a backward agricultural sector that is unable to respond to people’s increased demand for food, inefficient
distribution and storage facilities leading to artificial shortages of goods, and production of some goods controlled by
some people.

If inflation is high in an economy, the following problems can arise

 low income groups are particularly hurt

 people on a fixed income (e.g. pensioners, students) will be worse off in real terms due to higher prices and
equal income as before
  inflation discourages exports as domestic sales are attractive and BoP problems can be caused
 Increasing uncertainty may discourage investment and saving. With the declining value of money, people
would be more inclined to spend than save anticipating that their money can buy even less in the future
 Inflation tax happens. When a government borrows and spends, the cash held by people erodes in value due
to inflation
 strikes can take place for higher wages which can cause a wage spiral.

Small amount of inflation can be good. It can be argued that a low level of inflation can be good if it is result of
innovation as new products are launched at high prices, which quickly come down through competition. Therefore,
there is encouragement for innovation and the problem is short lived. Also, a small price rise is necessary for wages to
go up. It further helps the economy keep off deflation which can otherwise set off a recession. Besides, inflation at a
moderate level is an incentive to the producer. At any rate, small price rises are inevitable in a growing economy.

Controlling Inflation

 Fiscal measures include reduction in indirect taxes

 Dual pricing like in sugar
 Monetary measures include rate and reserve requirement changes. Open market operation can stabilize
prices under normal conditions. Also, sterilization through Government bond transaction as in the case of
MSBs
 Supply side factors include making goods available- import of wheat in India.
 Administrative measures include implementation of de-hoarding and anti-black-marketing measures. Wage
and price controls cap also be used

Dual pricing: Government enforces a dual pricing policy for the sugar industry. Presently 40% of the production is sold
at a fixed price to the government which is used for PDS and other market operations. Mills under levy are free to sell
the remaining 60 % of sugar (as 40% is supplied to government) in the open market at the market determined price.

Measures of Inflation

 GDP Deflator

GDP deflator is a measure of the change in prices of all new, domestically produced, final goods and services in an
economy. The GDP deflator is not based on a fixed market basket of goods and services but applies to all goods and
service domestically produced.

 Cost of Living Index

The cost of living is the cost of maintaining a certain standard of living. It is defined with reference to a basket of
goods and service. An index value of 105 indicates that the cost of living is five percent higher than in the base year.

 Producer Price Index

Producer price index (PPIs) measures the change in the prices received by a producer. The difference with the WPI is
accounted for by logistics, profits and taxes mainly. Producer price inflation measures the price pressure due to
increase in the cost of raw material.

 WPI

It measures the change in price of a selection of goods at wholesale; prior to retail sales thus excluding sales taxes.
These are very similar to the Producer Price Indexes.
  CPI

It measures the change in price paid by the consumer at the retail level. It can be for the whole community or group-
specific-for example, CPI for industrial workers etc as in India.

Index of Industrial Production (IIP)

It details out the growth of various sectors in an economy such as mining, electricity and manufacturing. It is published
monthly by the CSO, 6 weeks after reference month ends. (6 weeks lag)

Mining and Quarrying: 141.57; Manufacturing: 755.27; Electricity: 103.16 weights are given

 Eight Core Industries comprise 40.27% of the weight of items included in the Index of Industrial Production
(IIP)

Petroleum Refinery production (weight: 28.04%), Electricity generation (19.85%), Steel production (17.92%), Coal
production (10.33%), Crude Oil production (8.98%), Natural Gas production (6.88%), Cement production (5.37%),
Fertilizers production (2.63%) (RESCoCNCF)

Indices of Inflation

All indices use a base year which means that rise or fall in prices are measured with reference to the price in that year.

Wholesale Price Index (WPI)

Government launched a new series of WPI with 2004-05 as base from 2010. The new series of WPI has 676 items as
compared to 435 in the previous series. Consumer items widely used by the middle class like ice-cream, mineral
water, flowers, microwave oven, washing machine, gold and silver are reflected in the new series of WPI. This would
give better picture of the price variation. Readymade food, computer stationary, refrigerators, dish antenna, VCD,
petroleum products and computers will also be part of the new series.

Items and Weights

Number of Items Weights

Current Earlier Current Earlier
Primary Articles 102 98 20.1 22.0
Fuel and Power 19 19 14.9 14.2
Manufactured Products 555 318 65.0 63.8
The new series is based on the recommendation of a working group that was set up under Plan Commission
Member Abhijit Sen, which in its technical report submitted in May 2008 recommended the change in base year to
2004-05.

The WPI, published weekly by the Economic Advisor in the Ministry of Commerce and Industry, with a two week
lag, tracks the wholesale traded price of 676 items that include agricultural commodities (such as rice, tea, raw cotton,
groundnut oil seed), industrial commodities (such as iron ore, bauxite, coking coal), intermediate products for industry
(such as cotton yam, polyester fiber, synthetic resins, iron & steel, sheet glass), products for consumers (atta, sugar,
paper, electricity, ceiling fans) and energy items (petrol, kerosene, electricity for commercial use). The weight
attached to each item in the index is meant to reflect the volume (by value) of wholesale trade in that item in the
Indian market.

The WPI is not intended to capture the effect of price rise on the consumer though it generally and broadly
indicates it.

WPI is the only price index in India which is available on a weekly basis with the shortest possible time lag of two
weeks. It has an All India character. It is due to these attributes that it is widely used in business and industry circles
and in Government and is generally taken as an indicator of the rate of inflation in the economy.

This provisional weekly index is made final after a period of 8 weeks.

The inflation rate is calculated on point to point basis i.e. on the basis of the, variation between the index of the
current year and for the corresponding week of the previous year

Seasonal items are handled in the index in a special manner. When a particular seasonal item disappears from the
market and its prices are not quoted, the index of such an item ceases to get compiled and its weight is distributed
over the remaining items and new seasonal items, if any, in the concerned sub-group.

The advantage of the WPI is that it covers more goods; is available with relatively small time lag of fortnight; is
convenient to compile. Disadvantages are that it does not include services like transport, health, education etc.

WPI new reporting method: From late 2009, India presented inflation figures on a monthly basis instead of weekly
system.

Consumer Price Inflation (CPI)

There are three Consumer Price Indices in India. Each tracks the retail prices of goods and service for specific group of
people, because the consumption patterns of different groups differ.

 CPI-IW = 370 commodities at 2001 base year including services by Ministry of Labor
 CPI- UNME (Urban Non Manual Employees) = 180 Commodities at 1984-85 base year including services by
Ministry of Statistics and Programme Implementation
 CPI-AL = 60 Commodities at 1986-87 base year by Ministry of Labor

UNME: The target group of this index was urban families who derived major portion of their income from non
manual occupations in the non-agricultural sector. This index had a limited use as it was used for determining
dearness allowances of employees of some foreign companies working in India in service sectors such as airlines,
communications, banking, insurance and other financial services.

Each commodity is given a specific weight, which differs from one index to another index. For example, the CPI-AL
would give a greater weight to food grains than the CPI-UNME, since a greater proportion of the agricultural laborer's
expenditure would go toward food grains, and he would be unlikely to buy the sort of items the office-goer would buy.
CSO decided to discontinue CPI (UNME) in 2008.

In the organized sector, CPI-IW is used as a cost of living index

CPI-AL and CPI-UNME are not considered as robust national inflation measures because they are designed for
specific groups of population with the main purpose of measuring the impact of price rise on rural and urban
poverty.

GDP deflator is a comprehensive measure statistically derived from national accounts data released by the Central
'Statistical Organization (CSO). Since it encompasses the entire spectrum of economic activities including services, the
scope and coverage of national income deflator is wider than any other measure. At present, the GDP deflator is
available only annually with a long lag of over one year and hence has very limited use for the conduct of policy.

Wholesale Prices vs. Consumer Prices

Wholesale means sale in large quantities and meant for resale. It covers a certain set of goods that are traded at the
wholesale level. CPI on the other hand measures price rise at the retail level. A substantial portion of the differential
is accounted for by the retailers' margins which are built into what the consumer pays. Besides, the way the two
indices are calculated differs both in terms of weights assigned to products as well as the kind of items included in the
basket of products.

While wholesale prices are more or less the same throughout the country, consumer prices or retail prices vary
across regions (rural and urban) and also across cities according to the consumer preferences for certain products,
supplies and purchasing power. Besides, taxes levied by states comprise an important component of the variation in
prices of many products.

WPI vs. CPI

 First, food has a larger weight in CPI ranging from 46 per cent in CPI-IW to 69 per cent in CPI-AL whereas it
has a weight of only 27 per cent in WPI. The CPIs are, therefore, more sensitive to changes in prices of food
items.
 Second, the fuel group has a much higher weight in the WPI (14.2 per cent) than the CPIs (5.5 to 8.4per
cent). As a result, movement in international crude prices has a greater bearing on WPI than on the CPIs.
 Third, services are not covered under WPI while they are, to different degrees, covered under CPIs.
Consequently, service price inflation has a greater influence on CPIs

The CSO of MoSPI introduced the new series of CPI numbers for Rural, Urban and Combined (Rural + Urban) on base
year 2010. These indices are available for five major groups namely Food, beverages and tobacco; Fuel and light;
Housing; Clothing, bedding and footwear and Miscellaneous.

CPI (Urban) numbers are compiled at state/UT as well as All India level. 310 towns are surveyed every month by field
officials of NSSO and 250 items are included

CPI (Rural) numbers are compiled at state/UT as well as All India level. 1181 villages are surveyed every month by
department of posts and 225 items are included

CPI-Rural (Dept of Posts) CPI-Urban (NSSO) CPI Combined

Food, beverages and tobacco 59.31% 37.15% 49.71%
Fuel and Light 10.42% 8.40% 9.49%
Clothing, bedding & footwear 5.36% 3.91% 4.73%
Housing Nil 22.53% 9.77%
Miscellaneous 24.91% 28% 26.31%
Revisions will be done every five years. In the new series compiled by the CSO, the consumption patterns have been
derived from the results of the Consumer Expenditure Survey conducted by the National Sample Survey Office during
2004-05.

Which index should one use?

The WPI is useful in certain contexts. For example, for industrialists, the costs of setting up a factory over the course of
several years; and further to calculate the costs of production and returns over several years. The basket of items in
the CPI does not include machinery, chemicals, and so on. Secondly, the price of electricity in the CPI is the
consumer tariffs, not the industrial tariffs.

Figures for inflation in the WPI are on the average much lower than those in the CPI indices. There could be two
reasons for this difference in rates between the WPI and CPI: first, prices of the items in the CPI basket might have
risen more sharply than items excluded from it — this would mean that prices of mass consumption goods have risen
more sharply than inputs for production; secondly, the retail prices of commodities might have grown more sharply
than the wholesale prices, indicating that middlemen have taken a bigger share.

Services and Price Index

While the WPI now does not include services, the two consumer price indices (CPI) meant for urban non-manual
employee and industrial workers, do include certain service's such as medical care, education, recreation and
amusement, transport and communication. On the other hand, some of the other major services such as trade,
hotels, financing, insurance, real estate and business services do not find a mention either in the WPI or in the CPIs.

Producer Price Index

The process of introducing the (producer price index) (PPI) is also underway in India, according to Dr. Abhijit Sen,
Member of Planning Commission. It means prices of goods as they are sold to the wholesalers by the producers. The
difference between WPI and PPI is accounted for by the margins and other transport and distribution costs.

Core or underlying inflation

Core or underlying inflation measures the long-run trend in the general price level. Temporary effects on inflation
are factored out to calculate core inflation. For this purpose, certain items are usually excluded from the computation
of core inflation. These items include: changes in the price of fuel and food which are volatile or subject to short-term
fluctuations and/or seasonal in nature like food items. In other words, core or underlying inflation is an alternative
measure of inflation that eliminates transitory effects. These price changes are not within the control of monetary
policy in as much as these are supply shocks.

The main argument here is that the central bank should effectively be responding to the movements in permanent
component of the price level rather than temporary deviations.

When fuel and food inflations are added to core inflation we get headline inflation

Headline Inflation = Core Inflation + Fuel and Food Inflations

Inflation Targeting

Inflation targeting focuses mainly on achieving price stability as the ultimate objective of monetary policy. This
approach entails the announcement of an inflation target- either a number or a range, that the central bank promises
to achieve over a given time period. The targeted inflation rate will be set jointly by the RBI and the government,
although the responsibility of achieving the target would rest primarily on the RBI. This would reflect an active
government participation in achieving the goal of price stability with fiscal discipline by way of a rational borrowing
programme (not borrowing in excess)

Monetary policy and fiscal policy have to converge for achievement of inflation targeting. Advantage is that it
promotes transparency in the conduct of monetary policy. Further it increases the accountability of monetary
authorities to the inflation objective.

Ideal Inflation Rate

Ideal inflation rate is one that takes into consideration human, social and economic impact in the level of inflation
beyond which the adverse consequences are strong. Chakravarty Committee (1985) had indicated 4 per cent as an
acceptable level of inflation on a long-term basis. However, such a level of inflation cannot be fixed at one level for
all times. It depends on growth rate. It also depends on what the global levels are RBI sees about 5.5% rate of
inflation as 'comfortable'- neither does it hurt in human terms nor in growth terms.

Collection of Statistics Act, 2008

Collection of Statistics Act, 2008 was made to bring in new rules aimed at improving data collection. Government will
levy higher penalty for not sharing data and tougher punishment will be imposed in cases where manipulation of data
is involved.

Under the new Act, people or companies not divulging data would have to pay a fine of Rs 1,000 and they would be
given a 14-day notice period to comply. If the information is not provided even after two weeks, the penalty will rise
to Rs 5,000 per day.

The Act also makes willful manipulation or omission of data a criminal offence, punishable by a prison term that
may extend up to 6 months. This penalty will also apply if a company prevents or obstructs any employee from
collecting data.

The Collection of Statistics Act, 2008, gives powers to the government to classify any statistics as core statistics and
also determine the method to collect and disseminate the same.

Phillips Curve (PINE- Phillips, Inflation, Unemployment)

The inverse relationship between inflation and rate of unemployment is shown in the Phillips Curve. Price stability
has a trade-off against employment. Some level of inflation could be considered desirable in order to minimize
unemployment.

Potential Output or Natural GDP is the level of GDP where the economy is at its optimal level of production, given
various constraints-institutional and natural. This level of output corresponds to the Non-Accelerating Inflation Rate
of Unemployment, NAIRU. (If GDP exceeds its potential, inflation will accelerate and if GDP falls below its potential
level, inflation will decelerate) as suppliers attempt to use excess capacity by cutting prices.

Deflation

Deflation is a prolonged and widespread decline in prices that causes consumers and businesses to curb spending as
they wait for prices to fall further. It is the opposite of inflation, when prices rise, and should not be confused with,
disinflation, which merely describes a slowdown in the rate of inflation.

Deflation occurs when an economy's annual headline inflation indicator -- typically the consumer price index --enters
negative territory. Deflation is hard to deal with because it is self-reinforcing. Put simply, unless it is stopped early,
deflation can breed deflation, leading to what is known as a deflationary spiral.

When an economy has fallen into deflation, demand from businesses and consumers to buy products falls because
they expect to pay less later as prices fall. But as producers struggle to sell and go bankrupt, unemployment rises,
reducing demand further. That causes deflation to become more pronounced

Remedies for deflation

 Tax cuts to boost demand from consumers and businesses

 Lowering central bank interest rates to encourage economic activity
 Printing more currency to boost money supply
 Capital injections into the banking system
 Increase government spending on projects that boost the return on private investment

Growth Inflation Trade off

With high growth, economy overheats as in India from 2011. Overheating of the economy means demand overshoots
supply and there is pressure on prices. As growth creates more employment and incomes rise, demands rises
pushing up prices. As prices rise, the central bank intervenes and raises rates to cool consumption and so prices fall
relatively.

Such intervention by the central bank has a dampening impact on growth as higher interest rates prevent easy
borrowing and thus demand slackens. It leads to deceleration of growth rate. We thus see growth being 'softened' to
ease inflation in the country. It is a trade-off between growth and inflation.

Fiscal drag operates in an overheated economy. That is the tax liability increases as wages rise. That leaves less
purchasing power in the hands of the people and so demands drops automatically. It acts as an automatic stabilizer
in an overheated economy.

India and Inflation

Reasons for current inflation in India

 Growth
 Bad monsoons
 Improper management of buffer stocks
 NREGA
 MSP increases
 Fuel Price deregulation for petrol and increase in prices of diesel and LPG
 Hoarding and cartelization
  Middle Men
 Imported inflation due to rupee depreciation

Reasons for food inflation

 Shift in dietary habits towards protein foods

 Pressure stemming from inclusive growth policies
 Large increases in MSPs of food grains
 Shocks from global food inflation
 Financialization of commodities

Government steps to control inflation

The Government has taken a number of short term and medium term measures to improve domestic availability of
essential commodities and moderate inflation.

 It has procured record food grains. Even after keeping the minimum buffer stock, there is enough food grains
to intervene in the market to keep the prices at reasonable level.
 A Strategic Reserve of 5 million tonnes of wheat and rice has also been created to offload in the open market
when prices are high. This is in addition to the buffer stock held by FCI every year.
 Issue price of grains supplied through PDS outlets are frozen. The price situation is reviewed periodically at
high-level meetings such as the Cabinet Committee on Prices (CCP).

Fiscal Measures

 Reducing import duties to zero - for rice, wheat, pulses, edible oils and sugar
 Allowed import of raw sugar at zero duty
 Reduced the fiscal deficit

Administrative Measures

 Banning export of edible oils, onions and pulses

 Imposition of stock limit orders in the case of rice, paddy, pulses, sugar, edible oils and oilseeds
 Using Minimum Export Price (MEP) to regulate exports
 Distribution of one million tons of imported edible oils to States/UTs at a subsidy
 To augment availability of pulses, the Public Sector Undertakings (namely, STC, MMTC, and PEC) and NAFED
were permitted to import and sell pulses under a scheme and losses, if any, up to 15% are reimbursed by the
Government. Distribution of imported pulses to State Governments for supply through PDS at a subsidy of
Rs.10 per kg
 Banning of futures trade in key essential commodities
 In addition to the above, Government has also taken medium initiatives such as the National Rural
Employment Guarantee Programme (NREGP), Integrated Scheme of Oilseeds, Pulses, Oil Palm and
Maize(ISOPOM), National Food Security Mission (NFSM) and Rashtriya Krishi Vikas Yojna (RKVY) Monetary
Measures
 RBI increased CRR and repo and reverse repo rate
Open Inflation

When the government does not attempt to prevent a price rise, inflation is said to be open. Thus, inflation is open
when prices rise without any interruption. In open inflation, the free market mechanism is permitted to fulfill its
historic function of rationing the short supply of goods and distribute them according to consumer's ability to pay.

Repressed Inflation

When the government interrupts a price rise, there is a repressed or suppressed inflation. Thus, it refers to those
conditions in which price increases are prevented at the present time through an adoption of certain measures like
price control and rationing by the government, but they rise on the removal of such controls and rationing.

Repressed inflation is criticized as it breeds number of evils like black market and uneconomic diversion of
productive resources from essential industries to non-essential or less essential goods industries since there is a free
price movement in the latter and hence are more profitable to investors.

Inflation Tax

Price rise means more money being paid by the consumers for what they buy. Thus, it is a type of tax.
Banking System in India

A commercial bank is a type of financial intermediary because it mediates between the savers and borrowers. It does
so by accepting deposits from the public and lending money to businesses and consumers. Its primary liabilities are
deposits and primary assets are loans and bonds.

Investment banks assist companies in raising funds in the capital markets (both equity and debt), as well as in
providing strategic advisory services for mergers, acquisitions and other types of financial transactions. It is also called
merchant bank.

The commercial banking system in India consists of public sector banks; private sector banks and cooperative banks.

Currently, India has 88 scheduled commercial banks (SCBs) – 21 public sector banks (that is with the Government of
India holding majority stake; 19 nationalized and 2 PSUs-SBI and IDBI), 25 private banks and 43 foreign banks, 56
Regional rural Banks (RRB), 1589 Urban Cooperative Banks and 93550 Rural Cooperative Banks. RBI also gave
approval to 11 Payments Banks and 10 Small Banks. Public sector banks hold over 75 percent of total assets of
banking industry, with the private and foreign banks holding 18.2% and 6.5 respectively.

Public Sector Banks

They are owned by the Government either totally or as a majority stake holder.

 State Bank of India and its five associate banks called the State Bank group
 19 nationalized banks
  Regional Rural Banks mainly sponsored by Public Sector Banks

Private Sector Banks include domestic and foreign banks.

Co-operative Banks are another class of banks and are not considered as commercial banks as they have social
objectives and profit is not the motive.

Development Banks are those financial institutions which provide long term capital for industries and agriculture :
Industrial Finance Corporation of India (IFCI); Industrial Development Bank of India (IDBI); Industrial Credit and
Investment Corporation of India (ICICI) that was merged with the ICICI Bank in 2000; Industrial Investment Bank of
India (IIBI); Small Industries Development Bank of India (SIDBI); National Bank for Agriculture and Rural
Development (NABARD); Export Import Bank of India; National Housing Bank (NHB is subsidiary of RBI).

Land Development Bank is of quasi-commercial type that provides services such as accepting deposits, making
business loans, and offering basic investment products. The main objective of the LDB is to promote the
development of land, agriculture and increase the agricultural production. The LDB provides long-term finance to
members according to the number of shares he holds in the bank directly through its branches.

The commercial banking network essentially catered to the needs of general banking and for meeting the short-
term working capital requirements of industry and agriculture.

Specialized development financial institutions (DFIs) such as the IDBI, NABARD, NHB and SIDBI, etc., with majority
ownership of the Reserve Bank were set up to meet the long-term financing requirements of industry and
agriculture.

The all India financial institutions can be classified under four heads according to their economic importance that are:

 All-India Development Banks

 Specialized Financial Institutions (SIDBI)
 Investment Institutions (The Industrial Reconstruction Corporation of India Ltd., set up in 1971 for
rehabilitation of sick industrial companies)
 State-level institutions (SFC)

S.H. Khan Committee appointed by RBI (1997) recommended transforming the DFI (development finance institution)
into universal banks that can provide a menu of financial services and leverage on their assets and talent.

Bank Nationalization

In 1969 and again in 1980, Government nationalized private commercial banking units for channelizing banking
capital into rural sectors; checking misuse of banking capital for speculative purposes; to shift from ‘class banking’ to
mass banking’ (social banking); and to make banking into an integral part of the planning process of socio-economic
development in the country.

Commercial Banks

Today banks are broadly classified into two types- Scheduled Banks and Non-scheduled Banks. Schedule banks are
those banks which are included in the Second Schedule of the Reserve Bank Act, 1934. They satisfy two conditions
under the Reserve Bank of India Act.

 paid-up capital and reserves of an aggregate value of not less than Rs. 5 lakh.
 it must satisfy RBI that its affairs are not conducted in a manner detrimental to the depositors.
The scheduled banks enjoy certain privileges like approaching RBI for financial assistance; refinance etc. and
correspondingly, they have certain obligations like maintaining certain cash reserves as prescribed by the RBI etc.

Non-scheduled banks are those banks which are not included in the second schedule of the RBI Act as they do not
comply with the above criteria and so they do not enjoy the benefits either. There are only 3 non-scheduled
commercial banks operating in the country with a total of 9 branches.

Scheduled Commercial Banks are categorized into 5 different groups

 SBI and its Associates

 Nationalized Banks
 Private Sector Banks
 Foreign Banks
 Regional Rural Banks

Cooperative Banks

Co-operative Banks are organized and managed on the principle of co-operation, self-help, and mutual help. They
function with the rule of “One member, one vote” and on “no profit, no loss” basis. Co-operative banks, as a
principle, do not pursue the goal of profit maximization.

Co-operative bank performs all the main banking functions of deposit mobilization, supply of credit and provision of
remittance facilities. Co-operative Banks provide limited banking products and are functionally specialists in
agriculture related products. However, co-operative banks now provide housing loans also.

Urban Co-operative Banks (UCBs) are located in urban and semi-urban areas. These banks, till 1996, were allowed to
lend money only for non-agricultural purposes. This distinction does not hold today. Earlier, they essentially lent to
small borrowers and businesses. Today, their scope of operations has widened considerably. Urban CBs provide
working capital, loans and term loan as well.

Co-operative banks are the first government sponsored, government-supported, and government- subsidized
financial agency in India. They get financial and other help from the Reserve Bank of India, NABARD, central
government and state governments.

Co-operative Banks belong to the money market as well as to the capital market- they offer short term and long
loans.

Primary agricultural credit societies provide short term and medium term loans. NABARD has supervisory functions
over DCCBs and SCBs which provide both short term and term loans. .

Land Development Banks (LDBs) provide long-term loans.

Long term cooperative credit structure comprises of state cooperative agriculture and rural development bank
(SCARDB) at the state level and primary PCARDBs or branches of SCARDB at the decentralized district or block level
providing typically medium and long term loans for making investments in agriculture, rural industries, and lately
housing.

Some co-operative banks are scheduled banks, while others are non-scheduled banks. For instance, SCBs and some
UCBs are scheduled banks (included in the Second Schedule of the Reserve Bank of India Act).

Co-operative Banks are subject to CRR and SLR requirements as other banks. However, their requirements are less
than commercial banks.
Payment Banks

The RBI granted ‘in principle’ approval for payment banks to 11 entities, including big names like Reliance Industries,
Aditya Birla Nuvo and Tech Mahindra, as also Airtel and Vodafone.

What are they?

New stripped-down type of banks, which are expected to reach customers mainly through their mobile phones
rather than traditional bank branches

What they can and can’t do

 They can’t offer loans but can raise deposits of up to Rs. 1 lakh, and pay interest on these balances just like a
savings bank account does.
 They can enable transfers and remittances through a mobile phone.
 They can offer services such as automatic payments of bills, and purchases in cashless, cheque less
transactions through a phone.
 They can issue debit cards and ATM cards usable on ATM networks of all banks.
 They can transfer money directly to bank accounts at nearly no cost being a part of the gateway that
connects banks.
 They can provide forex cards to travelers, usable again as a debit or ATM card all over India.
 They can offer forex services at charges lower than banks.
 They can also offer card acceptance mechanisms to third parties such as the ‘Apple Pay.’

Who has Reserve Bank granted in-principle approval to be a payment bank?

 Aditya Birla Nuvo Ltd

 Airtel M Commerce Services Ltd
 Cholamandalam Distribution Services Ltd
 Department of Posts
 Fino PayTech Ltd
 National Securities Depository Ltd
 Reliance Industries Ltd
 Dilip Shantilal Shanghvi
 Vijay Shekhar Sharma
 Tech Mahindra Ltd
 Vodafone m-pesa Ltd

Why are they going to be a game-changer?

This is for the first time in the history of India's banking sector that RBI is giving out differentiated licenses for specific
activities. RBI is expected to come out with a second set of such licenses — for small finance banks — and the process
for those is in its final stage. The move is seen as a major step in pushing financial inclusion in the country.

It’s a step to redefine banking in India. The Reserve Bank expects payment banks to target India’s migrant labourers,
low-income households and small businesses, offering savings accounts and remittance services with a low
transaction cost. It hopes payments banks will enable poorer citizens who transact only in cash to take their first step
into formal banking. It could be uneconomical for traditional banks to open branches in every village but the mobile
phones coverage is a promising low-cost platform for quickly taking basic banking services to every rural citizen. The
innovation is also expected to accelerate India’s journey into a cashless economy.
India’s domestic remittance market is estimated to be about Rs. 800-900 billion and growing. With money transfers
made possible through mobile phones, a big chunk of it, especially that of the migrant labour, could shift to this new
platform. Payment banks can also play a crucial role in implementing the government’s direct benefit transfer
scheme, where subsidies on healthcare, education and gas are paid directly to beneficiaries’ accounts.

Also, this is the first time since banks were nationalized, that private sector business groups have bagged the RBI’s nod
for banking services.

What has the experience been in other countries?

Payment technologies have proved hugely popular in other developing countries. In Kenya, the most cited success
story, Vodafone’s M-Pesa is used by two in three of adults to store money, make purchases and transfer funds to
friends and relatives.

Prakash Bakshi Committee

In August 2012, the RBI constituted a committee to suggest ways to strengthen the rural cooperative credit
structure. It will review the existing short term cooperative credit structure, focusing on structural constraints in the
rural credit delivery system. It will mainly assess the role played by the state and district cooperative bodies in fulfilling
the requirement of agriculture credit.

The major factors that contributed to the deteriorating bank performance till the end of eighties are

 high SLR and CRR locking up funds

 low interest rates charged on government bonds
 directed and concessional lending for populist reasons
 administered interest rates
 lack of competition

The reforms that set the above problems right were

 Floor and cap on CRR and floor or SLR removed in 2006

 interest rates were deregulated to make banks respond dynamically to the market conditions
 near level playing field for public, private and foreign banks in entry adoption of prudential norms-Reserve
Bank of India issued guidelines for income recognitions, asset classification and provisioning to make banks
safer.
 Basel II norms adopted for safe banking
 VRS for better work culture and productivity
 FDI up to 74% is permitted in private banks

The objectives of the banking sector reforms are

 to make them competitive and profitable

 to strengthen the sector to face global challenges
 sound and safe banking
 to help them technologically modernize for customer benefit
 make available global expertise and capital by relaxing FDI norms
Narasimham Committee, 1991

Banking sector reforms in India were conducted on the basis of Narasimham Committee reports I and II 1991 and 1998
respectively). The recommendations of Narasimham committee 1991 are

 No more nationalization
 create a level playing field between the public sector, private sector and foreign sector banks
 select few banks like SBI for global operations
 reduce Statutory Liquidity Ratio (SLR) as that will leave more resources with banks for lending
 reduce Cash Reserve Ratio (CRR) to increase lendable resources of banks
 rationalize and better target priority sector lending as a sizeable portion of it is wasted and also much of it
turning into non-performing asset
 introduce prudential norms for better risk management and transparency in operations
 deregulate interest rates
 Set up Asset Reconstruction Company (ARC) that can take over some of the bad debts of the banks and
financial institutions and collect them for a commission

Non Performing Assets

Non-performing assets are those accounts of borrowers who have defaulted in payment of interest or installment
of the principal or both for more than 90 days.

Stressed assets = NPAs + Restructured loans + Written off assets

RBI rules require that banks should set aside certain amount of money (provisioning) for the NPAs. Gross NPAs include
the amount due along with the amount provisioned. Net NPAs include only the amount due.

NPAs are largely fallout of banks credit appraisal system, monitoring of end-usage of funds and recovery procedures.
It also depends on the overall economic environment, the business cycle and the legal environment for recovery of
defaulted loans. Willful default; priority sector problems among the poor etc. are also responsible.

High levels of NPAs means: banks’ profitability diminishes; precious capital is locked up; cost of borrowing will rise
as lendable assets shrink; stock prices of banks will go down and investors will lose; investment suffers etc.

The following are the RBI guidelines for NPAs classification and provisioning:

 Sub Standard Assets- These are those accounts which have been classified as NPAs for a period less than or
equal to 12 months.
 Doubtful Assets- These are those accounts which have remained as Sub standard for a period exceeding 12
months.
 Loss Assets- In other words, such an asset is considered uncollectible and of such little value that its
continuance as a bankable asset is not warranted although there may be some salvage or recovery value. But
a loss asset has not been written off, wholly or partly.

What is being done to handle NPAs?

 Provisioning for NPAs

 CAR norms
 Securitization law (pooling a group of assets and selling securities backed by these assets)
 Foreclosure (taking over of NPAs by the lender of mortgaged property if the borrower does not conform to
the terms of mortgage)
  One time settlement
 Interest waivers
 Write offs
 Debt recovery tribunals

SARFAESI Act, 2002

To expedite recovery of loans and bring down the non-performing asset level of the Indian banking and financial
sector, the government in 2002 made a new law that promises to make it much easier to recover bad loans from
willful defaulters. Called the Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act 2002 (SARFAESI), the law has given unprecedented powers to banks, financial institutions and asset
reconstruction/securitization companies to take over management control of a loan defaulter or even capture its
assets.

Asset Reconstruction Company

Normally banks and FIs themselves recover the loans. But in the case of bad debts (sticky loans), it is outsourced to
the ARCs who have built-in professional expertise in this task and who handle recovery as their core business. ARCs
buy bad loans from banks and try to restructure them and collect them. ARCs were recommended by Narasimham
committee II. ARCIL- the first asset reconstruction company was set up recently.

Prudential norms make the operations transparent, accountable and safe. They bring out the true position of a bank’s
portfolio and help in prevention of its deterioration. Prudential norms relate to

 Income recognition
 Provisioning
 CRAR
 Asset Classification

Basel Norms

Banks have to keep aside a certain percentage of capital as security against the risk of non-recovery. Basel
committee provided the norms called Basel norms to tackle the risk.

Basel is city in Switzerland and is the headquarters of Bureau of International Settlement (BIS) which fosters
cooperation among central banks with a common goal of financial stability and common standards of banking
regulations.

Basel guidelines refer to broad supervisory standards formulated by a group of 27 member nations called the Basel
Committee on Banking Supervision.

Basel 1

It was introduced in 1988 and focused entirely on credit risk. The minimum capital requirement was fixed at 8% of
risk weighed assets.

Basel 2

It was introduced in 2004. The guidelines were based on three pillars- capital adequacy ratio (8%), Supervisory
review and market discipline.
According to Supervisory review, Banks were needed to develop and use better risk management techniques in
monitoring and managing all three types of risks that a bank faces- credit, market and operational.

Market discipline implies increased disclosure requirements like CAR, risk exposure etc. to the central bank

Basel 3

In 2010 Basel 3 norms were released in response to the financial crisis of 2008. Capital to Risk Weighed Assets Ratio
(CRAR) of 9% was prescribed

Presently Basel 2 norms are being complied with by Indian banks. RBI guidelines based on Basel 3 will have to be fully
implemented by 2018. Indian banks would require a huge amount of capital ($30-40 billion) which would impose a
heavy financial burden on the government.

Under Basel 3 norms a countercyclical capital buffer is prescribed to keep aside capital that can be used when the
cycle turns down and the loans may turn bad.

Credit Risk: A bank always faces the risk that some of its borrowers may not repay loan, interest or both

Market Risk: As part of statutory requirement, Banks are required to invest in liquid assets like gold, cash, government
and other approved securities. Such investments are risky because of the change in their prices. This volatility of a
bank’s investment portfolio is called market risk

Operational Risk: These risks are attributed to internal systems, processes, people and external factors

Capital Adequacy Norms

Tier 1 Capital: Actual contributed equity + retained earnings. Tier 1 capital is used to absorb losses without ceasing
operations. This money funds a bank uses to function on a regular basis and forms the basis of a financial
institution's strength

Tier 2 Capital: Preferred shares + 50% of subordinated debt. It is meant to be used at the time of winding up

 Retained Earnings: percentage of net earnings not paid out as dividends, but retained by the company to be
reinvested in its core business, or to pay debt.
 Preferred Shares: a share which entitles the holder to a fixed dividend, whose payment takes priority over
that of ordinary share dividends
 Subordinated Debt: a debt owed to an unsecured creditor that in the event of liquidation can only be paid
after the claims of secured creditors have been met.

In 2019, under Basel III, the minimum total capital ratio is 12.9%, which indicates the minimum tier 2 capital ratio is
2%, as opposed to 10.9% for the tier 1 capital ratio

Capital to Risk Weighted Assets Ratio (CRAR) as given by the Basel Committee is the capital that is required to be set
aside for absorbing risks. It is not to be provisioned from deposits raised but has to be additionally provided from
debt, equity, reserves etc.

BIS

The Bureau of International Settlements is an international organization of central banks which fosters international
monetary and financial cooperation and serves as a bank for central banks. It also provides banking services but
only to central banks or international organizations. It seeks to make monetary policy more predictable and
transparent. The BIS’ main role is in setting capital adequacy requirements to safeguard bank’s operations.
Shadow Banks

NBFCs are largely referred to as shadow banking system or the shadow financial system. They do not accept
demand deposits and therefore are not subject to the same regulations.

Universal Banking in India

It was recommended by Narasimham Committee and Khan Committee reports. It aims at widening and integration of
financial activities.

Universal Banking is a multi-purpose and multi functional financial super market. It refers to those banks offering a
wide range of financial services beyond the commercial banking functions like Mutual Funds, Merchant Banking,
Factoring, Credit Cards, Retail Loans, Housing Finance, Insurance etc.

Banks can reduce average costs and improve spreads by diversification.

However one drawback of universal banking is that it leads to a loss in specialization and indulging in too many risky
activities.

Financial Inclusion

Many people, particularly those living on low incomes, cannot access mainstream financial products such as bank
accounts and low cost loans. This financial exclusion forces them to borrow from the moneylenders at high cost.
Therefore, financial inclusion has been the goal of government’s policy since late sixties. It comprises

 Access to banking
 Access to affordable credit
 Access to free face to face money advice

Thus, financial inclusion is the delivery of banking services at an affordable cost to the vast sections of
disadvantaged and low-income groups. The Government of India’s rationale for creating Regional Rural Banks (RRBs)
in the years in 1975 following the nationalization of the country’s banks was to ensure that banking services reached
poor people.

Priority sector credit under which 40% of all bank advances should go to certain specified areas like agriculture is a
form of directed credit that is aimed at financial inclusion.

Micro-finance (savings, insurance and lending in small quantities) and self-help groups are another innovation in
financial inclusion. Differential rate of interest; kisan credit cards; no-frills account (allowing opening of account with
very little or no minimum balances) etc. are examples of financial inclusion.

Access to finance by the poor and vulnerable groups is a prerequisite for poverty reduction and social cohesion. This
has to become an integral part of our efforts to promote inclusive growth.

Financial inclusion means delivery of financial services at an affordable cost to the vast sections of the disadvantaged
and low-income groups.

NSSO data reveal that 45.9 million farmer households in the country (51.4%), out of a total of 89.3 million
households do not access credit, either from institutional or non-institutional sources. Further, despite the vast
network of bank branches, only 27% of total farm households are indebted to formal sources (of which one-third
also borrow from informal sources). The poorer the group, the greater is the exclusion.
The Committee on Financial Inclusion headed by Shri C.R. Rangarajan, submitted its report in 2008 and
recommended that

 semi-urban and rural branches or commercial banks and Regional Rural Banks may set for themselves a
minimum target of covering 250 new cultivator and non-cultivator households per branch per annum
 A National Mission on Financial Inclusion (NaMFI) comprising representatives from all stakeholders may be
constituted to aim at achieving universal financial inclusion within a specific time frame.
 A National Rural Financial Plan (NRFIP) may be launched with a clear target to provide access to
comprehensive financial services, including credit, to at least 50% of financially excluded households, by 2012
 proposed the constitution of two funds with NABARD- the Financial Inclusion Promotion & Development Fund
and the Financial Inclusion Technology Fund
 The Business Facilitator/Business Correspondent (BF/BC) models riding on appropriate technology can deliver
this outreach and should form the core of the strategy for extending financial inclusion.
 The Committee has recommended the recapitalization of RRBs with negative Net Worth and widening of their
network to cover all unbanked villages in the districts where they are operating, either by opening a branch or
through the BF/BC model in a time bound manner.
 The Committee has recommended amendment to NABARD Act to enable it to provide micro finance service to
the urban poor.

A Joint Liability Group (JLG) is an informal group comprising preferably of 4 to 10 individuals coming together for
the purposes of availing bank loan either singly or through the group mechanism against mutual guarantee.

Bank Consolidation

Bank Consolidation means merging public sector banks to form big and globally aspiring banks is bank consolidation. It
is expected to bring about financial stability and was recommended by the Narasimham Committee- II (1997) on
financial sector reform.

State Bank of Saurashtra merger with SBI has been achieved and the remaining six are to be merged. Government says
that bigger banks can take on competition; can raise more than smaller banks.

Rationalizing the manpower and branch network after bank mergers are a challenge and the criticism also includes
that the bigger banks will be so much more bureaucratized. Bigness also does not reduce chances of failure as seen in
the west in the current meltdown.

Financial Stability

Financial stability is a situation where the financial system operates with no serious failures or undesirable impacts on
development of the economy as a whole, while showing a high degree of resilience to shocks.

RBI’s role in financial stability

 Licensing of banks
 Deciding on who can set up a bank or expand its branches
 SLR and CRR norms
 CAR rules
 Lender of last resort
 Laying down prudential norms
 Supervisory functions
RBI tracks excessive volatility in interest rates, exchange rates and asset prices, signs of excess leverage in the financial
sector, companies and households and unregulated parts of the financial sector to maintain financial stability.

It set up the Financial Stability Unit in 2009 and started presenting periodical reports since March 2010. New risk
assessment measures are introduced by the RBI – such as the Financial Stress Indicator and Banking Stability Index.

Risks to financial stability are

 Widening CAD
 volatile inflows
 Persistently high inflation
 Asset quality of banks
 Asset liability mismatch
 Micro finance institutional structure

Banking Stability Index

It is a simple average of 5 sub indices based on 4 parameters: operational efficiency, asset quality, liquidity and
profitability. The 5 key dimensions are

 capital adequacy ratio

 cost-to-income ratio (Operational Efficiency)
 non-performing loans to total loans ratio (Asset Quality)
 liquid assets to total assets ratio and (Liquidity)
 net profit to total assets ratio (Profitability)

Capital Adequacy Ratio (CAR), also known as Capital to Risk (Weighted) Assets Ratio (CRAR), is the ratio of a bank's
capital to its risk.

CAR = (Tier 1 Capital + Tier 2 Capital)/ Risk Weighted Assets

Toxicity Index

Toxicity index measures the probability of a bank causing distress to another bank. Vulnerability index measures
the probability of being affected by the distress of other banks. Another index called the Cascade Effects looks at the
likelihood of a Domino effect of banks in the financial system.

Weak bank

A weak bank is one where a total of accumulated losses of the bank and the net NPA amount exceed the net worth
of the bank

Narrow banking

Narrow banking is restricting banks to hold liquid and safe government bonds to prevent bank runs

Bank Run

It is a type of financial crisis which occurs when a large number of consumers of a bank fear it is insolvent and
withdraw their deposits.
Subordinated Debt

It is debt that is unsecured or has lesser priority than that of the other debt claims on the same asset.

Core Banking

It is defined as the business conducted by a banking institution with its retail and small business customers. Core
banking is basically depositing and lending money.

World Bank Recapitalization

Government of India has made an assessment that the public sector banking system would need as much as Rs.
35,000 crore worth of Tier- I capital by 2012, given projections of how much their business needs to expand. Past
divestment of equity has significantly reduced the government’s shareholding in many public sector banks. Hence, it is
argued, if 51 per cent government ownership has to be maintained to secure the public sector character of these
banks, this recapitalization has to be in the form of new government equity capital. Since the government is
strapped for funds for this purpose, it has decided to use this requirement as the basis for opting for a sector-specific
$2 billion World Bank loan.

Bank Stress Test

A stress test is an assessment or evaluation of a Bank’s balance sheet to determine if it is viable as a business or likely
to go bankrupt when faced with certain recessionary and other stress situations- whether it has sufficient capital
buffers to withstand the recession and financial crisis. European banks were recently subjected to such stress tests.

Financial Sector Reforms

Reforming the financial sector-banking, insurance, pension reforms- is crucial to make them generate resources; gain
efficiencies; innovate new products and serve the economy and people well.

Some recent initiatives in this sector relate to

 introduction of base rate (Base Rate is the minimum rate below which Bank's are not permitted to lend
barring certain exceptions) for banks;
 setting up of Financial Stability and Development Council;
 business correspondent model for financial inclusion.
 CRR and SLR have been freed from floor and cap to make banking more flexible
 Consolidation of banks
 NPS has been introduced

Debt market: The bond market in India remains limited in terms of nature of instruments, their maturity, investor
participation and liquidity. Recent reforms include raising of the cap on investment by foreign institutional investors,
or FIIs, from $6 billion to $15 billion.

Regulatory reforms- setting up of the FSDC is crucial for better supervision and clear demarcation of the jurisdiction.
The Chairman of the Council is the Finance Minister and its members include the heads of financial sector
Regulators (RBI, SEBI, PFRDA, IRDA & FMC) Finance Secretary and/or Secretary, Department of Economic Affairs,
Secretary, Department of Financial Services, and Chief Economic Adviser.

The roadmap for financial sector reforms has been defined by the RH Patil, Percy Mistry & Raghuram Rajan reports
How Indian banks survived the global crisis?

Even though many banks failed and some survived on huge bailouts in the west due to the global financial crisis,
Indian banking is almost unscathed for the following reasons

 Public sector banks- 26- dominate

 FDI is 74% in private banks but voting rights are only 10%
 We adopted capital account convertibility in a measured manner
 RBI has been conservative and regulated the banks well. Banks were not allowed to invest in risky
instruments like credit default swaps (CDS)
 Basel norms, SLR and CRR levels were well maintained
 Prudential norms also saved the Indian banks from recklessness

Basics of Base Rate

It is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the
government, RBI rules stipulate that no bank can offer loans at a rate lower than Base Rate to any of its customers.

How is the base rate calculated?

A host of factors, like the cost of deposits, administrative costs, a bank’s profitability in the previous financial year
and a few other parameters, with stipulated weights, are considered while calculating a lender’s BR. The cost of
deposits has the highest weight in calculating the new benchmark. Banks, however, have the leeway to take into
account the cost of deposits of any tenure while calculating their BR.

How is it different from bank prime lending rate?

Base Rate is a more objective reference number than the bank prime lending rate (BPLR)- the current- benchmark.
BPLR is the rate at which a bank tends to lend to its most trustworthy low-risk customer. However, often banks lend
at rates below BPLR. For example, most home loan rates are at sub-BPLR levels. Some large corporates also get loans
at rates substantially lower than BPLR. For all banks, BR will be much lower than their BPLR

How often can a bank change its BR?

A bank can change its Base Rate every quarter, and also during the quarter.

What does it mean for corporate borrowers?

Under the BPLR system, large corporates who enjoyed rates as low as 4-6% will be hit.

What are its benefits?

It makes the lending rates transparent. Monetary policy changes will find genuine transmission. Cross subsidization of
the corporate at the expense of MSMEs will stop and MSMEs will get credit more affordably.

What are the exceptions?

Educational loans, export credit, credit to weaker sections can be given at sub-base rate.
Swabhimaan, 2011

The government has launched Swabhimaan – a programme to ensure banking facilities to habitations with
population in excess of 2000 by March 2012. The government has decided to pay Rs. 140 for every no frills account
they open as part of the financial inclusion plan.

It would enable small and marginal farmers to obtain credit at lower rates from banks and other financial
institutions. It would insulate them from usurious money lenders.

Once banking access increases, it is hoped that the subsidies and social security benefits can be directly credited to the
accounts of the beneficiaries.

Priority Sector: Nair Committee Recommendations

 Priority sector targets for public sector and private sector banks could be retained at the current level of 40%
of the net credit
 Several changes should be made to exposure of foreign banks. Priority sector target for these banks should
also be increased to 40% from current 32%
 5% of the banks’ credit to NBFCs could be classified as priority sector
 Lending to gold companies will not be classified as priority sector
 Special treatment should be given to small and marginal farmers and housing loans below Rs. 2 lakhs should
be classified under priority sector

Priority Sector Lending Norms as of May 2016

Priority Sector includes the following categories:

Agriculture, Micro, Small and Medium Enterprises, Export Credit, Education, Housing, Social Infrastructure,
Renewable Energy and Others

PSL for Domestic scheduled commercial banks and Foreign banks with 20 branches and above

 40 percent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure,
whichever is higher
 18 percent Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure for
Agriculture (8% for small and marginal farmers); (foreign banks to achieve by 2018)
 7.5% for Micro enterprises; (foreign banks to achieve by 2018)
 10% of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher for advances to
weaker sections; (foreign banks to achieve by 2018)

Savings Bank Deregulation

RBI deregulated savings rate in 2011. Earlier RBI changed the repo and reverse repo rates many times but the same
was not reflected in the interest rates that the normal household gets. There was a huge gap between savings and
term deposit rates. Thus the depositors of Savings bank account suffered. After deregulation, it is expected that the
savings rate would move in tandem with the RBI monetary policy thus making the policy more effective

Financial Institutions and Others under Department of Financial Services (DFS)

Industrial Finance Corporation of India

  Set up in 1948 as a statutory corporation through IFCI Act, 1948 to provide medium and long term finance to
industry
 In 1993, IFCI became a public limited company registered under Companies Act.
 In 2012 it became a Government Controlled Company
 Systemically Important Non-Deposit taking Non-Banking Finance Company (NBFC-ND-SI), registered with the
Reserve Bank of India.

Export-Import Bank of India (EXIM Bank)

 Premier export finance institution of India

 commenced operations in 1982 under the Export-Import Bank of India Act, 1981

National Bank for Agriculture and Rural Development (NABARD)

 approved by the Parliament through Act 61 of 1981

 came into existence on 12 July 1982
 fully owned by Government of India
 Its mission is to promote sustainable and equitable agriculture and rural development through participative
financial and non-financial interventions, innovations, technology and institutional development for securing
prosperity
 providing refinance support to building rural infrastructure
 SHG Bank Linkage Project launched by NABARD in 1992 has blossomed into the world’s largest micro finance
project
 Kisan Credit Card
 Government of India created the Rural Infrastructure Development Fund (RIDF) in NABARD in 1995-96
 dedicated Long Term Irrigation Fund (LTIF) in NABARD with an initial corpus of Rs. 20,000 crore for funding
and fast tracking the implementation of incomplete major and medium irrigation projects

National Housing Bank (NHB)

 NHB was set up on July 9, 1988 under the National Housing Bank Act, 1987
 principal agency to promote housing finance institutions both at local and regional levels

Small Industries Development Bank of India (SIDBI)

 set up on 2nd April 1990 under an Act of Indian Parliament

 Principal Financial Institution for Promotion, Financing and Development of the Micro, Small and Medium
Enterprise (MSME) sector as well as for co-ordination of functions of institutions engaged in similar activities

SME Rating Agency of India Ltd (SMERA)

 Operational from September 2005

 3rd party credit rating agency exclusively set up for MSMEs
 Integral part of the ecosystem SIDBI has built for MSMEs in India
 SMERA now operates as a separate division of Acuite Ratings & Research Limited

India Infrastructure Finance Company Ltd (IIFCL)

 wholly-owned Government of India company set up in 2006 to provide long term debt for infrastructure
projects- both public and private
 provision of long term funds from commercial banks is restricted due to their asset-liability mismatch
 priority is given to private companies awarded PPP projects via competitive bidding process
 registered as a NBFC-ND-IFC with RBI since 2013
 IIFCL raises funds from domestic as well as external markets on the strength of government guarantees
Public Sector

PSEs normally have the following forms of organizational structure

 Departmental Undertakings: Formed by executive actions of government. Eg: Railways

 Statutory Corporations: Formed by acts of legislature eg: ONGC
 Companies registered under the Companies Act.
 Boards: Control boards are set up to manage government projects Eg: River valley projects
 Cooperatives: Registered under Multi State Cooperative Societies with >65% capital held by central
government

Objectives of PSUs are

 To build a self reliant economy

 To prevent and reduce concentration of private economic power
 Establish sound economic infrastructure
 Set up industries in the backward regions and thus help bring about balanced development
 Assist in ancillarization and thus spread the benefits of industrialization
 Create sufficient levels of employment and set standards in labor welfare
 Selling goods and services at reasonable prices
 Invest in areas where private sector would not invest

List of industries reserved for public sector

 Atomic Energy
 Minerals specified in schedule to Atomic energy order, 1953
 Railway transport

PSU reforms so far

 Dereservation
 Withdraw from commercial and other areas like hotels, bakeries, cycles etc.
 Disinvest a portion of the PSU equity for a variety of purposes
 Strategic sale where PSE is sold over to a strategic partner who buys majority equity and takes over
management
 Subjecting PSUs to market discipline by listing on stock exchanges
 Liberal FDI norms thereby increasing competition
 MoU system with greater weightage to financial performance
 Navratnas granted financial autonomy and managerial autonomy
 Professionalization of boards

Disinvestment

It is the sale of shares of the government to the retail public or employees or mutual funds or FIIs. There is no
change in management from public to private hands because either the government holds majority (51%) equity and
even if it doesn’t, rest of the equity is distributed among various individuals, none of whose share is >50%.

If the government sells a chunk of equity to a single buyer- 26% or 51% or more to whom the management is also
handed over, it is called strategic sale or privatization
Advantages

 Raises finance for the government that can be spent on restructuring the PSEs
 Makes additional resources available for social spending schemes
 Exposes the enterprises to market discipline thereby making them more efficient
 Firms become more professionalized
 Results in wider distribution of wealth through offering of shares to small investors and employees
 Beneficial to capital market due to depth provided
 Reduces public debt
 Releases other tangible and intangible resources such as large government manpower

Criticism of divestment

 They constitute family silver and should not be liquidated

 PSEs check private sector in the wider market place and are crucial to the economy
 PSEs contribute by way of dividends and profits

Divestment Policy

 List all unlisted PSEs and sell a minimum of 10% equity to the public
 Completing the process of off loading 5-10% of equity in previously identified profit making non-Navratna
companies
 Auction all loss making PSUs that cannot be revived
 Fully protect the interests of the workers
 Making shares available to a wider section of the public

Strategic PSEs: 1. Arms, ammunitions and Defence, 2. Atomic Energy, 3. Railways

Board for reconstruction of PSEs (BRPSE)

It was set up in 2004 to

 Advise the government on ways and means for strengthening the PSEs in general and making them more
autonomous and professional in particular
 Consider restructuring- financial, organization and business of CPSEs and suggest ways and means for funding
such schemes
 Advise the government on disinvestment/ closure/ sale in full or part in respect of chronically sick or loss
making companies which cannot be revived
 Monitor incipient sickness (incurring loss for two consecutive years) in CPSEs
 Make recommendations and advice the government on such other measures assigned to it from time to time

It comprises of a Chairman, 3 Non official members, 3 official members and three permanent invitees

Navratnas

Quantitative system to confer the status of Navratna

 Net Profit to Net worth (Total Assets – Total Liabilities)

 Total Manpower cost as a percentage of total cost of production
 PBDIT on Capital Employed
 PBDIT on turnover
  EPS
 Inter sectoral performance

PSEs should get a score of at least 60 out of 100 on the above parameters

Navratnas have freedom to

 Incur capital expenditure

 Decide upon joint ventures
 Set up subsidiaries and offices abroad
 Enter into technological and strategic alliances
 Raise funds from capital markets
 Enjoy substantial operational and managerial autonomy
 Boards of PSEs have been broad based with induction of non-official part time professional directors

Arjun Sengupta Committee

Report on empowerment of central PSEs recommended

 Greater autonomy for PSUs

 Central PSUs to have truly independent boards
 Empowering PSU boards to take decisions about M&A, JVs, pricing, exports, appointments, selection of
dealers, promotion and transfer of employees and so on
 Ministry concerned not to review the PSU more than twice a year
 Supervision by sector specific supervisory boards
 Ministries should not interfere with functioning of the PSUs under them
 Government should have the flexibility to divest stake in PSUs
 Supplementary audit by CAG should be an exception rather than the rule
 Reworking of accountability of PSEs so that questions on their functioning do not compromise sensitive trade
data

MoU

It was based on the French system. It is also called the Signaling System. It is possible to make an overall judgment of
the enterprise’s performance in the signaling system.

MoU is a freely negotiated agreement between the PSE and the administrative ministry. Under the agreement, the
PSE undertakes to achieve the targets set in the agreement at the beginning of the year. The MoU covers both
financial performance and non financial performance. The objectives of the MoU are to improve the performance of
the public enterprises by increasing autonomy and accountability of the management, remove the fuzziness in the
goals and objectives, enable the evaluation of managerial performance through objective criteria and provide a
mechanism to reward good performance through performance incentives to stimulate improved performance.

Professionalization of PSU boards

 MoU
 Outside professionals should be inducted in the boards of PSU in the form of non-official directors (at least
one third of the total number)
 Under Navratna and Miniratna package, the boards of select PSUs have been professionalized by inducting a
minimum of 4 non-official directors in case of Navratnas and 3 in case of Mini ratnas
 Number of government directors on the board should not be greater than two

Problems of PSU restructuring

 Tenure of CEO and board is subject to government rules and regulation

 Business decisions in PSUs are influenced by presence of a number of controlling agencies like the ministry,
CAG, CVC, parliamentary committees etc.
 PSUs are expected to function on commercial considerations but they are burdened by takeover of some sick
units
 Investment in new units is based on socio-political considerations rather than strong economics

National Investment Fund (under DIPAM)

 The proceeds from divestment will be channeled into NIF formed in 2005
 It will be professionally managed by public sector insurance and fund managers to provide sustainable
returns to the government, without depleting the corpus
 75% of the annual income of NIF will be used to finance select social sector schemes. The residual 25% will
be used to meet the capital investment requirements of profitable and revivable CPSEs that yield adequate
returns
Money Market and Capital Market in India

Money market covers sources of finance- lending and borrowing short term funds- funds with a maturity of less
than 1 year

Money market instruments

Call Money

Call or Notice Money is money borrowed or lent for a very short period. If the period is between 1 to 14 days, it is
called notice money, otherwise it is call money. No collateral security is required to cover these transactions. The call
market enables the banks and institutions to even out their day to day deficits and surpluses of money.

 Call Money: money borrowed for 1 day

 Notice Money: money borrowed for 2 to 14 days
 Term Money: money borrowed for >14 days

Interest rates are market determined. Commercial banks, cooperative banks, mutual funds, primary dealers and
others are allowed to borrow and lend in this market

Treasury Bills

They are short term money market instruments issued by the RBI on behalf of the GOI as well as state governments.
GOI uses these funds to meet its short term financial requirements. They are sovereign zero risk instruments. They
are available in both primary and secondary markets and are issued at a discount to face value.

There are T-bills of 14 days, 91 days, 182 days and 364 days maturity. Minimum investment required in case of T-bills
is Rs. 25,000.

The usual investors in T-Bills are banks, insurance firms and Financial Institutions.

Inter Bank Term Money

Inter Bank Market for deposits of maturity beyond 14 days and up to 3 months is referred to as Inter Bank Term
Money market

Certificate of Deposit

It is the next lowest risk category investment option after treasury bills. It is issued by scheduled commercial banks
and FIs. RRBs and Local Banks cannot issue CoDs.

It is a negotiable promissory note, secure and short term in nature. It is issued at a discount to face value. Minimum
amount of a CoD should be at least 1 lakh. Maturity period is between 15 days and 1 year for banks and 1 to 3 years
for FIs. It can be issued to both individuals and to firms

Inter Corporate Deposit Market

An ICD is an unsecured (without a collateral requirement) loan extended by one corporate to another. Existing
mainly as an avenue for low rated corporate, this market allows fund-surplus companies to lend to other corporate.
Commercial Paper

It is a short term unsecured promissory note issued by top corporate companies, primary dealers, satellite dealers
and all India FIs.

 Corporate having tangible net worth of >4 crores

 All CPs require credit rating from an agency
 Maturity period can vary from 7 days to 1 year
 Minimum amount invested by single investor is Rs. 5 lakhs or multiple thereof
 CPs are issued at discount to face value

Commercial Bills

Bills of exchange are negotiable instruments drawn by the seller of the goods on the buyer for the value of goods
delivered. They are also called trade bills. They are called commercial bills when they are accepted by commercial
banks. If the bill is payable at a future date and the seller needs money immediately, he may approach the bank for
discounting the bill

Discount and Finance House of India

It was set up in 1988 to deal in money market instruments in order to provide liquidity. Its task is to develop a
secondary market in the existing money market instruments. It has to facilitate the smoothening of short term
liquidity imbalance by developing an active money market and integrating the various segments of the money market.

Capital Market

Capital market refers to a market for funds with a maturity of 1 year and above referred to as term funds.

Banks, Insurance Companies, Financial Institutions like ICICI, IDBI, mutual funds like UTI are the main participants in
this market. The elements of the Capital Market in India are

 Government Securities
 Industrial Securities
 Primary and Secondary Market
 Development Financial Institutions
 State Financial Corporations
 Private Sector
 Financial Intermediaries
 Merchant Banks
 Mutual Funds
 Leasing Companies
 VC companies

G-Secs or Government Securities

G-Secs are issued by the RBI on behalf of the GOI to meet the latter’s borrowing programme for financing Fiscal
Deficit. It has a maturity period ranging from 1 to 30 years and carries a coupon rate paid semi-annually.

Minimum investment in G-Secs is Rs. 10000.

It can be held by any person, firm, corporate body, state government, PFs, trusts and NRIs and FIIs registered with SEBI
Types of G-Secs

 Dated Securities: They have fixed maturity and fixed coupon rates payable half yearly
 Floating rate bonds: They are bonds with variable interest rates with fixed percentage over a benchmark rate
 Capital Indexed Bonds: They are bonds where the interest rate is a fixed percentage of WPI

Overall limit for FII investment in G-Secs is $20 billion.

RBI has decided to allow long term investors like Sovereign Wealth Funds, Multi lateral agencies, endowment funds,
pension funds and foreign central banks to be registered with SEBI to invest in G-Secs.

Development Financial Institutions

All India Financial Institutions: IDBI, IFCI, ICICI, SIDBI, National Housing Bank, EXIM Bank, UTI, LIC etc.

State level: SFCs and State Industrial Development Corporations

Merchant Banks

These banks manage and underwrite new public issues floated by companies to raise funds from public. They only
deal with companies and not general public

Underwriting an issue means to guarantee to purchase any shares in a new issue or rights issue not fully subscribed
by the public.

Mutual Funds

Mutual Funds raise money from public and invest them in securities, bonds etc. Retail investors have to pay the
service tax and not the fund

Hedge Fund

It is like a mutual fund limited to a few investors. It is non-transparent and non-regulated. SEBI does not allow
them.

Venture Capital

It is the money provided by financial institutions who invest alongside management in young, rapidly growing
companies that have the potential to develop into significant economic contributors.

Angel Investors

They are Individuals who invest in businesses looking for higher returns than possible from traditional investments.
They invest their own money unlike a VC which invests public money

Qualified Institutional Placement

The QIP scheme is open to investments made by QIP which includes public financial institutions, mutual funds,
foreign institutional investors, VC funds and foreign VC funds registered with SEBI in any issue of equity shares/ fully
convertible debentures or any securities which are convertible into or exchangeable with equity shares at a later date.
NBFC

A company is treated as NBFC, if its financial assets are more than 50% of total assets and income from financial
assets is more than 50% of the gross income.

NBFCs are similar to banks but they do not accept bank deposits.

RBI in 2011 approved the creation of a separate category of NBFCs for the MFI sector and specified that such
institutions need to have a minimum net owned fund of Rs. 5 crore.

NBFC Factor

Factoring is the business of selling invoices (receivables) to a factoring company at a discount. Consequently the
selling corporate can get cash quickly and avoid the risk of collecting debt. Export oriented factoring is called
Forfeiting. It is the purchase of an exporter’s receivables (amount owed by importers) at a discount by paying cash.

External Commercial Borrowings (ECBs)

ECB is an instrument to facilitate the access of foreign money by Indian corporations and PSUs. They include
commercial bank loans, buyers’ credit, credit from official export credit agencies and commercial borrowings from
private sector. It cannot be used for investment in stock market or speculation in real estate.

The Department of Economic Affairs (DEA) along with the RBI monitors and regulates the ECB guidelines and
policies. ECB access may be restricted when there is a deluge of foreign inflows.

Banks, FIs, Housing finance Companies and NBFCs are not permitted to raise ECBs.

Financial Institutions dealing exclusively with infrastructure or export finance such as IDFC, PFC, IRCON and EXIM Bank
are considered on a case by case basis.

RBI in June 2012 allowed Indian companies to avail of ECBs to pay rupee loans of domestic banking system.

Euro Issues

Indian companies are permitted to raise foreign currency resources through issue of foreign currency convertible
bonds (FCCBs), ordinary equity shares through GDRs to foreign investors. Euro issues include GDRs and Euro
convertible Bonds

A convertible bond is a type of bond that the holder can convert into a specified number of shares of common stock in
the issuing company or cash of equal value.

An FCCB is a type of convertible bond where the money raised by the issuing company is in the form of a foreign
currency.

Private Equity

PE means equity in companies that is privately placed by the management to a finance firm. Capital is raised primarily
from institutional investors.

Credit Default Swaps

It is a form of insurance against debt default. When an investor buys corporate bonds, he faces risk of default on part
of the issuing agent. The investor can insure its investment in such bonds against default through a third party. The
investor pays a premium to the party providing insurance. In the event of default by the bond issuer, the insurer
would step in and pay the investor. A CDS is just that insurance which is bought by those who fear default.

By insuring against risks of default, CDS allow riskier companies to raise funds.

The third party insurer issuing CDS must have the capital to pay up in case of debt default. Therefore the issuers of
CDS must be well capitalized and have stringent regulations on their exposure.

During the financial crisis, speculators started buying CDS on even the bonds they did not hold, hoping to make good
the gains in case of a default. This kind of CDS is also called naked CDS wherein the buyer does not hold the
underlying debt. In many cases, such investors were holding CDSs worth much more than the underlying debts betting
on the defaults in the US sub-prime market. And when those defaults did happen, CDSs compounded the problem as
the underwriters did not have the capital to honor their commitments.

CDS will be subject to strict capital requirements, ensuring that business is within prudential limits. Naked CDS is not
allowed in India. Insurance cannot be higher than the value of the underlying debt. These steps are expected to
control speculation on default of bonds, restricting them to their proper use.

Corporate Debt

Non convertible debentures, partly convertible debentures and fully convertible debentures are some of the types of
corporate debt securities.

FII investment

FIIs can invest in government and corporate debt- primary and secondary market. FII debt is rupee debt.

Measures taken by RBI to attract FIIs are

 Limits in G-secs are raised

 QFIs allowed to invest with a larger portfolio that includes certain types of MFs and corporate debt
 The terms and conditions for the scheme for FII investment in Infrastructure Development Funds have been
further rationalized in terms of lock in period and residual maturity

Take out financing

It came into effect in 2010. It is a method of providing finance for longer duration projects by banks sanctioning
medium term loans. It is the understanding that loans will be taken out of the books of the financing bank within
pre fixed period by another institution thus preventing any possible asset liability mismatch.

Under this process, institutions engaged in long term financing such as IDFC agree to take out the loan from books of
the banks financing such projects after a fixed time period when the project reaches certain previously defined
milestones. On the basis of such understanding, the bank concerned agrees to provide a medium term loan say 5
years. At the end of 5 years, the bank could sell the loans to institution and get it off its books. This ensures that the
project gets long term funding through various participants. Banks otherwise cannot lend for infrastructure as their
deposits are for a short period and the loans are for a long period leading to asset liability mismatch.

Infrastructure Debt Funds (IDFs)

They are envisaged to facilitate flow of long term debt into infrastructure projects. The IDF will be set up either as a
trust or a company. IDF can relieve pressure off banks and can mobilize more savings.
Stock Markets in India

A stock market is an organization which provides a platform for trading shares- either physical or virtual.

Importance of stock exchanges

 For efficient working of the economy and for smooth functioning of the corporate form of organization
 An efficient medium for raising long term resources for business
 Help raise savings from the general public by way of issue of equity and debt capital
 Attract foreign currency
 Exercise discipline on companies
 Invest in backward regions for job creation
 Another vehicle for investors’ savings

Over 9000 companies are listed on stock exchanges serviced by 7500 stock brokers in India. There are 24 stock
exchanges in India, 21 of them being regional exchanges.

BSE is the oldest stock exchange in India located in Dalal Street, Mumbai. It was established in 1875 and is the
largest in India with more than 6000 listed firms. It has a market capitalization of $1.1 trillion in 2012.

One of the unique features of BSE includes the automatic online trading system known as BOLT that ensures an
efficient and transparent market for trading in equity, debt instruments and derivatives.

Classification of companies listed in BSE

 A: Companies with large capital base, large shareholder base and good growth record with regular dividends
and greater volumes in secondary market
 B1: Relatively liquid scrips with good management and satisfactory growth prospects and volumes
 F: Segment for non convertible debentures
 G: Central and State Government Securities
 Z: Companies not complying with clauses of the listing agreement and are not redressing the grievances of
the investor

Sensex

It is a value weighted index composed of 30 companies with the base 1978-79. Inclusion of these companies is on the
basis of market capitalization.

Demutualization

Mutualization refers to ownership and management of the exchange being combined in the same hands- brokers
elected by the broker community from among them. Demutualization is when the management and ownership are
separated. All stock exchanges are to be demutualized according to a government law made in 2004.

NSE

 It commenced operations in 1994 based on the recommendations of Pherwani Committee. Its promoters are
IDBI, IFCI, ICICI and LIC, GIC, SBI Capital Markets, Stock Holding Corporation of India, IL&FS

Inter Connected Stock Exchange of India Limited (ISE)

 ISE is being promoted by the regional stock exchanges to set up a new national level stock exchange.
SEBI

The capital markets in India are regulated by Securities and Exchange Board of India. It was established in 1988 and
given a statutory basis in 1992. It regulates the working of stock exchanges and intermediaries such as stock brokers
and merchant bankers, accords approval to mutual funds and registers FIIs who wish to trade in Indian scrips. It shall
be the duty of the board to protect investors. It promotes investor’s education and training of intermediaries. It
prohibits fraudulent and unfair practices relating to security markets and insider trading in securities with the
imposition of monetary penalties. It also regulates substantial acquisition of shares and takeover of companies and
calling for information from, carrying out inspection, conducting inquiries and audits of stock exchanges and
intermediaries and self regulatory organizations in the securities markets.

Some steps taken by SEBI to strengthen the markets are

 Reconstitution of governing boards of stock exchanges

 Introduction of capital adequacy norms for stock brokers
 Making rules for making client broker relationship more transparent
 Enforced corporate disclosures
 ban on insider trading
 register and regulate mutual funds
 introduced a code of conduct for all credit rating agencies
 clause 49 of the listing agreement was introduced that mandates that all listed companies should have half
of the directors on the board as independent directors

Anchor Investor Concept

An investor can subscribe up to 30% of the quota for institutional investors in an initial public offering. The investor
would have to pay 25% of the total investment at the time of applying for the IPO and the balance within two days of
the closure of the issue. They have to adhere to a lock in period of one month from the date of share allotment.

Capital Market reforms

 SEBI given statutory status

 Electronic Trade
 Rolling Settlement to reduce speculation
 FIIs are permitted since 1992
 Setting up clearing houses
 Settlement guarantee funds at all stock exchanges
 Compulsory dematerialization of share certificates
 Clause 49 for corporate governance
 Restrictions on Participatory notes

Primary Market

It is that part of the capital markets that deals with the issuance of new securities directly by the company to the
investors. In case of new stock issue, this sale is called IPO. If the company already issued shares and is going to the
market again with a new issue it is called Follow On Public Offer (FPO).

Secondary Market

It is the financial market for trading of securities that have already been issued in an initial public offering
Preferred Stock

It is generally issued to banks by the companies though retail investors are also eligible for them. They are preferred
because

 In terms of dividend payment, they are given dividends even if the common stock holders are not
 When the company is to be closed, preferred stock holders are given money first from the proceeds of the
sale
 May have enhanced voting rights such as the ability to veto mergers or acquisitions or the right of first refusal
when new shares are issued (i.e. the holder can buy as much as they want before the stock is offered to
others)

Derivatives

These are financial instruments which derive their value from an underlying asset.

Futures and options are two types of derivatives

Future is a contract between two parties to buy or sell an asset at a certain time in the future for a certain price.
Futures are traded on the exchange while forward contracts are not traded on exchange.

Options are a class of derivatives where the buyer or seller has the right but not the obligation to buy or sell an asset.

Buyback of shares is the process by which a corporation repurchases the stock it has issued. It is usually considered a
sign that the company management is optimistic about the future and believes that the current share price is
undervalued.

Rolling Settlement

It is a mechanism of settling trades. Trades done on a single day are settled separately from the trades on another
day on the basis of T+2 system. Speculation is drastically reduced in this system.

Commodity Exchanges

These are institutions that provide a platform for trading in commodity futures. They play a critical role in price
discovery where several buyers and sellers interact and determine the most efficient price for the product.

Forward Markets Commission

It is a regulatory authority which monitors and disciplines the working of exchanges. It works under the ministry of
Consumer Affairs and Public Distribution. It recognizes an exchange or can withdraw such recognition. It collects and
publishes information regarding the trading conditions in respect of goods. It is now merged with SEBI.

Mutual Fund

It is a financial intermediary that mops up money from a group of investors to invest in capital market so as to
generate returns for the investors. It does it for a fee.

Open ended funds

They issue shares to investors directly at any time. The price of the share is based on Net asset value. They have no
time duration and can be purchased or redeemed at any time on demand but not on the stock market.

Closed Ended Funds

Only a fixed number of shares are issued in an IPO. They trade on an exchange and share prices are determined by
investor demand and not by NAV. They can be traded only on stock exchanges. Shares are not redeemable until the
fund liquidates.

NAV = Total Value of all securities in a fund/ No. of shares

Foreign Institutional Investors (FII)

FIIs are organizations which invest huge sums of money in financial assets – debts and shares of companies and in
other countries- a country different from the one where they are registered. They include banks, insurance
companies, pension funds, hedge funds etc.

Foreign individuals have to go through FIIs. It is also called hot money as it can leave the country with the same
speed with which it comes in.

Qualified Foreign Investor (QFI)

A QFI is an individual, group or association resident in a foreign country that is compliant with Financial Action Task
Force standards. They can invest in corporate debt, equities and mutual funds. From 2012, they can invest in India
directly.

A QFI is a resident of a country that is a member of the Financial Action Task Force (FATF) or member of the group
which is part of FATF against money laundering and terror funding, or a resident of a country signatory to IOSCO or
has signed a bilateral agreement with SEBI

It aims to widen the class of investors, attract more funds and reduce market volatility and deepen the Indian capital
market

The individual and aggregate investment limit for QFIs shall be 5% and 10% of paid up capital for an Indian
company.

A resident of IOSCO can also be a QFI.

IOSCO

The International organization of Securities Commissions (IOSCO) is an association of organizations that regulate
the world’s securities and future markets. The organization’s role is to assist its members to promote high standards
of regulation and act as a forum for national regulators to cooperate with each other and other international
organizations.

Financial Action Task Force (FATF)

It is an inter-governmental organization founded in 1989 to develop policies to combat money laundering and
terrorism financing. It is responsible for setting global standards on anti money laundering and combating financing of
terrorism.

Global Depository Receipts

Indian companies are allowed to raise equity capital in the international market through the issue of GDRs. They are
designated in dollars/euros or any other foreign currency.
The proceeds of the GDR can be used for financing capital goods imports, capital expenditure including domestic
purchase, buildings, investment in software development, prepayment or scheduled payment of earlier external
borrowings etc.

American Depository Receipts

ADRs are like shares and are issued to US retail and institutional investors. ADR route is taken as non USA
companies are not allowed to list on US stock exchanges by issuing shares.

Participatory Notes

These are instruments used for making investments in the stock markets. FIIs use these instruments for facilitating
the participation of overseas funds like hedge funds and others who are not registered with the SEBI and thus are
not directly eligible for investing in stock markets.

Participatory notes are popular because they provide a high degree of anonymity which enables large hedge funds to
carry out their operations without disclosing their identity and the source of funds. Hedge funds are not allowed in
India.

Important Terms

Clearing House

An organization which registers, monitors, matches and guarantees the trades of its members and carries out the final
settlement of all futures transactions. National Securities Clearing Corporation is the clearing house for the NSE.

Bond

A debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing

Debenture

Unsecured debt issued by a corporation

Gilt

A bond issued by the government (T-bills)

Primary Dealers

Subsidiaries of scheduled commercial banks and all India financial institutions engaged predominantly in securities
business and in particular the government securities market. The company should have net owned funds of Rs. 50
crore.

Market Depth

Ability of the market to handle large volumes of trade without significant impact on prices

Market Breadth

Number of companies that are participating

Short Selling

Sale of a security by an investor who does not own it

Negotiated Dealing System

It is an electronic trading platform for facilitating dealing in Government securities and Money Market Instruments

Ponzi Scheme or Pyramid Scheme

It is a fraudulent investment operation that pays high returns to investors and promises higher returns to those who
join the scheme later. The payments are done from investors’ own money or money paid by subsequent investors
rather than from any actual profit earned

Bimal Jalan Committee

It was set up to study and recommend changes on the ownership and governance of the Market Infrastructure
Institutions like stock exchanges, depositories and clearing corporations. Its recommendations are

 Raising of entry level barriers for the new exchanges

 Only financial institutions and banks with net worth of over Rs. 1000 crore could become anchor investors
 Cap on profits that MII shareholders can enjoy
 Cap on remuneration of top executives of the exchange
 Trading and clearing members will be ineligible to serve on the boards
 No stock exchange to be listed
 Stock exchanges and MIIs to fulfill the disclosure requirements of the listing agreement applicable to public
companies
Balance of Payments

Balance of Payments is an overall statement of a country’s economic transactions with the rest of the world over
some period-usually one year.

Balance of payments can be broken down into balance of current account (Balance of trade in goods + Balance of
trade in services and remittances) and Balance of Capital Account (Investment and Borrowing). Foreign trade is part of
the current account.
Balance of Payments in the 1990s in India

The decade began with a crisis caused by both the immediate Gulf War and the cumulative problems of the Indian
Economy. It led to an IMF sponsored bail out.

Gulf crisis led to increase in crude prices and consequent rise in India’s import bill depleting foreign reserves. Rating
agencies downgraded India’s status and India’s credit worthiness plunged. A substantial outflow of deposits held by
NRIs added to the crisis. Reserves declined to a low of $0.9 billion.

India had to pledge gold in May 1991 and again in July 1991 to avoid a default on its short term obligations.

Measures taken

 Rupee was partially freed in 1992, wherein 40% of the foreign exchange earnings were to be surrendered at
the official exchange rate and remaining 60% could be converted at market determined exchange rates.
 Foreign portfolio investments were welcomed
 Indian companies were allowed to raise capital from foreign countries
 Convertibility of the rupee was gradually brought
 Tariff and Non-tariff trade barriers were dropped

Invisibles

Invisible Trade is trade in services. It consists of three parts

 Services
 Transfers
 Income

Services include transportation, Telecom, financial services, professional services etc.

Transfers include remittances from Indians working abroad and International Aid

Income receipts are income earned as profits, interest or dividends from the ownership of overseas assets by Indian
companies, governments and individuals.

The receipts under “Miscellaneous category” in the invisible account which include software exports rose
substantially.

Remittances

Remittances to India have been on the rise over the past few years as it became the preferred destination for global
capital flows. The Gulf region accounted for nearly 27% of the total remittance flows. North America remains another
major contributor.

Convertibility of Rupee

Convertibility refers to the freedom of the holder of domestic currency to freely convert it into any other currency.
No country grants full convertibility- restricts it for certain purposes and excluding certain other purposes. For
example, trade account convertibility is confined to exports and imports and certain associated aspects of
remittances.

It has three dimensions

  Freedom to convert
 Convert at market rate
 Removal of restrictions for conversion on capital and current account i.e. liberalization of flows

The rupee’s external value was regulated by the RBI till 1992. Unlike in developed economies where by and large the
market forces dictate the exchange rate of the currency, the rupee was artificially valued by the RBI because the
country did not have a pro-FDI policy.

Current Account Convertibility

It allows free inflows and outflows for all purposes other than capital purposes. Residents are free to make and
receive trade related payments, receive payments in dollars etc. It refers to freedom to convert domestic currency
into foreign currency and vice versa for the following purposes

 Exports and imports

 Payments due as interest on loans etc
 Remittances
 Travel
 Education

Capital Account Convertibility

Full convertibility means freedom to convert rupee into foreign currency and vice versa for both current account and
capital account purposes with least restrictions. It means there should be 100% FDI and FII across all sectors. Similarly
there should be very liberal regime for outflows- that means Indians can invest abroad and borrow from abroad and
there should be no controls on current account transactions.

We have virtual capital account convertibility for NRIs and foreigners for investing in India and taking out profits
relating to FDI, portfolio investment and bank deposits in India. For Indian residents and corporate, fairly
conservative limits still exist on how much they can invest abroad. Indian companies also need permission of RBI to
borrow funds from abroad for some designated purpose.

Advantages of fuller capital account convertibility

 Availability of foreign capital for investment

 FII flows can increase liquidity and also modernize our financial sector
 Creates competition for domestic players
 Advantages of FDI such as technology, investment and trade are available
 Wider range of choice for investment and borrowing
 Exerts macro-economic discipline

Fears of fuller convertibility are

 Can be destabilizing
 Domestic interests in retail are hurt as it can create unemployment
 Rupee still not being a hard currency can be subject to volatility with serious effects
 FDI hike in defence and other critical sectors need to be discussed from security perspective

Pre requisites for fuller convertibility are

 Fiscal deficit should be minimal

  Forex reserves should be adequate
 NPAs should be minimal
 Inflation and interest rates should be moderate

Dutch Disease

Netherlands experienced Dutch disease as a result of its discovery of oil and related fuels in 1960s. The foreign
exchange inflows led to the Guilder appreciating so much that the competitiveness of Dutch industry was affected
adversely. Exports suffered and imports increased due to appreciation. Deindustrialization is the result.

Relaxations in Capital Account Convertibility

 Capital Account transactions are regulated under FEMA which is a highly liberalized version of FERA
 FDI, barring a few strategic industries is put on automatic route
 FIIs allowed liberally
 ECBs no longer require the approval of RBI or Ministry of Finance up to a value
 Inflows are liberalized far more than outflows
 Aggregate ceiling on overseas investment by Mutual Funds increased
 Overseas investment limit for Indian companies increased
 All Indian citizens can invest up to $200000 per year in foreign markets

Tarapore committee on Capital Account Convertibility was set up in 1997 and gave a roadmap for introduction of
CAC. But it could not be implemented due to Asian Crisis.

Tarapore Committee 2 on fuller rupee convertibility, 2006 recommended that India should make the rupee more
freely convertible over the next 5 years to realize the country’s maximum economic potential. But before making the
rupee freely tradable, India must improve regulatory and supervisory standards across the banking system and get
its financial house in order including taming its worsening CAD.

Sector Limit

Agriculture – 100%

Civil aviation – 100%

Courier service – 100%

Credit rating – 74%

Defence – 100%

Education – 100%

FM radio – 26%

Insurance – 49%

Multi brand – 51%

Sector Limit

Pension – 49%

Pharma – 100%

Power – 49%

Print media – 26%

PSBs – 20%

Pvt bank – 74%

Railway infrastructure – 100%

Single brand – 100%

Stock exchange – 49%

Telecom – 100%

Tourism – 100%

Food products – 100%

Private Security – 49%

Current Account Deficit (CAD) (1.1% in 2015-16 down from 1.8% of GDP in 2014-15)

CAD = (Ex-Im) + Net Factor Income + Net Transfer Payments

Ex-Im = Balance of trade in goods and services

Net Factor Income = Interest + Dividends + Profits

Net Transfer Payments = Foreign Aid + Remittances

CAD is said to be good up to a limit as the country uses foreign savings which are imports for its development.
However it should be financed from dependable flows like FDI and it should be within limits.

FAQ on CAD

India runs a large trade deficit; that is, its imports exceed exports. Some of this trade deficit is covered by the surplus
on the invisibles side -- largely IT exports and remittances by Indian workers overseas --leaving India with a net deficit
on the current account.

What are the Implications of a Large Current Account Gap?

Deficit on the current account means a net outflow of foreign exchange. In India's case, this means a dollar outgo.
Such a deficit could exhaust a country's forex reserves if inflows to make up the deficit do not materialize. Therefore,
a country with a current account deficit has to attract capital flows, which could be in the form of, say, foreign direct
investment, to meet the shortfall.

But when capital flows are insufficient to meet the deficit, the country's currency starts to depreciate on concerns
that it may find it difficult to meet its international commitment or fund its current purchases. This is why a current
account deficit in excess of 2.5% of GDP is seen as worrisome in case of India.

What should the Government do?

India's large current account deficit has been fuelled by heavy gold and crude oil imports. The rupee depreciation
has served as an automatic check on gold imports by making the yellow metal expensive. Although crude is softening,
the potential benefit may not materialize because of a slowdown in merchandise exports. For a sharper decline, India
will need to push exports and slow down consumption imports such as fuel and gold. Raising diesel prices, for
instance, will help curb demand.

Measures taken by Government to fight CAD

 Raised customs duty on gold

 Petrol has been deregulated and prices of other petroleum goods have been raised
 RBI took a slew of measures on ECB, FII, QFI and NRI deposit routes
 RBI also cracked down on speculators by disallowing them to renew their forward currency contracts during
the period rupee was sliding

Currency Mechanisms

There are many ways a currency’s exchange rate is arrived at. Some are

In floating rate, the forces of demand and supply determine the valuation and role of monetary authority is nil or
negligible except in indirect terms like buying and selling currency in the market, changes it makes in interest rates,
CRR etc.

In dirty float, the exchange rate is largely market determined but the central bank manages the rate in a specific
band that suits certain national goals like export promotion. The objective here is to make exchange rate conducive
to certain macro-economic goals like export promotion and balancing it with import liberalization, remittances etc. It
is also called managed float and is followed in India.

In fixed exchange rate, the Central Bank artificially and arbitrarily fixes the exchange rate which may not have any
relation to market forces. India had this system till 1992.

In pegged system, the currency is pegged to the International hard currency like dollar. It is essentially meant for
imparting stability and credibility to the domestic currency so as to invite investors. Central Bank shall have sufficient
foreign reserves to intervene in this situation. Otherwise there will be speculative attacks and currency meltdowns.
China has a managed peg.

Crawling peg means that the government accepts that the currency will crawl up or down gradually by a certain
annual rate
Rupee Value

Why did the rupee slide down to historic lows?

 Euro zone crisis

 Flight to safety
 Dollar is relatively strong as US economy came out of recession
 Risk aversion for foreign investors
 Domestic policy and investment climate was not encouraging
 GAAR and retro laws
 CAD widening

Is the rupee likely to recover?

It may not reverse to the earlier levels. The new normal seems to be around Rs. 55 for dollar due to

 Falling exports
 CAD could rise
 Dependence on foreign flows
 Fiscal deficit
 Growth slows

What is the real value of the rupee?

The factors that influence the value of rupee are

 Demand and Supply

 Capital flows
 Performance of the economy and its prospects
 Forex reserves with RBI
 Interest rates
 Short term debt and CAD
 International Prices of commodities on whom the nation depends

The prevailing official exchange rate is called the nominal effective exchange rate (NEER). The potential for
adjustment according to the factors mentioned above brings in Real Effective Exchange Rate. REER is an inflation
adjusted exchange rate- the differential between India’s inflation and India’s trading partners’ inflation rate is
factored to arrive at REER. NEER always tends towards REER even though there may be a time lag to suit the macro-
requirements of the economy.

How much reserves are enough?

 Today RBI holds over $340 billion forex reserves to

 Check appreciation of rupee
 To gain external account security
 To defend the rupee when needed
 To import essentials for economic and social security
 To enable the country to globalize further
Whether it is adequate or not is determined by the composition of our flows and external debt. NRI deposits and FII
investment are vulnerable. Global crude prices are also a factor in estimating the quantum of forex that is necessary.
Drought and resulting food position is another factor. Short term debt is another input.

India’s foreign exchange reserves comprise foreign currency assets of RBI, gold held by RBI and Special Drawing
Rights of IMF. Problems with huge forex reserves are

 Cost of acquisition is high

 Sterilization costs are high
 Market risks with their deployment in US securities are evident since 2008
 Returns on such deployment are miniscule

Rupee Devaluation

When rupee depreciates due to market forces or is devalued by the central bank, exports go up as in price terms
Indian goods and services will be cheaper especially in relation to similar goods from competitive countries. With
depreciated rupee, FIIs will flow in and better goods can be exported.

Price elasticity of our exports is also to be considered before depreciation is advocated.

J Curve Effect: In the short term a depreciation of the exchange rate can worsen the overall balance of payments
because of inelastic demand for imports and exports.

It is a theory stating that a country’s trade deficit will initially worsen after
depreciation of its currency. This is because higher prices on foreign imports
will be greater than the reduced volume of imports. When exports become
price competitive and imports are reduced due to high cost, BoP turns
positive.

Rupee Appreciation

Normally currency appreciates when the economies are doing well. The resentment is among exporters while
importers and borrowers from abroad and the consumers are gainers.

The Indian consumer is a gainer because the costs of a host of imported goods such as petro products, electronic
and consumer items become cheaper. Appreciation is suggested for the following reasons

 Helps manage inflation

 Puts pressure on export sector to scale up the value chain
 Forces the industry to cut costs and be competitive in quality terms
Bretton Woods Institutions and Others

International Monetary Fund

The International Monetary Fund (IMF) is an international organization that was initiated in 1944 at the Bretton
Woods Conference and formally created in 1945 by 29 member countries. The IMF's stated goal was to assist in the
reconstruction of the world's international payment system post–World War II. India was a founding member in
1945.

The IMF has 188 members in 2012 and is headquartered in Washington and its MD is Christine Lagarde.

Upon joining, each member of the IMF is assigned a quota based broadly on its relative size in the world economy.
The current quota formula is

 GDP: 50% weight

 Openness: 30%
 Economic Variability: 15%
 International Reserves: 5%

Each IMF member’s votes are comprised of basic votes plus one additional vote for each 100000 SDR of quota

A member’s quota guides

 Subscriptions: the amount the member is obliged to provide to the IMF

 Voting Power
 Access to Financing

A country normally pays up to one quarter of its quota in the widely accepted currencies such as dollar, Euro, Yen or
Pound. The remaining three quarters are paid in the country’s own currency.

India’s quota in IMF is 2.44%. (5821.50 million SDR) and after 2010 review it is 2.76% and 2.64% voting share

IMF reviews members’ quotas in 5 years.

Objectives of IMF are

 To promote international monetary cooperation

 To facilitate balanced growth of international trade for the economic growth of all member countries
 To promote exchange rate stability, maintain an orderly exchange rate arrangement and to avoid competitive
exchange rate revaluation
 To help members in times of BoP crisis

The work of the IMF is of three types

 Surveillance: involves monitoring of economic and financial developments and the provision of policy advice
aimed especially at crisis prevention
 Lend: It lends to countries with BoP difficulties, to provide temporary financing and also to support policies
aimed at correcting the underlying problems, loans to low income countries etc.
 Train: Provides countries with technical assistance and training in its areas of expertise

Special Drawing Rights

SDR is an international reserve asset created by IMF in 1969 to supplement its member countries’ official reserves.
The respective weights of the U.S. dollar, euro, Chinese Renminbi, Japanese yen, and pound sterling are 41.73
percent, 30.93 percent, 10.92 percent, 8.33 percent, and 8.09 percent. SDRs can be exchanged for national
currencies. The basket composition is reviewed every 5 years to ensure that it reflects the relative importance of
currencies in the world’s trading and financial system.

SDR is a potential claim on the freely usable currencies.

IMF Borrowing Arrangements

While quota subscriptions of member countries are its main source of financing, the IMF can supplement its resources
through borrowing if it believes that resources might fall short of members’ needs.

IMF has a total quota resources corpus of SDR 477 billion ($668 billion)

General Arrangements to Borrow and New Arrangements to Borrow are the credit arrangements between IMF and a
group of members and institutions to provide supplementary resources to the IMF to prevent or cope with problems
of the International Monetary System or to deal with an exceptional situation that poses a threat to the international
monetary stability.

General Arrangement to Borrow (GAB) established in 1962 enables the IMF to borrow specified amounts of
currencies from 11 industrial countries at market related rates of interest to lend to countries for stabilizing their
external account.

New Arrangements to Borrow (NAB) is a set of credit arrangements between IMF and 39 member countries.
Commitments from member countries are based on relative economic strength. NAB can provide supplementary
resources of up to SDR 182 billion (about $254 billion)

FTP or Financial Transactions Plan of the IMF is the mechanism through which the Fund finances its lending and
repayment operations to its members.

The financial assistance provided by IMF is for

 Rebuilding international reserves

 Stabilizing currency
 Paying for imports
 Restoring conditions for strong growth

Low income countries may borrow from IMF at a concessional rate under the Poverty reduction and growth facility
(PRGF) and the Exogenous Shocks Facility (ESF).

Non concessional loans are provided mainly through Stand by Arrangements (SBA) for members with very strong
policies and policy frameworks.

The amount a country can borrow from the fund varies depending on the type of the loan but is a multiple of the
country’s IMF quota.

IMF and global financial crisis

 Increased crisis lending

 Financial analysis and advisory
 Financial safety net to avoid spread of the crisis
  Drawing lessons from the crisis and incorporating them into future regulations

IMF and Conditionalities

There has been a controversy about the IMF loans that the debtor countries are suggested economic reforms that are
socially and in human terms damaging in return. Debtor counties hold that the reforms suggested are anti-poor and
anti-development like cutting subsidies, scrapping priority sector lending, opening up the country at a fast pace etc.

Some of the conditions are

 Reduce fiscal deficit

 Follow privatization
 Deregulate the rupee in external transactions
 Downsize the government
 Enact flexible labor market reforms
 Reduce subsidies

Another criticism is that the reforms suggested are the same for all the countries irrespective of the cause of the
crisis. India suggested that IMF must be more sensitive to the domestic realities of the member countries.

Role of IMF has been criticized for the following reasons

 One size fits all approach

 Conditionalities that demand the spending on poor to be reduced
 Private international flows are huge in comparison to IMF and is rendered ineffective
 IMF MD is invariably from a European Country
 India wants greater voting rights
 IMF failed to predict the global recession of 2008

Quotas are determined by a formula based on GDP, Openness, Economic Variables and International Reserves

SDRs are an alternative to the US dollar as a global reserve currency

The International Monetary system needs fundamental reform. Dollar as a global reserve currency is neither viable nor
desirable to the same degree as before. It has led to problems like the huge CAD and fiscal deficit of USA. The growing
US CAD can lead to global volatility. These deficits create excessive indebtedness both external and internal. So if the
US were to shrink its deficit too quickly, a deficiency of supply of the global reserve currency could result.

Some experts argue that the global role of SDRs should be increased as it would avoid the need for countries like India
and China to build reserves of dollars. US deficits can also be resolved. Global stability enhances as dollar worries
recede. However, SDRs can only supplement the dollar and other global reserve currencies and goals as the SDR is the
creation of the US and the west within the IMF. If SDR becomes a rival to dollar and Yen, it may not receive the
support of these countries.

IMF brings out World Economic Outlook, Global Financial Stability Report and Fiscal Monitor Report

World Bank Group

World Bank Group consists of 5 agencies

 International Bank for Reconstruction and Development (IBRD)

 International Development Association (IDA)
  International Finance Corporation (IFC)
 Multilateral Investment Guarantee Agency (MIGA)
 International Centre for Settlement of Investment Disputes (ICSID)

IBRD and IDA together constitute the World Bank.

World Bank Group is owned by its member governments which subscribe to the basic share capital with votes
proportional to its shareholding. Membership gives certain voting rights but there are also additional votes which
depend on financial contributions to the organization. A country has to first join the IMF to become a member of the
World Bank.

India has 3.01% of voting power (7th largest) in World Bank (IBRD) compared to USA’s 16.39%

World Bank’s activities are focused on

 Governance
 Human Development
 Rural Development
 Environment Protection
 Infrastructure
 Agriculture development

IBRD focuses on middle income and creditworthy poor countries while IDA focuses on poorest countries of the
world.

IBRD: Fight poverty by financing states

IDA: Long term interest free loans to 80 poorest countries

IFC: Promotes private sector investment in member countries particularly developing countries as a way to reduce
poverty and improve people’s lives

MIGA: promotes FDI into developing countries by insuring investors against political risk, advising governments on
attracting investments etc.

ICSID: Facilitates for conciliation and arbitration of investment disputes between the member countries and
individual investors

The World Economic Forum is a Swiss nonprofit foundation, based in Cologny, Geneva. It is committed to improving
the state of the world by engaging business, political, academic, and other leaders of society to shape global, regional,
and industry agendas. World Economic Forum produces Global Competitiveness Report.

IMF vs. World Bank

IMF World Bank

Oversees the international monetary system
Promotes exchange rate stability and orderly exchange
relations among its members
Assists all members- both industrial and developing
countries that find themselves in temporary BoP
difficulties by providing short to medium term credits
Supplements the currency reserves of its members
Seeks to promote the economic development of the
world’s poorer countries
Assists developing countries through long term financing
of development projects
Provides to the poorest developing countries whose per
capita GNP is <$865 a year through the IDA
Encourages private sector in developing countries
through the allocation of SDRs through IFC
Draws its financial resources principally from the quota Acquires most of its financial resources by borrowing on
subscriptions of its member countries the international bond market
Has at its disposal fully paid in quotas now totaling SDR Has an authorized capital of $184 billion of which
145 billion members pay in about 10%

Financial Action Task Force (FATF)

FATF is an inter-governmental body in Paris responsible for setting global standards for anti-money laundering and
combating financing of terrorism. India is a member of FATF from 2010.

It will help India build the capacity to fight terrorism and trace terrorist money and help to successfully investigate
and prosecute money laundering and terrorist financing offences.

FATF process will also help in coordination of international efforts in anti money laundering and combating the
financing of terrorism.

Asian Clearing Union

It was established to promote regional cooperation, to facilitate payments among member countries for eligible
transactions on a multilateral basis, thereby economizing on the use of foreign exchange reserves and transfer costs
as well as promoting trade among the participating countries.

Members are Iran, India, Bangladesh, Bhutan, Nepal, Pakistan, Sri Lanka, Myanmar, Maldives.

In 2010 Reserve Bank has barred Indian Companies from using the ACU to process current account transactions for oil
and gas due to pressure from Washington.

Asian Development Bank

Its mission is to reduce poverty and improve quality of life in developing nations.

Financial Stability Board

It was established in 2009 in Basel and includes G20 major economies. It was established to address the
vulnerabilities and develop and implement strong regulatory, supervisory and other policies for financial stability.

G-20

G-20 was created as a response to the financial crises of the late 1990s and to a growing recognition of the fact that
key emerging countries were not adequately included in the core of global economic discussions and governance.

It promotes open and constructive discussion between industrial and emerging market countries on key issues
related to global economic stability. By contributing to strengthening of the international financial architecture and
providing opportunities for dialogue on national policies, international cooperation and international financial
institutions, the G20 helps to support growth and development across the globe.

The Finance Ministers of G-20 are mandated to work towards

 Framework for a strong, sustainable and balanced growth

 Strengthening the IFRS
 Modernizing our global institutions to reflect today’s global economy
  Reforming the mandate, mission and governance of the IMF
 Energy security and climate change
 Strengthening support for most vulnerable
 Putting quality jobs at the heart of recovery
 An open global economy

OECD: Organization for Economic Cooperation and Development is an international economic organization of 34
countries founded in 1961 to stimulate economic progress and world trade.

ECB: European Central Bank or ECB administers the monetary policy of the 17 EU member countries

Bretton Woods 2.0

 We need to restructure global finance based on an expanded system of capital adequacy standards, financial
reporting, system wide risk management etc. where FSB and BIS will have a larger role
 IMF should have an expanded role and be the lender of last resort. SDRs should be more central to the global
monetary system
 World Bank should be refocused with clear goals and accountability for their success. It should help the
poorest countries achieve the MDGs
 Global trade agenda should be reoriented to promote environmental sustainability
 New global financial structure should help rescue the world from human induced climate change
 G-20 summit should be the policy guidance platform
WTO and GATT

The General Agreement on Tariffs and Trade (GATT) is an agreement that was arrived at in 1947 by 23 countries to
establish a free and fair international trading regime among member countries based on dismantling of trade
barriers. GATT continues as WTO’s umbrella treaty for trade in goods.

Limitations of GATT

 Lacked institutional structure

 It didn’t cover trade in services, IPR etc.
 Dispute resolution mechanism was absent
 It was perceived as representing interests of the west
 It failed to curb quantitative restrictions

WTO was set up in 1995 as a result of the Uruguay round (1986-94). Dunkel Draft led to Marrakesh treaty which was
signed in 1994 and paved the way for the establishment of WTO in 1995.

Dunkel Draft Marrakesh Treaty WTO

GATT is a treaty while WTO is an organization. GATT had no dispute settlement mechanism while WTO had one.

WTO states that its aims are to increase international trade by slashing trade barriers and providing a platform for
the negotiation of trade and related issues. It has a one country one vote system making it relatively democratic
and decisions are made by consensus.

Principles of the trading system under WTO

 Most Favored Nation (MFN): If a host country grants some country a special favor (such as a lower customs
duty rate for one of their products), then they’ll have to do the same for all other WTO members.
 National Treatment: Treating foreigners and locals equally once a product has entered the market
 Lowering trade barriers such as customs duties, import bans, quotas
 Make the business environment stable and predictable

Structure of the WTO

The WTO’s top level decision-making body is the Ministerial Conference which meets at least once every two years.

Below this is the General Council (normally ambassadors and heads of delegation in Geneva, but sometimes officials
sent from members’ capitals) which meets several times a year in the Geneva headquarters. The General Council also
meets as the Trade Policy Review Body and the Dispute Settlement Body.

At the next level, the Goods Council, Services Council and Intellectual Property (TRIPS) Council report to the General
Council.

Numerous specialized committees, working groups and working parties deal with the individual agreements and other
areas such as the environment, development, membership applications and regional trade agreements.

WTO procedures require 60 days of consultations among the disputants to resolve the dispute failing which
disputes panel is set up. If the losing country does not correct its laws, the complainant country is allowed to take
cross retaliatory measures.
Agreement on Agriculture (AoA)

Domestic subsidies are grouped under three boxes

 Green Box Subsidies relate to R&D and infrastructure like universities, roads in rural areas etc. since they do
not distort trade, there is no limit on them
 Amber Box includes those domestic subsidies that impact on market prices. Eg: Food subsidies. Therefore
they need to be limited at an agreed level
 Blue Box contains subsidies that are direct payments to the farmers to limit production as agriculture needs
to play a multifunctional role that includes environmental stability. Eg: Leaving land fallow

Subsidies in USA and Europe make agricultural goods so cheap that their markets are virtually inaccessible to
exports from developing countries. The expected gains by the developing countries from a genuinely free
international trade in agricultural goods have not come about as the advanced countries are least inclined to reduce
subsidies to the statutory levels. It is one of the implementation concerns discussed in the Doha round.

Export Subsidies are to be limited by the developed countries either in value or volume terms so that international
prices are not lowered below a point and exports of developing countries are not priced out.

Market access means all member countries should throw open their domestic market to agricultural imports by
reduction of tariffs and removal of non-tariff trade barriers.

TRIPS

IP is the work of intellect or mind to create products that have commercial uses like drugs, paintings etc. Holders of
the patents are entitled to the commercial proceeds for a specified time period exclusively.

Types of IPR

 A Patent may be granted to a new, useful and non-obvious invention and gives the patent holder an exclusive
right to commercially exploit the invention for a certain period of time (typically 20 years)
 Copyright is given for creative and artistic works and gives the copyright holder the exclusive right to control
reproduction or adaptation of such works for a certain period of time
 A trademark is a distinctive sign which is used to distinguish the products or services of different businesses
 An industrial design right protects the form of appearance, style or design of an industrial object (eg: spare
parts, furniture or textiles)

Agreement on TRIPS

It lays down legal standards for the member countries to protect IP by way of copyrights, geographical indications,
industrial designs, integrated circuit layout designs, patents, monopolies for developers of new plant varieties,
trademarks. TRIPS regulates dispute resolution procedures and enforcement procedures.

A patent is an exclusionary right. It grants the right to exclude others from making use of patented invention for the
period of 20 years from the filing date. Patent is an incentive to innovate and invent. It sustains R&D.

Product Patents provide for absolute protection of the product exhausting all the process that may lead to the
product whereas process patents provide protection in respect of technology and the process or method of
manufacture.

Protection of process patents does not prevent the manufacture of the product by reverse engineering.
TRIPS allows both product and process patents though only product patents may be awarded for food,
pharmaceuticals and chemicals. Developing countries have 10 years to adopt the TRIPS agreement standards while
advanced countries adopted them in 1995 itself.

Geographical Indications

There are world famous goods that owe their origin to the region in which they originate and are nurtured. The
climate, soil and the native efforts of the region account for their fame, utility and qualities.

GI is granted to a community or group or an institution that represents the interests of the product. It is generally not
granted to an individual. It is given to a product for a specified period of time (10 years in India).

GIs prevent spurious goods from entering the market and helps maintain quality and greater accountability. It also
boosts exports. Source: http://ipindia.nic.in/girindia/

Geographical Indications of Goods (Registration and Protection) Act, 1999 seeks to provide for the registration and
protection of geographical indications relating to goods in India. The Act is administered by the Controller General of
Patents, Designs and Trademarks.

Patents Amendment Act, 2005

 Product patents protection to drugs, foods and chemicals

 Availability of Pre-grant and post-grant challenge
 Discovery of a new form of a known substance does not qualify for a patent, nor mere discovery of any new
property or new use for a known substance
 Introduction of a provision for enabling grant of compulsory license and parallel imports to meet public
health crisis

Prior to 1970, 85% of medicines available in India were produced and distributed by MNCs and the prices of drugs
were highest in the world. The 1970 Patents Act of India provided for process patents for pharmaceuticals and agro-
chemical products. This enabled the growth of strong generic market in India which produced the same drugs at
lower prices.

India accepted TRIPS and product patents because Indian pharma industry is going global and TRIPS helps R&D.

There is a fear that prices of medicines will spiral due to product patents as it can lead to monopoly pricing.

On the positive side, it helps Indian pharma companies to grow into MNCs. Indian companies can take up contract
research. FDI will flow in with all the technological benefits. Safeguard provisions help meet public health concerns.
Drug Price Control Order gives the government power to regulate the prices and make them affordable. Generic
manufacturers can continue in India by paying reasonable fee.

Another criticism is that it acts as a roadblock to cheap drugs. Two thirds of the world’s population will be deprived of
cheap generic life saving drugs like HIV drugs when the Indian law comes into effect.

The other criticism is that patents being given for 20 years will stunt technological development in India.

Anti-Counterfeiting Trade Agreement (ACTA)

It is a multinational treaty for the purpose of establishing international standards for IPR enforcement. The
agreement aims to establish an international legal framework for targeting counterfeit goods, generic medicines and
copyright infringement on the internet and would create a new governing body outside the existing forums such as
WTO and WIPO.

The agreement was signed in 2011 by Australia, Canada, Japan, Morocco, NZ, Singapore, South Korea and USA. In
2012 Mexico, EU signed as well. No signatory has ratified the agreement which would come into force when 6
countries ratify it.

Opponents say the convention adversely affects fundamental rights including freedom of expression and privacy.
ACTA has also been criticized for endangering access to medicines in developing countries. The secret nature of
negotiations has excluded civil society groups, developing countries and the general public from the agreement’s
negotiation process.

Parallel Importation is the importation of drugs from another country where they are sold at a lower price to meet
a public health crisis. It can take place when there are no manufacturers in the country facing the public health crisis
and the pharma company that holds the patent for the drug is unwilling to price it affordably for the sake of the ailing
public.

Compulsory Licensing allows a government to temporarily override a patent. Government may issue a compulsory
license to a company to produce generics when faced with a public health crisis. This allows generic copies of a
patented product to be produced domestically with compensation paid to the patent holder. Generic drugs are much
cheaper than branded drugs. By introducing generics, government can bring down the price of a certain medicine
thereby ensuring adequate affordable stock of essential drugs.

Case of Tamiflu

Indian Patent Office denied Gilead Sciences Inc, Patent rights for its influenza drug Tamiflu in India. Mumbai based
Cipla filed a pre-grant opposition suit with the Indian Patent Office against the applicant Gilead Sciences Inc alleging
that Tamiflu did not have the inventive step or non-obviousness.

Cipla’s version of Tamiflu is priced at about Rs.1000 per strip compared to $60 of Gilead Sciences.

Novartis’ drug Glivec was refused patent on the grounds that the drug is not new molecule but an amended version
of a known compound.

Government has allowed Natco Pharma to make and sell a patented cancer drug Nexavar at a fraction of the price
charged by Germany’s Bayer AG creating a controversy with the use of compulsory licensing.

One important consequence of the order may be that MNCs may adopt multiple/dual pricing – selling drugs
relatively cheap in developing countries.

Three key conditions for granting compulsory licensing are

 German firm was able to supply its drugs to only 2% of the country’s patient population and did not meet the
reasonable public criteria requirement
 Its price was not reasonably affordable
 It was imported and not manufactured in the country

Sui Generis system: Members can protect their inventions either on the basis of patents or any other indigenous
system (sui generis)
General Agreement on Trade in Services

It is the set of regulations that governs trade in services among the WTO countries. GATS rules cover a broad range of
economic activities such as healthcare, education, telecommunications, banking, insurance, BPO, tourism etc.

In services, members of the WTO offer one another Most Favored Nation Status which means grant of non
discriminatory trade or normal trade.

Negotiations is services under GATS are classified in 4 modes, interests of different countries depend upon this
classification –

 Mode 1 – It includes cross border supply of services without movement of natural persons. For eg. Business
Process Outsourcing, KPO or LPO services. Here, it’s in India’s interest to push for liberalization given its large
human resource pool and competitive IT industry.
 Mode 2 – This mode covers supply of a service of one country to the service consumer of any other country.
E.g. telecommunication
 Mode 3 – Commercial presence – which covers services provided by a service supplier of one country in the
territory of any other country.
 Mode 4 – Presence of natural persons – which covers services provided by a service supplier of one country
through the presence of natural persons in the territory of any other country. E.g. Infosys or TCS sending its
engineers for onsite work in US/Europe or Australia.

In reality, WTO negotiations proceed not by consensus of all members, but by a process of informal negotiations
between small groups of countries. Such negotiations are often called Green Room Negotiations.

Developing Countries’ demands and concerns

They want the US to slash its agricultural export and domestic subsidies and the EU to reduce its tariffs on
agricultural goods so that international market is relatively free of distortion and allows fair competition.

India wants acceptance of Special Products and Special Safeguards mechanisms

Developed Countries’ demands

They want developing countries to open up for the manufactured goods called Non Agricultural Goods Market
Access (NAMA) which the poor countries are resisting partly because it hurts the domestic industry at this stage and
partly to use it as a bargaining chip for reforms expected of the rich countries in agriculture.

Rich countries also want liberalization of the services sector in the fields of education, legal advice and insurance.

Most Favored Nation (MFN)

The principle of MFN treatment means that the tariff policy that one country receives should be extended to all
others. Contrary to the popular view, MFN doesn’t mean giving special treatment to imports from another country.
It only means normal treatment. It is not limited to tariffs. It extends on all matters like quotas and other rules
related to foreign trade.

 It provides level playing field among countries which is the essence of multilateralism
 A country can import from the most efficient source
 Poorer countries will have normal trading relations with rich countries which may not be the case otherwise
 Same tariffs being given to all countries will lead to customs rule simplification
  Domestic companies cannot lobby for protectionist measures as the government is committed to MFN tariffs
with all countries

WTO allows departures from MFN principle

 Imports from poor countries are allowed at lower/ zero tariffs

 Preferential or free trade arrangements among countries of a region are allowed at concessional and free
rates
 Article 24 of GATT allows Pakistan and India to depart from provisions of the Agreement in their bilateral
relations pending establishment of trade ties between them on a definitive basis.

Economic Integration among countries

 PTA: Preferential Trade Agreement is the first step towards integration wherein members agree to trade
with one another at a concessional tariff. The same concessional tariff is denied to other members
 FTA: Free Trade Agreement is the next step where there is duty free trade and concessional tariffs
 Customs Union: It is one where FTA members have a common tariff policy towards non members
 Common Market: Later comes common market where there is a free movement of labor, capital, goods and
services
 Monetary Union: If the common market has same currency it is called monetary union
 Economic Union: The last stage is the economic union in which members have a common currency and fiscal
and monetary policies

Benefits of Regional Trade Agreements

 Tariffs being a barrier to trade, reducing or removing them boosts trade

 Complementarities are established among the regional members
 More trade is created due to free trade
 Higher production and greater efficiency due to enhanced competition
 Prepares countries to face globalization and secure benefits

Problems of RTAs

 Trade diversion takes place. Imports are made from FTA member even if non member is more efficient due to
price advantage
 Also, these arrangements have undesirable fall out like loss of revenue due to tariff reduction or removal

Regional economic integration without prejudicing globalization and multilateralism is carried forward with open
regionalism. It is defined as external liberalization by trade blocs (PTAs and FTAs) i.e the reduction in barriers on
imports from non member countries that is undertaken when member countries liberalize trade among themselves.

While the regional trade blocs erode the MFN principle, the following arguments are advanced to show that they
promote globalization.

 Regional Free Trade is easier to implement in comparison to globalization

 Domestic lobbies for protectionism can be resisted more successfully by the government at the regional level
initially and later at the global level
 Scope for deeper integration at the regional level- not only trade but also comprehensive economic
cooperation
 Open regionalism is a step towards making regional trade blocs global
WTO Words

Aggregate Measurement of Support (AMS): It shows the extent of support provided by governments to the
agricultural sector, including direct payments to farmers and intervention in the market. There are limits on AMS
under the AoA of WTO

Agreement on Agriculture (AoA): It is the first multilateral framework for the long term reform of agricultural trade
through the creation of specific rules and commitments for international and domestic agricultural activities

Amber Box: Trade and production distorting policies which are subject to reduction commitments

Anti dumping duties: special import duties imposed when a firm following an enquiry, is assessed as having sold a
product in the importing market at a price below the one it charges in the home market or below the cost of
production or at less than fair value and it damages the producers of the importing country.

Blue Box: Trade distorting direct payments to farmers combined with production limiting programmes. It is not
subject to reduction commitments as per Uruguay round

Common Agricultural Policy: EUs internal agricultural policy intended to provide stable agricultural markets and
incomes for European farmers and food for European consumers through a system of domestic support, market
access protection and export subsidies

Countervailing Duties: Special duties imposed on imports to offset the actual or potential injurious effects of
subsidies to producers or exporters in the country of export

Dumping: Exporting goods at a price lower than the price a company normally charges on the domestic market

Export subsidies: Government payments or other financial contributions provided to domestic producers or exporters
if they export their goods and services

National Treatment: In services trade, a WTO member agrees in certain committed sectors to treat a foreign supplier
no less favorably than a domestic supplier.

Non Tariff barriers: Government measures other than tariff barriers such as quantitative restrictions, import
licensing, standards and conformance regulations

Safeguard action: Temporary measures to allow countries to adjust to heightened competition from foreign
suppliers even when the competition is not a result of dumped or subsidized product

Special & differential treatment: Flexibility given to developing countries in implementing WTO commitments
allowing longer phase in time and addressing concerns such as food security and rural development

Tariff escalation: Tariff rates that increase with each additional level of processing thus penalizing value added
products as is often the case with wood exports

Tariff Peaks: Tariffs on particular products that are significantly higher than the typical tariff that the country in
question levies on the full range of imports.

WTO Framework of July 2004 laid down two major elements of interest to developing countries in the area of
agricultural market access. It provided that the developing countries would be eligible to designate an appropriate
number of products as special products based on their food and livelihood security or rural development needs.
It also provided for the use of a special safeguard mechanism against surge in imports so as to safeguard domestic
producers of agricultural products in developing countries.

 Special products are agricultural products of particular importance to farming communities in developing
countries for reasons of food security, livelihood security and rural development. Special Products would
attract lower levels of tariff reduction commitment than other agricultural products. It is a part of S&D
component of WTO provisions.
 Special safeguard mechanisms are a set of provisions through which a WTO member country can temporarily
impose higher than bound tariff rates on the import of a particular agricultural product if there is a sudden
surge in imports of that product into the country.

Safeguard Duty

When imports of a particular product as a result of tariff concessions or other WTO obligations undertaken by the
importing country, increase unexpectedly to a point that they cause or threaten to cause serious injury to domestic
producers of like or directly competitive products, a safeguard which is a form of temporary relief is used. It gives
domestic producers a period of grace to become more competitive.

Government of the importing country may suspend the concession or obligation, but will be expected to provide
compensation by offering some other concession.

In agriculture, unlike normal safeguards

 Higher safeguards can be triggered automatically when import volumes rise above a certain level or if prices
fall below a certain level
 It is not necessary to demonstrate that serious injury is being caused to the domestic producer

Technical Barriers to Trade

It ensures that technical regulations, standards, testing and certification procedures do not create unnecessary
obstacles to trade. It prohibits technical requirements created in order to limit trade as opposed to those created for
legitimate purposes.

Agreement on Application of Sanitary and Phyto-sanitary measures

Under this agreement, WTO sets constraints on member states’ policies relating to food safety as well as animal and
plant health about imported pests and diseases.

Singapore Issues

 Investment in foreign companies on same terms as national companies

 Competition laws that deal with monopolies and cartels, price fixing, mergers etc
 Transparency in government procurement and creating a level playing field for all players- domestic and
foreign
 Trade facilitation- standardization and simplification of customs procedures

The four issues have been controversial and poor countries do not allow them to be brought under the agenda
Swiss Formula

In Swiss Formula, tariff rate cuts are proportionally higher for tariffs which are initially higher. Since Indian tariff
rates are on the higher side, using a Swiss formula can lead to India taking on greater reduction commitment than its
developed counterparts with lower initial tariffs.

Banana Wars

It refers to a series of trade disputes between the EU, US and several Latin American Countries concerning access to
Europe’s banana market. There is no duty imposed on bananas imported from former European colonies in Africa,
Caribbean and Pacific while the EU charges duties on bananas imported from other countries.

US cotton subsidies

American subsidies to cotton growers makes US cotton so cheap that it hurts other countries producing cotton. It
distorts international trade. Brazil dragged USA to WTO and had an important victory in 2009 slapping sanctions of
$300 million annually

Protectionism

It is the economic policy of restricting trade and economic relations between countries through methods such as
tariffs on imported goods, restrictive quotas etc. It refers to policies or doctrines which protect businesses and
workers within a country by restricting or regulating trade with foreign nations.

Instruments of protectionism

Tariffs: Import tariffs increase the cost to importers and increase the price of imported goods in local markets thus
lowering the quantity of goods imported

Import quotas: to reduce the quantity and thus protect the domestic producers

Administrative Barriers: Countries are sometimes accused of using their various administrative rules (eg: regarding
food safety, environmental standards etc.) as a way to introduce barriers to imports

Anti Dumping Legislation: Supporters of anti dumping laws argue that they prevent dumping of cheaper foreign goods
that would cause local firms to close down

Direct Subsidies: These are given to local firms that cannot compete well against foreign imports. They aim to protect
local jobs and to help local firms adjust to world markets

Export Subsidies: They are often used by government to increase exports.

Exchange rate manipulation: A government may intervene in the foreign exchange market to lower the currency in
forex market. It will raise the cost of imports and lower the cost of exports, leading to an improvement in its trade
balance. However it is effective only in the short run as it will most likely lead to inflation which will in turn raise the
cost of exports and reduce the relative price of imports.

Tragedy of Commons

It describes a dilemma in which multiple individuals acting in self interest can ultimately destroy a shared limited
resource even when it is clear that it is not in anyone’s long term interests for this to happen.
Beggar thy neighbor

It is an attempt to remedy the problems in one country by means which tend to worsen the problems of other
countries

Trade Facilitation

It looks at how procedures and controls governing the movement of goods across national borders can be improved to
reduce associated cost burdens and maximize efficiency while safeguarding legitimate regulatory objectives

World Intellectual Property Organization (WIPO)

It has 185 member states and seeks to promote the protection of intellectual property throughout the world. It is
responsible for promoting creative intellectual activity and for facilitating the transfer of technology related to
industrial property to the developing countries in order to accelerate economic, social and cultural development. Its
HQ is in Geneva.
Foreign Trade

Exports are foreign exchange earners. They stabilize and strengthen the exchange rate, if they grow. They make the
domestic economy efficient as international market requires high quality low price goods and services.

The Foreign Trade Policy (FTP) identified certain thrust sectors having prospects for export expansion and potential for
employment generation. They include Agriculture, Handlooms and handicrafts, Gems and Jewelry, Leather and
footwear.

India’s Foreign Trade Policy 2015

 Increase exports from $466 billion in 2013-14 to $900 billion by 2019-20

 Raise India’s share in world exports from 2% to 3.5%
 Launch merchandise export from India scheme and service exports from India scheme
 Higher support for export of defence, farm produce and eco-friendly products
 Rewards for export items with high domestic content and value addition
 Policy to be aligned to Make in India, Digital India and Skills India Initiatives

Besides trade policy, another initiative that gave fillip to exports have been the introduction of Special Economic Zones
(SEZ). The main objectives of the SEZ Act, 2005 are

 Generation of additional economic activity

 Promotion of exports of goods and services
 Promotion of investment from domestic and foreign sources
 Creation of employment opportunities
 Development of infrastructure facilities
Quantitative Restrictions (QRs)

QRs are measures other than tariffs to curb exports or imports. It can be in the form of quotas, licensing
requirements and canalization (bulk imports or exports are allowed only through designated agencies).

Non Tariff Barriers

The social clause that is sought to be brought into the scope of WTO to exclude imports from developing countries on
grounds of weak labor laws; child labor, human rights, weak green laws and so on are the prime examples of NTBs. It
is a form of back door protectionism

NTBs that are particularly relevant are the sanitary and phytosanitary measures (SPS) and technical barriers. SPS relate
to protection of animal, plant and human life within WTO members due to entry and spread of diseases- pests,
toxins etc. Technical barriers relate to laying down product characteristics and related processes of production
including packaging, labeling and marketing etc.

Overall strategy to increase exports includes

Product Strategy

 Build on our strengths in sectors such as engineering goods, basic chemical industries and pharmaceutical
industries
 Promote light manufacturing exports with high value addition
 Encourage high employment generating sectors such as gems and jewelry and agricultural products

Market Strategy

 Focus on markets in Asia, Africa and Latin America

Technologies and R&D

 Areas that hold out promise for high technology exports

o Pharmaceuticals
o Electronics
o Automobiles
o Computer and software based smart engineering
o Environmental products, green technology and high value engineering products
o High end areas in electronics, aerospace and engineering products
o Building a Brand Image
 Thrust for quality upgradation
 Expanded certification of export products encouraged
 Brand India promotion campaign for key export products
Essential Support

 Stable policy environment

 Preferential access to new markets
 Reduction in transaction costs
 Substantial step up in overall plan support
 Priority strengthening of trade related infrastructure

Focus Market Scheme

Under the FMS, 52 African Countries, 31 Latin American Countries, 10 Commonwealth Independent States and Central
African Republics, 5 East European Countries, 11 Asia-Oceania block countries and 1 Asian Country have been notified
for benefit on exports of all products

Market Linked Focus Product Scheme (MLFPS)

Under this scheme select products markets are identified

Board of Trade

It was set up in 1989 with a view to providing an effective mechanism to maintain continuous dialogue with trade
and industry in respect of major developments in the field of international trade. The terms of reference are

 Advise the government on policy measures for preparation and implementation of both short and long term
plans for increasing exports
 Review export performance of various sectors and identify constraints and suggest measures
 Examine existing institutional framework for imports and exports and suggest practical measures for further
streamlining
 Review the policy instruments and procedures and suggest steps to rationalize such schemes for optimum use
 Examine issues that are considered relevant for promotion of India’s foreign trade and to strengthen the
international competitiveness of Indian goods and services

Inter State Trade Council

It was set up in 2005 with a view to ensure a continuous dialogue with State governments and Union Territories. It
advises the government on providing a healthy environment for international trade in the States with a view to boost
India’s exports.

Export Promotion Councils

There are 11 Export promotion councils under the Department of commerce and 9 export promotion councils related
to textile sector under the administrative control of Ministry of Textiles. They are registered as non-profit
organizations under the Companies Act and perform both advisory and executive roles.

Global Standards India (GSI)

GSI is a not for profit standards body promoted by the Ministry of Commerce and Indian Industry to spread awareness
and provide guidance on adoption of global standards in supply chain management by Indian industry for the
benefit of consumers, industry, Government etc.
Agri Export Zones

These zones are meant to promote agricultural exports and provide remunerative returns to the farming community
regularly. They are to be identified by the State Government.

100% Export Oriented Units (EOUs)

The main thrust of these schemes is to boost and attract sector specific exports from all parts of India having huge
potential near to raw material source.

Incentives available to these units are

 Exemption from customs and excise on import of capital goods, raw materials, consumables & spares
 Reimbursement of central sales tax on purchases made from domestic tariff area (DTA)
 Corporate Tax Holiday

Government identified 12 export sectors as employment intensive- textiles and garments, leather goods, gems and
jewelry, cereals, horticulture, flowers, fruits and vegetables, dairy products, processed foods, toys and sports goods,
pharmaceuticals, automobiles and auto components, consumer electronics and electronic hardware.

Important Schemes

Market Access Initiative

It is intended to provide financial assistance for medium term export promotion efforts with sharp focus on a
country or product

Market studies, setting up warehouses, sales promotion campaigns, International department stores, publicity
campaigns, participation in international trade fairs, brand promotion etc. are funded under MAI scheme

Marketing Development Assistance

It is intended to provide financial assistance to a range of export promotion activities undertaken by the export
promotion councils such as export promotion seminars and trade fairs

Towns of Export Excellence

Selected towns producing goods of Rs. 1000 crore or more will be notified as Towns of Export Excellence (TEE) based
on potential for growth in exports.

Export and Trading houses categorization

Status Category Export Performance

Export House Rs. 20 Crores
Star Export House 100
Trading House 500
Star Trading House 2500
Premier Trading House 7500
Served from India

Its objective is to accelerate growth in export of services so as to create a powerful and unique “Served from India”
brand. Instantly recognized and respected the world over. Eligibility is based on certain minimum forex earnings and
they qualify for duty credit scrips (what they pay as duty on certain amount of their imports is credited to them for set
off later)

Vishesh Krishi Gram Udyog Yojana

VKGUY is to promote exports of agricultural produce and their value added products, minor forest produce and their
value added variants.

Focus Market Scheme (FMS)

Its objective is to offset high freight cost and other externalities to select international markets with a view to
enhance our export competitiveness in these countries. Eg”: Focus Africa and Focus ASEAN+2 programmes

Focus Product Scheme (FPS)

It objective is to incentivize export of such products, which have high employment intensity in rural and semi urban
areas so as to offset infrastructure inefficiencies and other associated costs involved in marketing of these products.
Some special focus initiatives are for agri products, handicrafts, gems and jewelry, leather and footwear etc.

e-Biz project

It will leverage the capabilities and potential of ICT to consolidate regulatory frameworks, re-engineer regulatory
processes and provide a platform that can be leveraged for enhanced G2B offerings.

The project aims at creating an investor friendly environment in India by making all regulatory information easily
available to various stakeholders concerned

Important Terms

Forfaiting: It involves the purchasing of receivables from exporters and transfer of risks from exporters to forfeiters

Mercosur: Argentina, Brazil, Uruguay and Paraguay for economic cooperation

Deemed exports: they are inputs to exports and concessions are given to them for export promotion

Duty Exemption: allows duty free import of inputs for exports under Advance License, Duty Entitlement Pass Book
(DEPB) and Duty Free Replenishment Certificate (DFRC) scheme

Advance License: granted for import of inputs without payment of customs duties

SEPB: to neutralize the incidence of basic and special customs duty on the import content of export products

Countervailing duty: duty imposed on specific products to offset improper subsidies

Assistance to States for Development of Export Infrastructure and other Activities (ASIDE)

ASIDE scheme aims at encouraging the active involvement of State Governments for development of export
infrastructure through assistance linked to export performance. The following are funded under the scheme

 Creation of export promotion industrial parks

  Setting up of electronic and other related infrastructure in export conclaves
 Equity participation in infrastructure projects including the setting up of SEZs
 Development of complementary infrastructure such as roads

Example of Interest Subvention: Factories would borrow money at 12% (market interest rate offered by bank), and the
institution making the loan (bank) would make 12%, but the borrower would only pay 7% and the government would
pay the other 5%.

Institutions and their functions

Institution Function
Dept. of customs and EXIM bank Line of credit
RBI Interest Subvention benefits
Export Credit guarantee Corporation Credit insurance
Central Excise department Rebate on excise
Commercial Tax department VAT reimbursement

Exchange Earner’s Foreign Currency Account (EEFCA)

It is an account which is foreign currency denominated account maintained with banks dealing with foreign
exchanges. It enables foreign exchange earners to retain their foreign exchange receipts in banks without converting
it into local currency. But they don’t earn any interest on the deposits
Agriculture

Soil Health Cards

Soil health is a critical factor for agricultural productivity and human health. Soil Health Cards would give farmers
information about the quality of the soil and what is the normal quantity of fertilizer to be used for a particular
crop.

Rainfed agriculture

Rainfed regions are those where crop production is exclusively dependent upon rainfall. Rainfed crops account for
48% of the total area under food crops.

Most agricultural areas in rain fed areas suffer from deficiency of sulfur and phosphorus. Soil has become acidic in
these areas.

National Rainfed Area Authority was set up in 2006 to coordinate the work of five ministries and improve productivity
of 85 million hectares of non irrigated agricultural land.

Droughts

 Meteorological drought is when the actual rainfall in an area is significantly less than the climatologically
mean of the area.
 Hydrological drought means marked depletion of surface water causing very low stream flow and drying of
lakes, rivers and reservoirs.
 Agricultural drought means inadequate soil moisture resulting in acute crop stress and fall in agricultural
productivity

Rural Credit

NABARD

National Bank for Agricultural and Rural Development (NABARD) was set up in 1982, as the apex development bank
for agriculture and rural development.

NABARD’s mission is to promote sustainable and equitable prosperity in rural India through effective credit support,
related services, institution development and other innovative initiatives. Its prime function continues to be that of
refinancing, supplementing the resources of cooperative banks, RRBs and commercial banks against the amounts
lent at the grassroots level for agriculture and rural development.

It has also been entrusted with supervisory functions in respect of cooperative banks and RRBs under the Banking
Regulation Act, 1949.

It lends to institutions and not directly to the consumers

Cooperative Credit Structure

Short term credit structure is managed by State Cooperative Banks and district central cooperative banks. Primary
Agricultural Credit Societies are short term cooperative credit institutions dealing directly with individual
borrowers.
The Banking model consists of a district central bank for each District in every state of India known with a name as a
respective District Central Cooperative Bank. The members and their elected directors who represent a multitude of
professional cooperative bodies like Milk Unions, Urban cooperatives, Rural cooperatives, agricultural and non
agricultural cooperatives and various others, in turn would elect the bank's President. These banks are collectively
represented by a State Apex Central Cooperative bank for each state and it acts as the ultimate bank and apex body
for the DCCs under each state.

Long term cooperative credit structure is managed by State Cooperative and Agriculture development banks
(SCARDBs) and Primary Cooperative Agriculture and Rural Development Banks (PCARDBs).

Regional Rural Banks

RRBs exclusively cater to the credit needs of rural population, especially small and marginal farmers. Central
government owns 50%, State government owns 15% and the rest is contributed by a sponsor commercial bank
which also manages it.

Local Area Banks

They were started in 1996 with a view to providing institutional mechanisms for promoting rural savings as well as for
the provision of credit for viable economic activities in the local areas. They are expected to bridge the gap between
credit availability and enhance the institutional credit framework in the rural and semi-urban areas.

Priority Sector

RBI sets targets in terms of percentage of total money lent by the bank to be lent to certain sectors which would not
have had the access to organized lending market or could not afford to pay the interest at the commercial rate. This
type of lending is called priority lending. 40% of the net bank credit should be for priority sector and of the 40%, 18%
should be for agriculture.

Foreign banks have 32% (to increase to 40% by 2018) priority sector lending and no target on agricultural advances.

Direct Agricultural Advance means advances given by banks directly to farmers for agricultural purposes like raising
crops.

Indirect financing denotes finance provided by banks to farmers indirectly through other agencies. Eg: financing of
distribution of fertilizers, pesticides, seeds etc.

Rural Infrastructure Development Fund (RIDF)

RIDF was introduced by government during 1995-96 for implementation and timely completion of various rural
oriented schemes in states which are languishing for funds. The fund is managed by NABARD.

Micro Finance

It is defined as provision of credit and other financial services like insurance of very small amount to the poor in
rural, semi-urban and urban areas for enabling them to raise their income and improve living standards. It covers
not only consumption and production loans for various farm and non-farm activities of the poor but also include their
credit needs such as housing and shelter improvements.

Areas of concern in Micro Finance

 Unjustified high rates of interest

 Lack of transparency in interest rates and other charges
  Upfront collection of security deposits
 Over borrowing
 Ghost borrowers
 Coercive methods of recovery

Malegam Committee

It is aimed at reviving the crisis ridden micro finance sector. It recommended

 Maximum interest rate of 24% on small loans which cannot exceed Rs. 25,000
 Creation of a separate category of NBFC-MFI for the micro-finance sector
 At least 75% of the loans extended by MFIs should be for income generation purpose
 Borrower cannot take loans from more than two MFIs
 NBFC-MFIs should have a net worth of at least 15 crore
 Bank lending to NBFC-MFIs will qualify as priority sector lending
 A borrower can be a member of only one SHG or JLG
 Credit information bureau must be established
 RBI must develop draft consumer protection code to be adopted by all MFIs

National Mission for Food Processing (NMFP)

NMFP is a centrally sponsored scheme for giving greater role to State/UTs, decentralized administration, better
outreach and effective supervision and monitoring. It would also provide flexibility to the States in the selection of
beneficiaries, location of projects etc.

Kisan Credit Cards

KCC was introduced in 1998-99 for timely, easy and flexible availability of production credit to farmers. Each farmer is
provided with a Kisan Credit Card and a passbook for providing revolving cash credit facilities. The farmer is provided
any number of withdrawals and repayments within a stipulated date which is fixed on the basis of land holdings.

Agriculture Price Policy in India

The main objective of the Government’s price policy for agricultural produce aims at ensuring remunerative prices to
the growers for their produce with a view to encouraging higher investment and adoption of modern technology for
achieving higher yields and also to safeguard the interests of the consumers by making available supplies at
reasonable prices.

Each season, government announces MSP for 24 major agricultural commodities and organizes purchase operations
through public and cooperative agencies. It operates effectively only for rice and wheat.

MSP is declared for following crops

 Kharif Crops: Paddy, Jowar, Bajra, Maize, Ragi, Tur (Arhar), Moong, Urad, Ground Nut in shell, Soyabean
(black/yellow), sunflower seed, sesamum, niger seed, cotton-medium and long staple
 Rabi Crops: Wheat, Barley, Gram, Masur (Lentil), Rapeseed/Mustard, Safflower/Kusum
 Other: Copra, Coconut-de husked, jute, sugarcane (FRP)

At the beginning of the sowing season for Kharif and Rabi crops, the government announces MSP at which it is
prepared to procure the produce that the farmer is willing to sell to the FCI for the PDS and buffer stock operations.
When it actually procures when harvesting is done, the MSP is added to and the procurement price is arrived at. The
grain is sold at the PDS outlets at issue price. The FCIs economic cost is what it costs the FCI to procure, store and
distribute.

The government decided on the support price for various agricultural commodities based on the recommendations
of the commission for agricultural costs and prices (CACP). Decisions are taken by CCEA headed by PM.

The criticism of MSP is that it is promoting rice and wheat while the need is for diversification. It helps the big farmer
while the majority of farmers in India are subsistence farmers.

National Food Security Mission

To increase the production of rice, wheat and pulses by 10, 8 and 2 million tons respectively

Its aims are increasing the food grains production of rice, wheat and pulses through area expansion and productivity
enhancement; restoring soil fertility and productivity; creating employment opportunities and enhancing farm level
economy to restore confidence of farmers of targeted districts.

Rashtriya Krishi Vikas Yojana

RKVY aims at achieving 4% annual growth in agriculture by ensuring holistic development of agriculture and allied
sectors. RKVY will be a state plan scheme and the eligibility for assistance would depend on the amount provided in
the State budget for agriculture and allied sectors. The main objectives are

 To incentivize the states to increase public investment in agriculture

 Provide flexibility and autonomy to the states in planning and executing agriculture and allied sector schemes
 Ensure the preparation of plans for districts and states are based on agro climatic considerations,
availability of technology and natural resources
 Ensure that local needs, crops, priorities are better reflected
 Achieve the goal of reducing the yield gaps in important crops through focused interventions
 Maximize returns to farmers

Second green Revolution

2nd green revolution is necessary and spearheaded by the corporate sector helped by new laws. It is focusing on fruits
and vegetables which can double agricultural growth to 4% per year. Contract farming has been made possible.

National Horticulture Mission

NHM is facilitating the holistic development of horticulture by promoting latest technologies involving production and
supply of good quality planting material through tissue culture as well as nurseries, area expansion with improved
varieties, organic farming etc.

Visesh Krishi Upaj Yojana

The objective of the scheme is to promote export of fruits, vegetables, flowers, minor forest produce and their
value added products by incentivizing exporters of such products.

AGRINDIA

It is a registered company which will undertake protection and management of intellectual properties generated in
the system and its commercialization/ distribution for public benefit.
Modified Crop Insurance

In 2010 GoI modified the National Agricultural Insurance Scheme, now mNAIS moving from a social crop insurance
program with ad hoc funding from the GoI to market based crop insurance program with actuarially sound premium
rates and product design. Under the actuarial regime, farmer premiums and government subsidies will both be paid
upfront at the start of the crop season to the insurer who will be responsible for settling all claims as they fall due.

Its features are

 Actuarial premiums (Actuarial rate is an estimate of the expected value of future loss) will be paid for insuring
the crops
 Unit area of insurance for major crops is village panchayats
 Indemnity amount shall be payable for prevented sowing/ planting risk and for post harvest losses due to
cyclone
 Payment up to 25% of likely claims would be released as advance for providing immediate relief to farmers
 More accurate basis for calculation of threshold yield and minimum indemnity level of 70% instead of 60%
 Loanee farmers will be insured under compulsory category and non loanee farmers under voluntary
category
 Private sector insurers with adequate infrastructure and experience will also be allowed in the implementation
of mNAIS

mNAIS, Weather Based Crop Insurance Scheme and Coconut Palm Insurance Scheme are now merged under National
Crop Insurance Programme (NCIP)

Nutrient Based Fertilizer Subsidy

Government has shifted to a nutrient based fertilizer subsidy to help farmers get fertilizers such as Di-Ammonium
Phosphate, Muriate of Potash (MOP) at cheaper rates.

The new pricing would help farmers get complexes at cheaper rates as these fertilizers were not covered under the
previous subsidy regime that covered fertilizers which mainly contained Nitrogen, Phosphorus and Potassium. By
creating a new pricing policy, where all the fertilizers would be available to farmers at uniform rates, the Center
wanted to create a set up where farmers would be able to use fertilizer based on the requirement of the land and
not be swayed by cost alone.

It helps the farmer select the appropriate fertilizer with the right micro nutrients that suit the soil; soil fertility will
improve; production and productivity along with incomes will grow and augurs well for food security.

 Macronutrients: nitrogen (N), phosphorus (P), potassium (K), calcium (Ca), sulfur (S), magnesium (Mg)
 Micronutrients (or trace minerals): boron (B), chlorine (Cl), manganese (Mn), iron (Fe), zinc (Zn), copper (Cu),
molybdenum (Mo), nickel (Ni)

Agriculture Information System Network (AGRISNET)

It envisages promotion of e-governance by use of ICT. The objective of the programme is to provide IT enabled
services to farmers and also for computerization of various offices in the States in agriculture and allied sectors.
Precision Farming

It is the concept of using the new technologies and collected field information, growing the right crop in the right
region and soil at the right time. Collected information may be used to more precisely evaluate optimum sowing
density, estimate fertilizers and other input needs and to more accurately predict crop yields.
Poverty and Inequality

Poverty is deprivation of basic needs and opportunities that determine the quality of life. The factors responsible for
poverty include

 Historical factors like Imperialism and colonialism

 Over population
 Low growth rate
 Unsuitable models of growth
 Poverty itself preventing investment and development
 Widespread reliance on traditional agriculture
 Geographic factors
 Ineffective anti-poverty schemes
 War
 Lack of education and skills
 Gender discrimination

Matthew Effect: The phenomenon widely observed across advanced welfare states that the middle classes tend to
be the main beneficiaries of social benefits and services even if these are primarily targeted at the poor. It refers to
those already having an asset base benefiting from social welfare while those without it continue to be denied the
same.

Human poverty is the lack of essential human capabilities- literacy and nutrition

Income poverty is the lack of sufficient income to meet minimum consumption needs

The World Bank defines extreme poverty as living on less than $1 per day and moderate poverty as living on less
than $2 a day.

The most common standard indicator is the incidence of poverty also called poverty rate or headcount rate.

Poverty Gap is the measure of intensity of poverty among the poor- the difference between the mean income among
the poor and the poverty line. It is the combined measurement of incidence of poverty and depth of poverty. It is
also called as Foster-greer-Thorbecke (FGT) index.

Misery Index is unemployment rate added to inflation rate. A combination of rising inflation and more people out of
work implies deterioration in economic performance and a rise in the misery index.

Lorenz Curve

It is a graphical representation of income inequality. It is used to calculate Gini coefficient which is the numerical
indicator of inequality in a country.

Real economies have some but not complete inequality (Gini =1), so the Gini coefficients are between Zero and
One.

India’s Gini coefficient is 0.325 compared to Sweden’s 0.250

Ahluwalia-Chenery Welfare Index measures how each social group is impacted from prosperity
Multi dimensional Poverty Index (MPI)

It is made up of several factors that constitute poor people’s experience of deprivation- such as poor health, lack of
education, inadequate living standards, lack of income, disempowerment, poor quality of work and threat from
violence. It captures the multiple aspects that contribute to poverty. It was developed by Oxford Poverty and Human
Development Initiative and the UNDP

Dimensions of MPI Indicators

Child Mortality
Health
Nutrition
Years of school
Education
Children enrolled
Cooking fuel
Toilet
Water
Living Standards
Electricity
Floor
Assets

Inequality Adjusted HDI (IHDI)

IHDI takes into account not only the average achievements of a country on health, education and income, but also
how those achievements are distributed among its citizens by discounting each dimension’s average value
according to its level of inequality.

Gender Inequality Index (GII)

It is a measure for gender disparity introduced in 2010 HDR by UNDP. It is a composite measure which captures the
loss of achievement within a country, due to gender inequality and uses three dimensions to do so: reproductive
health, empowerment and labor market participation.

Dimension of GII Indicators

Reproductive Health Maternal Mortality Rate, Adolescent Fertility Rate
Empowerment Share of parliamentary seats, higher education attainment levels
Labor Market Participation Paid, unpaid or actively looking for employment status

India is ranked 127/160 countries in the Gender Inequality Index released by UNDP in HDR 2018
NCERT Chapter 4: Poverty

Poverty is hunger. Poverty is being sick and not being able to see a doctor. Poverty is not being able to go to school
and not knowing how to read. Poverty is not having a job. Poverty is fear for the future, having food once in a day.
Poverty is losing a child to illness, brought about by unclear water. Poverty is powerlessness, lack of representation
and freedom.

There are many ways to categorise poverty. In one such way people who are always poor and those who are usually
poor but who may sometimes have a little more money (example: casual workers) are grouped together as the
chronic poor. Another group is the churning poor who regularly move in and out of poverty (example: small farmers
and seasonal workers) and the occasionally poor who are rich most of the time but may sometimes have a patch of
bad luck. They are called the transient poor. And then there are those who are never poor and they are the non-
poor.

There are many ways of measuring poverty. One way is to determine it by the monetary value (per capita
expenditure) of the minimum calorie intake that was estimated at 2,400 calories for a rural person and 2,100 for a
person in the urban area.

Scholars state that a major problem with this mechanism is that it groups all the poor together and does not
differentiate between the very poor and the other poor

Also this mechanism takes into account expenditure on food and a few select items as proxy for income, economists
question its basis. This mechanism is helpful in identifying the poor as a group to be taken care of by the
government, but it would be difficult to identify who among the poor need help the most.

The existing mechanism for determining the Poverty Line also does not take into consideration social factors that
trigger and perpetuate poverty such as illiteracy, ill health, lack of access to resources, discrimination or lack of civil
and political freedoms.

For instance, Amartya Sen, noted Nobel Laureate, has developed an index known as Sen Index. There are other tools
such as Poverty Gap Index and Squared Poverty Gap.
Economic Survey 2015-16

Volume 1

Chapter 1: Economic Outlook, Prospects, and Policy Challenges

India’s macro-economy is stable, founded on the government’s commitment to fiscal consolidation and low inflation.

As regards monetary and liquidity policy, the benign outlook for inflation, widening output gaps, the uncertainty about
the growth outlook and the over-indebtedness of the corporate sector all imply that there is room for easing.

A year ago, the Economic Survey 2014-15 spoke about the “sweet spot” for the Indian economy, arising from a
combination of a strong political mandate and a favorable external environment. It argued therefore in favour of a
“persistent, creative and encompassing incrementalism”

This year’s Survey comes against the background of an unusually volatile external environment with significant risks of
weaker global activity and non-trivial risks of extreme events.

India’s macro-economy is robust, and it is likely to be the fastest growing major economy in the world in 2016.

Reforms undertaken include

 Creating perception of reduction in corruption

 Liberalizing foreign direct investment (FDI) across-the-board, including by passing the long-awaited insurance
bill
 Vigorously pursuing efforts to ease the cost of doing business
 Restoring stability and predictability in tax decisions, reflected in the settlement of the Minimum Alternate Tax
(MAT) imposed on foreign companies
 Implementing a major public investment program to strengthen the country’s infrastructure and make up for
the deficiency of private investment
 Instituting a major crop insurance program to cushion farmers
 Elevating to mission mode the financial inclusion agenda via the Jan Dhan Yojana by creating bank accounts
for over 200 million people within months

The country’s long run potential growth rate is still around 8-10 per cent

Key to creating a more competitive environment will be to address the exit (the Chakravyuha) problem which
bedevils the Indian economy and endures as an impediment to investment, efficiency, job creation and growth.

The Indian economy had moved from socialism with restricted entry to “marketism” without exit.

The government is undertaking a number of initiatives such as introducing a new bankruptcy law, rehabilitating stalled
projects, and considering guidelines for public private partnerships that can help facilitate exit, thereby improving the
efficiency of the economy.

Second, major investments in people— their health and education—will be necessary to exploit India’s demographic
dividend.

Centre should focus on improving policies, strengthening regulatory institutions, and facilitating cooperative and
competitive federalism while the states mobilize around implementing programs and schemes to ensure better
service delivery.
States that perform well are increasingly becoming “models and magnets”

There are numerous silent revolutions taking place all around the country—sugar and seeds in Uttar Pradesh, food
and kerosene in Andhra Pradesh, Chandigarh and Puducherry—that are helping the spread, and hence realizing the
promise, of the JAM agenda.

Financial Crises of past and future

Since the 1980s, external financial crises have followed one of three basic forms: the Latin American, the Asian
Financial Crisis (AFC), or the Global Financial Crisis (GFC) model.

In the Latin American debt crisis, governments went on a spending binge financed by foreign borrowing (of recycled
petrodollars) while pegging their exchange rates. The spending led to a classic sequence: economic overheating, large
current account deficits that eventually proved difficult to finance, and finally defaults on the foreign borrowing. The
Indian external crisis of 1991 belonged to this category, although the country did not and has never defaulted.

In the AFC of the late 1990s, the transmission mechanism was similar—namely, overheating and unsustainable
external positions under fixed exchange rates—but the instigating impulse was private borrowing rather than
government borrowing. The troubles in Eastern Europe in 2008 belonged to this category.

The GFC of 2008, with America as its epicentre, was unique in that it involved a systemically important country and
originated in doubts about its financial system. Even though the problems originated in the American financial system,
there was a flight of capital toward the United States, which triggered a sharp appreciation of the dollar and significant
currency depreciations in emerging markets.

The Japanese crisis was similar to the GFC in terms of the transmission mechanism (asset price bubbles encompassing
equity markets and real estate). But it was dissimilar in that it was corporate rather than household borrowing that
was the instigating impulse.

China’s current situation is similar to the AFC case in that fears about excessive corporate debts—in the context of
slowing growth and changing economic management—are fostering large capital outflows.
If macro-economic stability is one key element of assessing a country’s attractiveness to investors, its growth rate is
another. In last year’s Survey we had constructed a simple Rational Investor Ratings Index (RIRI) which combined two
elements, growth serving as a gauge for rewards and the macro-economic vulnerability index proxying for risks.

The current account deficit has declined and is at comfortable levels; foreign exchange reserves have risen to
US$351.5 billion in early February 2016, and are well above standard norms for reserve adequacy

India’s long-run potential GDP growth is substantial, about 8-10 percent. But its actual growth in the short run will also
depend upon global growth and demand. After all, India’s exports of manufactured goods and services now
constitute about 18 percent of GDP, up from about 11 percent a decade ago.

India’s medium-term growth trajectory could well remain closer to 7-7½ per cent, notwithstanding the government’s
reform initiatives, rather than rise to the 8-10 per cent that its long-run potential suggests.

The path for fiscal consolidation will determine the demand for domestic output from government.

There are three significant downside risks.

 Turmoil in the global economy

 Oil prices rise more than anticipated
 Finally, the most serious risk is a combination of the above two factors. This could arise if oil markets are
dominated by supply-related factors such as agreements to restrict output by the major producers
The one significant upside possibility is a good monsoon. This would increase rural consumption and, to the extent
that it dampens price pressures, open up further space for monetary easing

Putting these factors together, we expect real GDP growth to be in the 7 to 7.75 % range, with downside risks
because of ongoing developments in the world economy. The wider range in the forecast this time reflects the range
of possibilities for exogenous developments, from a rebound in agriculture to a full-fledged international crisis; it also
reflects uncertainty arising from the divergence between growth in nominal and real aggregates of economic activity.

As of December 2015, eight Indian startups belonged to the ‘Unicorn’ club (valuations greater than $1 billion).

The 2015 El Niño has been the strongest since 1997, depressing production over the past year. But if it is followed by a
strong La Niña, there could be a much better harvest in 2016-17.

An extended and strong El Niño explains why India had a deficient south-monsoon and dry weather lasting through
the winter this time.

La Niña is unlikely to deliver its full bounty in the coming monsoon, or at least not until late in the Kharif season.

The monsoon could also be good due to other favorable factors such as a “positive Indian Ocean Dipole”. The latter
phenomenon – where the western tropical Indian Ocean waters near Africa become warmer relative to those around
Indonesia – prevented at least two El Niño years (1997 and 2006) from resulting in droughts in India.

Declaring minimum support prices well before Kharif sowing operations, incentivizing farmers to produce crops most
prone to domestic supply pressures (such as pulses), and timely contracting of imports of sensitive commodities would
be essential components of this strategy.

Addressing the Twin Balance Sheet Challenge

One of the most critical short-term challenges confronting the Indian economy is the twin balance sheet (TBS)
problem—the impaired financial positions of the Public Sector Banks (PSBs) and some large corporate houses—
what we have hitherto characterized as the ‘Balance Sheet Syndrome with Indian characteristics’.

In August last year, the government launched the Indradhanush scheme, which includes a phased program for bank
recapitalization. Meanwhile, the RBI initiated the 5:25 and SDR schemes, which create incentives for the banks to
come together with their borrowers to rehabilitate stressed assets. These are good initial steps which might require
follow-up.

Resolving the TBS challenge comprehensively would require 4 Rs:

  Recognition: Banks must value their assets as far as possible close to true value (recognition) as the RBI has
been emphasizing
 Recapitalization: once they do so, their capital position must be safeguarded via infusions of equity
(recapitalization) as the banks have been demanding
 Resolution: the underlying stressed assets in the corporate sector must be sold or rehabilitated (resolution)
as the government has been desiring
 Reform: future incentives for the private sector and corporates must be set right (reform) to avoid a
repetition of the problem, as everyone has been clamoring

When the ratio of shareholder equity to assets for various central banks are compared, RBI is an outlier with an
equity share of about 32 per cent, second only to Norway and well above that of the U.S. Federal Reserve Bank and
the Bank of England, whose ratios are less than 2 per cent. The conservative European Central Bank (ECB) and some
EM central banks have much higher ratios, but even they do not approach the level of the RBI. If the RBI were to move
even to the median of the sample (16 per cent), this would free up a substantial amount of capital to be deployed for
recapitalizing the PSBs.

For most of the current fiscal year, inflation has remained quiescent, hovering within the RBI’s target range of 4-6
percent.

Oil prices have plunged in the first two months of 2016, as have some commodity prices, suggesting that input prices
are likely to be lower next fiscal year. Beyond this factor lie other deflationary forces. As growth in China continues to
slow, excess capacity there could continue to increase, which will put further downward pressure on the prices of
tradable goods all around the world.

CPI will ease to 4.5 to 5% in 2016-17.

What Explains the Incomplete Pass through of Monetary Policy?

RBI has shifted to an accommodative policy stance. Without doubt, policy rates have been reduced substantially. But
there has been much less “accommodation” in bank lending rates, which have only fallen by around 50 basis points.

The transmission problem indicates that that the gaps between policy rates and bank rates have increased
significantly over the past year.

Many commentators have emphasized that transmission is limited by high administered and small savings rates. The
argument is that banks worry that if they cut their deposit rates, customers will flee to small savings instruments.

However small saving schemes don’t always constrain pass through.

If liquidity conditions are tight, commercial banks will be extra cautious about passing on policy rate cuts into lower
deposit rates, for fear of losing customers and hence more liquidity.

Governments adopt various targets to achieve and signal fiscal sustainability. These include the overall deficit, the
primary deficit, the revenue deficit, and the debt-to-GDP ratio.

Overall government debt continued to grow as fast as GDP, keeping the debt ratio of the consolidated government
(Centre plus states) near 67 per cent of GDP.

One of the puzzles this year has been how remittances have held up despite a dramatic decline in oil prices and
hence in the health of countries that host overseas Indian workers. The Indian economy and foreign exchange
earnings were buoyed by this non-decline in remittance flows.
Overall exports declined by about 18 per cent in the first 3 quarters. Much of this was due to falling commodity
prices but the decline in non-oil dollar exports and export volume was still sizable.

India’s competitiveness will have to improve so that its services exports, currently about 3 per cent of world exports,
capture nearly 15 per cent of world market share.

There are two key issues in the Doha Development Agenda (DDA): the special safeguard mechanism (SSM) and food
security/public stockholding both of which affect farmer interests. The SSM embodies the right to impose trade
barriers if there is a surge in agricultural imports into India.

In the Uruguay Round, many countries including India were allowed to set ceiling (jargon for very high) tariff bindings:
that is, they were allowed to set, as their WTO obligation, high levels of tariffs which range from 40 per cent to 100 per
cent (India's modal rate in agriculture) to 150 per cent. Once India had this freedom, it was not necessary to have
safeguard actions because, in response to import surges, but even otherwise, India could raise tariffs up to the high
level of bindings.

India’s only real need for SSM arises in relation to a small fraction of its tariff lines—some milk and dairy products,
some fruits, and raw hides—where its tariff bindings are in the range of about 10-40 percent which can be
uncomfortably close to India’s current tariffs

The particular policies which are being defended are those that India intends to move out of in any case because of
their well-documented impacts: decline in water tables, over-use of electricity and fertilizers (causing health harm),
and rising environmental pollution, owing to post-harvest burning of husks. Moreover, the government is steadfastly
committed to providing direct income support to farmers and crop insurance which will not be restricted by WTO
rules.

Twenty years on, India’s position in agriculture has changed: it has become more competitive in agriculture and it now
relies relatively more on domestic support (and less on tariff protection) for agriculture both to sustain domestic
production and address low incomes for farmers.

Farm policy—minimum support prices and import and export policy—should be announced well in advance of the
crop growing season and should not be altered during the course of the season unless there are exceptional
developments.

India also needs to address two broader issues. The first is what might be called the “big-but-poor” dilemma. On the
one hand, India’s self-perception as a poor country translates into a reluctance to recognize and practice reciprocity
(give-and-take) in trade negotiations. On the other hand, India's policies have a significant impact on global markets
and it has become a large economy in which partner countries have a legitimate stake in seeking market access

Global demand is weak, and one of the powerhouses of trade in recent times—China—is slowing down.

 First, the most effective instrument to respond to threats to overall competitiveness is the exchange rate.
The rupee’s value must be fair, avoiding strengthening.
 Second, India should strengthen procedures that allow WTO-consistent and hence legitimate actions against
dumping (anti-dumping), subsidization (countervailing duties), and surges in imports (safeguard measures) to
be taken expeditiously and effectively.
 Third, India should eliminate all the policies that currently provide negative protection for Indian
manufacturing and favor foreign manufacturing. This could be achieved by quick implementation of the GST
as recommended by the recent report of the GST Committee. If delays are envisaged, a similar result could be
achieved by eliminating the countervailing duty exemptions.
Chapter 2: The Chakravyuha Challenge of the Indian Economy

The government’s initiatives including the new bankruptcy law, rehabilitation of stalled projects, proposed changes to
the Prevention of Corruption Act as well as the broader JAM agenda hold the promise of facilitating exit, and providing
a significant boost to long-run efficiency and growth.

The Chakravyuha legend from the Mahabharata describes the ability to enter but not exit, with seriously adverse
consequences.

Structural impediments to India’s economic progress have often been framed in relation to the problem of entry as
evoked in the famous phrase--“license-quota-permit Raj”--of C. Rajagopalachari, India’s original economic liberal.

Two caveats are in order. First, focusing on the exit problem does not mean that the challenges of entry have been
fully addressed. The Government’s reform agenda, including liberalizing FDI and launching the Start-up India and
Entrepreneurship initiatives are noteworthy endeavors to further facilitate entry.

Second, there are sectors in which exit is not a first-order problem, for example IT services and e-commerce,
evidenced most recently in the dynamism displayed in relation to start-ups in India. The case studies suggest that the
Chakravyuha challenge is more a feature of the relatively traditional sectors of the economy but is not restricted to
the public sector—indeed, impeded exit in the private sector is becoming a major challenge.

India unlike many countries seems to have a disproportionately large share of inefficient firms with very low
productivity and with little exit.

No sector illustrates the combination of fiscal, economic, and political costs more starkly than fertilizer.
In India, the exit problem arises because of three types of reasons, what might be called the 3 I’s: interests,
institutions, and ideas/ ideology.

 Interests

The first and perhaps most powerful reason for lack of exit is the power of vested interests. It has long been known
that trade liberalization is difficult because the beneficiaries are consumers (whose aggregate benefit is large but who
benefit individually by a small amount) and the losers are a few producers each of whom stands to lose by a lot. The
latter will be more influential because they have more voice, backed by financial power.

One good example of interest groups blocking reform comes from introducing JAM for MGNREGA expenditure. To
reduce leakages and payment delays, Andhra Pradesh introduced direct benefit transfers, so that salaries would be
paid directly to workers, with biometric Smartcards to reduce the scope of siphoning of funds via registering ghost
workers. The Smartcards program was a tremendous success, reducing payment delays by 19 per cent, increasing
MGNREGA wages by 24 per cent and reducing leakages by 35 per cent.

 Institutions

The problem arises from a combination of both weak and strong institutions. Examples of weak institutions are legal
procedures that increase the costs—time and financial costs—of exit. One example is the debt recovery tribunals
(DRTs) which help financial institutions recover bad debt quickly and efficiently. The share of settled cases is small and
declining; and the accumulated backlog of unsettled cases increased to nearly Rs. 4 lakh crore at the end of FY15.

Another stark example of weak institutions is simply the inability to punish willful defaulters.

Paradoxically in India, exit is also impeded by “strong” institutions. “referee institutions”-for example, some of our
investigative institutions have become enormously powerful over the last few decades. In the case of public sector
banks, it is well-known that senior managers are often reluctant to take decisions to write down loans for fear of being
seen as favoring corporate interests and hence susceptible to scrutiny. This encourages ever-greening of loans,
postponing exit.

In the case of India, ten large corporate houses account for a sizable share of private capital expenditure.

 Ideas/Ideology
A third reason for impeded exit relates to ideas/ideology. All around the world, and at most points in time, it is very
difficult to phase out entitlements.

Minimum support prices (MSPs) were envisioned as an insurance mechanism for farmers, but have become price
floors instead, favoring some crops in some regions at the expense of others. A variety of subsidies and tax
concessions are intended for the poor end up accruing to the relatively better-off.

Another factor that impedes exit is what might be called the “sanctification of the small.” To be sure, small firms and
enterprises merit help through easy availability of credit.

Addressing the problem of exit

 Avoid exit through liberal entry: In the financial sector, liberal entry of more banks and different types of
banks and entry into capital markets still remains an option to shrink the role of inefficient public sector banks.
 Direct policy action: This is why the government has introduced a new bankruptcy law that will significantly
expedite exit
 Empowering bureaucrats and reducing their vulnerability
 The Kelkar Committee on “Revisiting and Revitalizing the Public Private Partnership model of Infrastructure”
has made recommendations on resolving legacy issues and key contractual features going forward. The
Committee has recommended the setting up of independent sector regulators with a unified mandate.
 Technology and the JAM solution: DBT in fertilizer and other input use can achieve targeting which allows the
poor to be protected while allowing the underlying and persistent distortions to be removed. Technology can
help in two ways. First, it brings down human discretion and the layers of intermediaries. And, second, it
breaks the old shackles and old ways of doing business.
 Transparency: highlight the social costs of producing cereals in the north-western states: over-use of fertilizer
and the health and soil quality costs; over-use of water and power and the environmental costs; and the post-
harvest burning of stalks that leads to pollution and health hazards.
 Exit as an opportunity: Most public sector firms occupy relatively large tracts of land in desirable locations.
Parts of this land can be converted into land banks and made into vehicles for promoting the 'Make in India'
and Smart City campaigns. If the land is in dense urban areas, it could be used to develop eco-systems to
nurture start-ups and if located in smaller towns and cities, it could be used to develop sites for industrial
clusters.

Improving economic policy-making and implementation by getting public servants to decide without fear or favour

The problems with civil service decision-making stem from multiple sources.

 Firstly, there are gaps in capacity, training and specialized knowledge in dealing with certain kinds of
economic issues.
 Secondly, the increasing number and rigour of external oversight mechanisms may have unintended effects.
 certain provisions of the anti-corruption law and the way they have been used in recent years

In a bid to tighten anti-corruption law, the Prevention of Corruption Act of 1988, (PCA) added a provision in Section
13(1)(d)(iii) according to which:

“A public servant is said to commit the offence of criminal misconduct if he, while holding office as a public servant,
obtains for any person any valuable thing or pecuniary advantage without any public interest”

Since the law does not require the public servant to have had any improper motive, even a benefit conferred
inadvertently is sufficient to be prosecuted.
The purpose behind Section 13(1)(d)(iii) was to provide a catch-all offence to deal with difficult cases where a public
servant could confer favors without leaving any trail.

 The Prevention of Corruption (Amendment) Bill 2013, which is pending in the Rajya Sabha, seeks to carry out
major improvements to the PCA and in general strengthen the anti-corruption law by bringing it into
conformity the United Nations Convention against Corruption. It proposes to replace the provisions of Section
13(1) with new wording in conformity with international norms that is fairer and would prevent prosecution
for mere administrative errors.
 Many staff of the investigative agencies does not have the tools, skills or training to do a proper investigation
of modern day financial crime and corruption. It would be desirable for the Government to set up a
Commission to recommend a new prosecutorial policy for the offence of corruption which balances the need
for probity with the need for bona fide decisions to be taken without fear of false allegations of corruption.
 The Vigilance Officer system is widely felt to be ineffective and in some cases even counter-productive. It
may be time to consider whether the costs of this elaborate, but apparently ineffective, system are
worthwhile.
Chapter 3: Spreading JAM across India’s economy

Large-scale, technology-enabled, real-time Direct Benefit Transfers can improve the economic lives of India’s poor,
and the JAM Trinity—Jan Dhan, Aadhaar, Mobile—can help government implement them.

The PAHAL scheme reduced leakages by 24 per cent and seems to have excluded few genuine beneficiaries.

Our JAM preparedness index suggests that the main constraint on JAM’s spread is the last-mile challenge of getting
money from banks into people’s hands, especially in rural areas. The government should improve financial inclusion
by developing banking correspondent and mobile money networks, while in the interim considering models like
BAPU—Biometrically Authenticated Physical Uptake.

At present, the most promising targets for JAM are fertilizer subsidies and within government Fund transfers—areas
under significant central government control and with substantial potential for fiscal savings.

Failure on (1) leads to inclusion errors and leakage – benefits

intended for the poor flow to rich and “ghost” households, resulting
in fiscal loss. Failure on (2) and (3) leads to exclusion errors – genuine
beneficiaries being unable to avail benefits.

To identify beneficiaries, the government needs databases of eligible individuals. Beneficiary databases have existed
for long before Aadhaar, but their accuracy and legitimacy have been hampered by the administrative and political
discretion involved in granting identity proofs like BPL cards, driving licenses and voter IDs. Ghost and duplicate
names crept into beneficiary lists, leading to leakage. Aadhaar’s virtue lies in using technology to replace human
discretion, while keeping the system simple enough – fingerprints and iris scans – for citizens to understand.

Only in 4 states—Nagaland (48.9), Mizoram (38.0), Meghalaya (2.9) and Assam (2.4)—is penetration less than 50 per
cent.

100% Aadhaar coverage in Telangana, 99.4% in AP and HP

After identifying beneficiaries, the government must transfer money to them. Every beneficiary needs a bank account
and the government needs their account numbers. This constraint has been significantly eased by the Pradhan Mantri
Jan Dhan Yojana, under whose auspices nearly 120 million accounts were created in the last year alone

Having transferred money to people’s bank accounts, is the government’s job done? Perhaps in urban areas, where
people live near banks, even though financial literacy remains a concern. In rural India, however, there is a serious
“last-mile” problem of getting money from banks into household’s hands: only 27 per cent of villages have a bank
within 5 km. To help address this problem, the RBI in 2015 licensed 23 new banks – 2 universal banks, 11 payment
banks and 10 small finance banks.

The Kenyan BC:Population ratio is 1:172. By contrast, India’s average is 1:6630, less than 3 per cent of the Kenyan
level.

Spatial density of BCs is highest in Bihar, West Bengal and UP.

In terms of BC per population, HP has the best ratio.

Only in Bihar (54 per cent) and Assam (56 per cent) is mobile penetration lower than 60 per cent.

India should take advantage of its deep mobile penetration and agent networks by making greater use of mobile
payments technology.

Currently over 151 million beneficiaries receive LPG subsidies via DBT, and Rs. 29,000 crore have been transferred to
beneficiaries to date.

Household LPG is both untaxed and enjoys a universal subsidy, even though, 97 per cent of LPG is consumed by the
richest 30 per cent of households. Commercial establishments are ineligible for the subsidy and must pay market
prices plus central and state taxes of about 30 per cent on average. This violation of the One Product One Price
principle provides strong incentives for distributors to create ‘ghost’ household accounts and sell subsidized LPG to
businesses in the black market.

Now, with DBT in place, the government identifies beneficiaries by linking households’ LPG customer numbers with
Aadhaar numbers to eliminate ‘ghost’ and duplicate households from beneficiary rolls. Households buy at market
prices (currently ~Rs 670), and have the subsidy credited into their bank account within 3 days.

We estimate that the potential annual fiscal savings of Pahal will be Rs 12700 crore in a subsequent FY.

While households can buy only 12 subsidized cylinders a year, they can buy an unlimited number of unsubsidized
cylinders.

Another reform that could further reduce LPG leakages with limited genuine exclusion is lowering the household cap
from 12 to 10. There is a well-known ‘March problem’ in LPG. Because March is the end of the fiscal year, distributors
have strong incentives to invoice unconsumed subsidized cylinders to households and resell them in the black
market. Reducing the cap could significantly reduce this leakage.

The old MGNREGS system (and the current system for most schemes) has 4 major problems:

 Float: idle funds accrue interest costs for the central government since this is borrowed money.
 Leakages: funds had to pass through multiple layers, meaning more people can demand a cut to secure the
release of funds.
 Misallocation: funds, once disbursed, usually do not return, so forecast errors lead to misallocation of fiscal
resources, with idle funds in some accounts and shortages in others.
 Resource-intensity: scheme managers spend valuable time haggling with officials at higher administrative
units, who often demand arbitrary documentation to release funds.

First mile issues

First-mile issues deal primarily with beneficiary eligibility and identification

 Targeting: targeted subsidies are harder to JAM than universal programs, as they require government to have
detailed information about beneficiaries
 Beneficiary databases: to identify beneficiaries, the government needs a database of eligible individuals
 Eligibility: a third issue with identification is the household-individual connection. Some benefits are for
households while others are for individuals. Jan Dhan is monitored at household level, while Aadhaar is an
individual identifier

Middle mile issues

The chief middle-mile issues are the administrative challenge of coordinating government actors and the political
economy challenge of sharing rents with supply chain interest groups.

 Within-government coordination: ministries and state government departments share authority in

administering subsidies and transfers.
 Supply chain interest groups: agents along a commodity’s supply chain can obstruct the spread of JAM if
their interests are threatened.

Last mile issues

Last-mile issues relate to the risks of excluding genuine beneficiaries, especially the poor.

 Beneficiary financial inclusion: exclusion errors can be substantial if few beneficiaries have bank accounts and
can easily access them. Bank account penetration is growing, thanks to Jan Dhan, but in rural areas physical
connectivity to the banking system remains limited, and BCs and mobile money providers have not yet solved
this last-mile problem.
 Beneficiary vulnerability: exclusion error risks increase when the beneficiary population is poorer. The
poorest 3 deciles of Indian households consume only 3 per cent of subsidized LPG consumption, but 49 per
cent of subsidized kerosene.

So, where and how to JAM?

 The returns from pursuing JAM in other areas depend on the size of leakages in those sectors. Subsidies with
higher leakages have larger returns from introducing JAM
 Central government control: when introducing JAM, policymakers will confront administrative challenges in
coordinating central and state government departments, and political challenges in bringing the supply chain
interest groups like Fair Price Shops on board with DBT.

Based on these considerations, the policy areas that appear most conducive to JAM are those where the central
government has significant control and where leakages— and hence fiscal savings due to JAM—are high.

This combination is met for fertilizer and within-government fund transfers.

We consider two JAM options: DBT and BAPU—Biometrically Authenticated Physical Uptake. With DBT, subsidies are
transferred to beneficiaries in cash. With BAPU, beneficiaries certify their identity using Aadhaar and then physically
take the subsidized goods like today.

JAM Preparedness Index

We construct an index to measure states’ preparedness to implement (i) DBT in urban areas, (ii) DBT in rural areas,
and (iii) BAPU.

Because each condition is necessary and none on its own is sufficient, our index is not the average but the minimum
of the respective indicators.
In Urban DBT index, there is significant variation across states. Some, like Madhya Pradesh and Chhattisgarh, show
preparedness scores of about 70 per cent. Others, like Bihar and Maharashtra, have scores of only about 25 per cent.
The binding constraint here is basic bank account penetration—paying beneficiaries is the issue, not identifying
them.

The Rural DBT preparedness index adds an additional indicator: BC density as a ratio of the Kenyan level. The DBT rural
preparedness scores are significantly worse than the urban scores, with an average of 3 per cent and a maximum of 5
per cent (Haryana).

It is clear that last-mile financial inclusion is the main constraint to making JAM happen in much of rural India

What can be done to reduce leakages in the meantime, while banking correspondent networks develop and mobile
banking spreads? One possibility would be what we call BAPU—Biometrically Authenticated Physical Uptake.
Beneficiaries verify their identities through scanning their thumbprint on a POS machine while buying the subsidized
product—say kerosene at the PDS shop. This is being successfully attempted by Krishna district in Andhra Pradesh,
with significant leakage reductions.

BAPU preparedness is much better than for Rural DBT preparedness. The average state preparedness is 12 per cent,
but there are some states – like Andhra Pradesh (96 per cent), Chhattisgarh (42 per cent) and Madhya Pradesh (27 per
cent) – that with some policy push could be well-prepared for BAPU in the near future.

The Pahal scheme has been a big success. The use of Aadhaar has made black marketing harder, and LPG leakages
have reduced by about 24 per cent with limited exclusion of genuine beneficiaries. However, diversion of LPG from
domestic to commercial sources continues, because of the differential tax treatment of “commercial” and
“domestic” LPG. In other words, the One Product One Price principle is still being violated. Diversion could be further
reduced by equalizing taxes across end-uses. This will not necessarily be inequitable because LPG subsidies almost
entirely benefit the well-off.

In those areas where the centre has less control, it should incentivize the states to invest in first-mile capacity (by
improving beneficiary databases), deal with middle-mile challenges (by designing incentives for supply chain interest
groups to support DBT) and improve last-mile financial connectivity (by developing the BC and mobile money space).
To this end, states should be incentivized by sharing fiscal savings from DBT.
Chapter 4: Agriculture: More from Less

Indian agriculture, is in a way, a victim of its own past success—especially the green revolution. It has become cereal-
centric and as a result, regionally-biased and input-intensive

Agriculture requires a new paradigm with the following components:

 increasing productivity by getting “more from less” especially in relation to water via micro irrigation;
 prioritizing the cultivation of less water-intensive crops, especially pulses and oil-seeds, supported by a
favorable Minimum Support Price (MSP) regime that incorporates the full social benefits of producing such
crops and backed by a strengthened procurement system
 Re-invigorating agricultural research and extension in these crops.
 create one Indian agricultural market and boost farmers’ incomes

Mahatma Gandhi believed that India lives in villages and agriculture is the soul of Indian economy. These words still
ring true today.

In 1966-67, just before India’s Green and White Revolutions, Indian wheat and milk production were just about one
third of US output. By 2013-14, Indian wheat output was 60 per cent higher than America’s, while Indian milk output
was 50 per cent higher.

Indian agriculture is in a way, a victim of its own success, which over time is posing to be a major threat. Indian
agriculture has become cereal-centric and as a result, regionally biased and input-intensive, consuming generous
amounts of land, water, and fertilizer. Encouraging other crops, notably pulses (via a Rainbow Revolution to follow
the Green and White Revolutions) will be necessary to match supply with evolving dietary patterns that favor greater
proteins consumption. At the same time, rapid industrialization and climate change will require economizing on land
and water, respectively—getting “more from less” of these inputs.

While Brazil and China use approximately 60 per cent of their renewable fresh water resources for agriculture, India
uses a little over 90 percent

The central challenge of Indian agriculture is low productivity, evident in modest average yields, especially in pulses.

Wheat and Rice use a large part of the resources that the government channels to agriculture, whether water,
fertilizer, power, credit or procurement under the MSP program.

India happens to be the major producer and consumer of pulses, which is one of the major sources of protein for the
population. India has low yields comparable to most countries.

Not only is most of the land dedicated to growing pulses in each state unirrigated, but the national output of pulses
comes predominantly from un-irrigated land.

Meeting the high and growing demand for pulses in the country will require large increases in pulses production on
irrigated land, but this will not occur if agriculture policies continue to focus largely on cereals and sugarcane.

Although water is one of India’s most scarce natural resources, India uses 2 to 4 times more water to produce a unit
of major food crop than does China and Brazil

Irrigation investments must shift to adopting technologies like sprinkler and drip irrigation and rainwater harvesting
(leveraging labour available under the MGNREGS where possible).
In order to facilitate this shift, the new irrigation technologies need to be accorded “infrastructure lending” status
(currently accorded to canal irrigation) and both the centre and states need to increase public spending for micro
irrigation. The consolidation of ongoing irrigation schemes – the Accelerated Irrigation Benefit Programme (AIBP),
Integrated Watershed Management Programme (IWMP) and On Farm Water Management (OFWM) – into the Prime
Minister’s Krishi Sinchaayee Yojana (PMKSY) offers the possibility of convergence of investments in irrigation, from
water source to distribution and end-use.

It has long been recognized that a key factor undermining the efficient use of water is subsidies on power for
agriculture that, apart from its benefits towards farmers, incentivizes wasteful use of water and hasten the decline of
water tables.

India’s water tables are declining at a rate of 0.3 meters per year.

India was a “net importer” of water until around 1980s. With increases in food grain exports, India has now become a
net exporter of water – about 1 per cent of total available water every year.

A promising way forward, to increase productivity while conserving water (more for less), is to adopt micro irrigation
methods. The key bottlenecks in the adoption of this technology are the high initial cost of purchase and the skill
required for maintenance. Until now micro-irrigation techniques, owing to high fixed costs of adoption, have mostly
been used for high value crops.

Fertigation is the process of introducing fertilizer directly into the crop’s irrigation system.

When planting crops, farmers face several uncertainties in terms of their realized prices in the several months
following their harvest.

Instead, future prices are guaranteed by the government through the MSP. But while the government announces MSP
for 23 crops, effective MSP-linked procurement occurs mainly for wheat, rice and cotton. While there is no
government procurement per se in sugarcane, a crop with assured irrigation, mills are legally obligated to buy cane
from farmers at prices fixed by government, an effective MSP-like engagement.

In Punjab and Haryana, almost all paddy and wheat farmers are aware of the MSP policy. However, very few farmers
who grow pulses are aware of an MSP for pulses.

While in principle MSP exists for most farmers for most crops, its realistic impact is quite limited for most farmers in
the country. Public procurement at MSP has disproportionately focused on wheat, rice and sugarcane and perhaps
even at the expense of other crops such as pulses and oilseeds.

The absence of MSP procurement for most crops in most states implies either that farmers are selling their products
to private intermediaries above the MSP or the converse, i.e., farmers have little option but to sell their produce at
prices below the MSP, resulting in a regional bias in farm incomes. There is a general sense that the latter is a more
prevalent phenomenon

The social returns to pulse production is higher than the private returns, because it not only uses less water and
fertilizer but fixes atmospheric nitrogen naturally and helps keep the soil porous and well aerated because of its
deep and extensive root systems.

Farmers could also be assured a floor price for their crops through a “Price Deficiency Payment” (Niti Aayog [2015]).
Under this system if the price in an Agriculture Produce Market Committee (APMC) mandi fell below the MSP then
the farmer would be entitled to a maximum of, say, 50 per cent of the difference between the MSP and the market
price.
Paddy, sugarcane and black gram are grown in Kharif while chick pea, lentil and wheat are grown in Rabi season.

The agriculture universities have been plagued by: (i) resource crunch, (ii) difficulty in attracting talented faculty, (iii)
limited linkages and collaborations with international counterparts, (iv) weakening of the lab-to-land connect; and, (v)
lack of innovation

India’s current spending on agriculture research is considerably below that of China and as a share of agriculture GDP
even less than that of Bangladesh and Indonesia

There is a strong need to take steps to enhance research productivity among the scientists in public agriculture
research institutes by instituting performance indicators.

Since the costs of drones have fallen sharply, they can be used by State Agricultural Universities to provide crucial
information on crop health, irrigation problems, soil variation and even pest and fungal infestations that are not
apparent at eye level to farmers.

A host of studies has demonstrated significant net benefits of GM crops with leading countries such as Brazil and now
China opening up to new GM technologies and aggressively building their own research capacity. Nonetheless there
are good reasons for some of the public apprehensions on GMOs. Therefore, the regulatory process in India needs to
evolve so as to address the concerns in a way that does not come in the way adapting high yielding technologies and
rapidly moving towards the world's agro-technological frontier.

The causes of market segmentation are many – differences in remoteness and connectivity (rural roads), local market
power of intermediaries, degree of private sector competition, propensity of regional exposure to shocks, local
storage capacity, mandi infrastructure and farmers access to them, storage life of the crop and crop specific
processing cost.

Segmentation also creates a “wedge” at various points in the supply chain from the farm-gate to the final consumer in
India. It appears that the perishability of a product is an important factor driving the wedges.

Greater market integration is essential for farmers to get higher farm gate prices. While the GST bill is a step in the
right direction, a lot more needs to be done by the states, including, creating better physical infrastructure, improved
price dissemination campaigns, and removing laws that force farmers to sell to local monopolies, etc.
Chapter 5: Mother and Child

Relatively low-cost maternal and early-life health and nutrition programs offer very high returns on investment
because: (i) the most rapid period of physical and cognitive development occur in the womb, so in-utero and early-
life health conditions significantly affect outcomes in adulthood; and (ii) the success of subsequent interventions—
schooling and training—are influenced by early-life development.

Economists agree that human capital—physical health, education, skills and broader capabilities—is a key
determinant of a country’s growth potential

Returns to investment appear highest for programs that target young children and in-utero health. Programs
targeting younger children also appear relatively cheap in comparison to investments made in older children.

India’s working-age population share will continue rising till about 2035-2040, meaning that India has another 25
years—one more generation—to exploit this dividend.

Height is a good proxy for early life conditions, and a predictor of later-life outcomes, because both height and
cognitive development are partly determined by early life environment and net nutrition.

A child’s first 1000 days on earth are thought to be a “critical period” of physical and cognitive development with
long-run consequences.

Neonatal mortality— the number of infants that die in the first 30 days of life—is an important indicator of in utero
nutrition.

India has a high neonatal mortality rate. Out of all the infants who die in India, 70 percent die in the first month. A
leading cause of this is low birth weight. Babies with low birth weight are more prone to dying in the first few days of
life ; and women who begin pregnancy too thin and who do not gain enough weight during pregnancy are far more
likely to have low birth weight babies who die in the first few days of life than women who are better nourished
during pregnancy.

Not only are Indian women too thin when they begin pregnancy, they also do not gain enough weight during
pregnancy to compensate for low pre-pregnancy body mass. Women in India gain only about 7 kilograms during
pregnancy, which is substantially less than the 12.518 kg gain that the WHO recommends for underweight women.

The National Food Security Act of 2013 legislated a universal cash entitlement for pregnant women of at least 6,000
rupees. This program presents a promising opportunity to help improve nutrition during pregnancy, a problem which
affects both urban and rural women, and the middle-class and the poor.

If pregnant women receive cash payments from the government, and if families convert these payments into more,
higher-quality food and more rest for pregnant women, maternity entitlements will improve infants' birth weights.

The cash transfer should be given in a single, lump-sum payment early in pregnancy to avoid delays, reduce
administrative costs, and ensure that it is possible for the household to spend the money on better food during
pregnancy.

India has the largest rural open defecation rate in South Asia by a very large margin. It is interesting to note that in
Bangladesh open defecation has almost been fully eliminated.

The facts indicate that income constraints may not be the main determinant of open defecation. Research suggests
that rural Indian households reject the types of latrines promoted by the World Health Organization and the Indian
government partly because their pits needed to be emptied every few years. Latrine pit emptying, which is routine in
other countries, is substantially complicated by rural India's history of untouchability- work of disposing of human
faeces is associated with severe forms of social exclusion and oppression.

The problem of child stunting is worse in villages where a higher percentage defecate in the open.

All this evidence points to the vital importance of the Prime Minister’s Swachh Bharat Mission, which has raised the
profile of the pressing problem of open defecation especially in rural India, and has committed to ending it as quickly.

A big challenge here as in many other instances is deeply entrenched norms and facilitating behavioral change.

This has been due to programmes like the Janani Suraksha Yojana and other schemes under the Integrated Child
Development Scheme that are delivered via Anganwadi programmes.

Folic acid supplements, iodized salt in pre-pregnancy, calcium and protein supplements during pregnancy and
vitamin A supplements in post-natal period are crucial
Chapter 6: Bounties for the well-off

A number of policies provide benefits to the well-off. We estimate these benefits for the small savings schemes and
the tax/subsidy policies on cooking gas, railways, power, aviation turbine fuel, gold and kerosene, making
assumptions about the definition of “well-off” and the nature of neutral policies. We find that together these schemes
and policies provide a bounty to the well-off of about Rs. 1 lakh crore.

The government spends nearly 4.2 per cent of GDP subsidizing various commodities and services.

A move to GST would also eliminate leakages due to rationalization of indirect tax exemptions estimated to cost Rs.
3.3 lakh crore.

 Small Savings

“Small” savings schemes were initially created to mobilize saving by encouraging “small earners” to save, and offered
above market deposit rates in accessible locations like post offices for this purpose.

Because small savings schemes offer high and fixed deposit rates (within year) and compete with banks, it is difficult
for banks to reduce their own deposit rates and hence pass on policy rate cuts to consumers in form of lower lending
rates. Recently, the government has reduced rates on some small savings schemes to make them more responsive
to market conditions.

The first set of “actually small” schemes ranges from postal deposits to schemes for the elderly and women. The
second set is of “not so-small” schemes, which includes the most important of all – the Public Provident Fund (PPF).
And the third category is “not-small-at all” schemes, which includes tax-free bonds issued by designated public sector
companies like IRCL, IIFCL, PFC, HUDCO, NHB, REC, NTPC,NHPC, IREDA, NHAI and others, Supposedly to finance
infrastructure projects.

Ideally, savings schemes should be taxed according to the “EET principle”. The first “E” stands for tax exemption of
the contribution, the second E for exemption of interest income, while T stands for taxation of the principal (and
interest) when it is withdrawn.

Most schemes in the “actually small” category are TTT – neither the interest nor the contributions to the scheme are
exempt from tax under Section 80C of the Income Tax Act. By contrast, the PPF, which is a “not-so-small” scheme, is
EEE: the interest is tax exempt, contributions are tax exempt, but up to a limit of Rs 1.5 lakhs, and tax exempt at the
time of withdrawal. Finally, schemes in the “not small at all” category are TET – the contribution is taxable but the
interest is tax exempt and there are no limits (unless otherwise indicated at the time, they are issued) on the
permissible subscription to these bonds.

In sum, the effective returns to PPF deposits are very high, creating a large implicit subsidy which accrues mostly to
taxpayers in the top income brackets.

In India, savings in several instruments are further incentivized by exempting fully, or partially, the earnings at the
accumulation stage as well as the withdrawals from tax (both the contribution and the earnings). In effect, savings are
subject to exempt-exempt-exempt (EEE) method of taxation i.e. they are exempt at all three stages of contribution,
accumulation and withdrawal.

The emerging wisdom is that savings should be taxed only at the point of contribution (TEE) or withdrawal (EET);
the latter being the best international practice on several counts.
We define the “poor” as those whose consumption is in the bottom three deciles (lowest 30 per cent) of the
population, and the “better off” as the rest , except in case of electricity and railways where this classification is
different.

 Gold

Gold is a strong demerit good: the ‘rich’ consume most of it (the top 20 per cent of population account for roughly 80
per cent of total consumption) and the poor spend almost negligible fraction of their total expenditure on it. Yet gold
is only taxed at about 1-1.6 per cent (States and Centre combined), compared with tax of about 26 per cent for
normal goods. In other words, there is a huge subsidy of about 25 percentage points (the difference between average
tax on other commodities and tax on gold). About 98 per cent of this subsidy accrues to the better-off and only 2 per
cent to the bottom 3 deciles.

 Railways

There is a difference between the subsidy for the better-off and the poor in railways, because fares vary in different
classes of travel. We combine the categories of A/C, first class, second class, sleeper as the primary modes of rail travel
by rich and unreserved category as mode of travel used primarily by the poor.

On this basis, the subsidy rate (implicit subsidy as a ratio of actual cost of journey to railways) amounts to 34 per cent
for the better-off and 69 per cent for the poor.

 LPG

LPG consumers receive a subsidy of Rs. 238.51 per 14.2 kg cylinder (as in January 2016), which amounts to a subsidy
rate of 36 per cent (ratio of subsidy amount to the market price). It turns out that 91 per cent of these subsidies are
accounted for by the better-off as their share of consumption of LPG in the total consumption is about 91 per cent.

Another important point to note is that LPG is subsidized heavily, as compared to other energy related commodities
like petrol, diesel etc which are taxed at very high rates, hence the effective subsidy to the better-off on account of
LPG is much more than the actual direct subsidy of 36 per cent.

 ATF

Aviation fuel is taxed at about 20 percent (average of tax rates for all states), while diesel and petrol are taxed at
about 55 per cent and 61 per cent (as in January 2016).

 Kerosene

There is a subsidy of Rs. 9.16/litre (as in January 2016) on kerosene distributed under the public distribution system,
which translates into a subsidy rate of about 38 per cent (subsidy per litre as a ratio of nonsubsidized Market price per
litter) for both rich and poor. Kerosene Makes up about 1 Per cent of the consumption basket of the poor; however
about 50 per cent of the Kerosene given under PDS is consumed by the well-off and the rest by the bottom 3 deciles,
showing that half of the subsidy benefit goes to the well-off section.
Implicit Subsidy to rich: LPG>Electricity>Kerosene>Gold>Railways>ATF
Chapter 7: Fiscal capacity for the 21st century

Simple tax-GDP and spending-GDP ratios suggest that India under-taxes and under-spends relative to comparable
countries

India does stand out in the number of individual income taxpayers, currently about 4 percent, far from our desirable
estimate of about 23 percent.

One low hanging fruit would be to refrain from raising exemption thresholds for the personal income tax, allowing
natural growth in income to increase the number of taxpayers.

Tax administration is being improved: now around 95 per cent of filings are electronic, tax refunds are now being
issued in a record 7-8 days, and a new Tax Policy Council (headed by Union Finance Minister has 9 members –
Minister of State for Finance, Commerce Minister, NITI Aayog Vice-Chairman, Chief Economic Advisor and Finance
Secretary, Secretaries from Revenue, DEA, DIPP and Commerce)and Tax Policy Research Unit (headed by Revenue
Secretary)are being created.

If spending is about the entitlements of citizenship in a democracy, taxation is about the obligations of citizenship.

Taxation is not just about financing public spending; it is the economic glue that binds citizens to the state in a
necessary two way relationship.

The precocious India phenomenon is that economic development lags political development.

India’s tax to GDP ratio at 16.6 per cent also is well below the EME and OECD averages of about 21 per cent and 34
per cent, respectively.

The history of Europe and the US suggests that typically, states first provide essential services (physical security,
health, education, infrastructure, etc.) before they take on their redistribution role. That sequencing is not accidental.

Unless the middle class in society perceives that it derives some benefits from the state, it may be largely unwilling to
finance redistribution.

 First, the government’s spending priorities must include essential services that all citizens consume: public
infrastructure, law and order, less pollution and congestion, etc.
  Second, reducing corruption— fiendishly difficult as it is—must be a high priority not just because of its
economic costs but also because it undermines legitimacy.
 Third, subsidies to the well-off (amounting to about Rs. 1 lakh crore) need to be scaled back
 Fourth, property taxation needs to be developed.

Chapter 8: Preferential Trade Agreements

FTAs have led to increased imports and exports, although the former has been greater. We find that the average effect
of an FTA is to increase overall trade by about 50 percent over roughly four years.

Within the broad category of PTAs, one can distinguish five forms

 Partial Scope Agreement (PSA): A PSA is only partial in scope, meaning it allows for trade between countries
on a small number of goods.
 Free Trade Agreement (FTA): A free trade agreement is a preferential arrangement in which members reduce
tariffs on trade among themselves, while maintaining their own tariff rates for trade with nonmembers.
 Customs Union (CU): A customs union (CU) is a free-trade agreement in which members apply a common
external tariff (CET) schedule to imports from nonmembers.
 Common Market (CM): A common market is a customs union where movement of factors of production is
relatively free amongst member countries.
 Economic Union (EU): An economic union is a common market where member countries coordinate macro-
economic and exchange rate policies.

The two major megaregionals are the Trans-Pacific Partnership (TPP), which has been signed but not yet ratified by
member countries, and the Trans Atlantic Trade and Investment partnership (TTIP), which is currently being
negotiated. The TPP comprises twelve member countries: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico,
New Zealand, Peru, Singapore, United States, and Vietnam. The TPP will cover 40 percent of global GDP and 33
percent of world trade.

TTIP, when concluded, will be a PTA between the United States and the European Community of 27 member states
and representing “30 percent of global merchandise trade, about 40 percent of world trade in services, and nearly
half of global GDP”. India is not part of these groupings.
The two basic axioms are that trade flows between countries are directly proportional to the “size” of the two
countries - as measured by GDP - and inversely proportional to the distance between them.

The overall effect on trade of an FTA is positive and statistically significant. India’s FTAs have worked exactly as might
be expected. They have increased trade with FTA countries more than would have happened otherwise. Increased
trade has been more on the import than export side, most likely because India maintains relatively high tariffs and
hence had larger tariff reductions than its FTA partners.

The trade increases have been much greater with the ASEAN than other FTAs and they have been greater in certain
industries, such as metals on the import side. On the export side, FTAs have led to increased dynamism in apparels,
especially in ASEAN markets. This is consistent whether one looks at aggregated partner level effects or at dis-
aggregated partner-product level effects.

Against this background, India has a strategic choice to make: to play the same PTA game as everyone else or be
excluded from this process. The results of our preliminary analysis suggest that Indian PTAs do increase trade without
apparently leading to inefficient trade.

In the current context of slowing demand and excess capacity with threats of circumvention of trade rules, progress on
FTAs, if pursued, must be combined with strengthening India’s ability to respond with WTO-consistent measures such
as anti-dumping and conventional duties and safeguard measures.
Chapter 9: Reforming the fertilizer sector

Recent reforms in the fertilizer sector, including neem-coating to prevent diversion of urea to industrial uses, and
gas-pooling to induce efficiency in production, are steps in the right direction. Fertilizer accounts for large fiscal
subsidies (about 0.73 lakh crore or 0.5 percent of GDP), the second-highest after food. We estimate that of this only
17,500 crores or 35 per cent of total fertilizer subsides reaches small farmers.

Reforms to increase domestic availability via less restrictive imports (“decanalisation”) and to provide benefits directly
to farmers using JAM will address many of these problems.

Distortions in urea are the result of multiple regulations.

 First, there are large subsidies based on end use—only agricultural urea is subsidized—which creates
incentives to divert subsidized urea to industry and across the border.
 Second, under-pricing urea, relative to other fertilizers, especially P & K, encourages overuse, which has
resulted in significant environmental externalities, including depleted soil quality.
 Third, multiple distortions—price and movement controls, manufacturer subsidies, import restrictions—feed
upon each other, making it difficult to reallocate resources within the sector to more efficient uses.

There are 3 basic types of fertilizer used—Urea, Diammonium Phosphate (DAP), and Muriate of Potash (MOP).

The optimal N:P:K ratio varies across soil types but is generally around 4:2:1

Government involvement in DAP and MOP is limited to paying producers and importers a fixed nutrient based subsidy
which works out to be roughly 35 per cent of the cost of production.

The case of Urea is very different. The government intervenes in the sector in five ways:

 It sets a controlled Maximum Retail Price (MRP) at which urea must be sold to farmers. This price is currently
Rs. 5360 per metric tonne—approximately Rs. 268 per 50 kg bag—less than one-third the current imported
price (Rs. 18600 per tonne);
 It provides a subsidy to 30 domestic producers that is firm-specific on a cost plus basis, meaning that more
inefficient producers get larger subsidies;
 It provides a subsidy to importers that is consignment-specific;
 Imports are canalized—only three agencies are allowed to import urea into India;
 Finally, about half of the movement of fertilizer is directed—that is, the government tells manufacturers and
importers how much to import and where to sell their urea.

Urea is only subsidized for agricultural uses. Subsidies like this violate what we call the One Product-One Price
principle. The 75 per cent subsidy on agricultural urea creates a large price wedge which feeds a thriving black market
diverting urea to industry.

Black market effects are aggravated by a further regulation—canalization. Only three firms are allowed to import
urea into India, and the canalisers are also instructed when to import, what quantities to import, and in which districts
to sell their goods.

The black market hurts small and marginal farmers more than large farmers since a higher percentage of them are
forced to buy urea from the black market.

A third source of leakage arises from some of the urea subsidy going to sustaining inefficient domestic production
instead of going to the small farmer.
Reforms needed

 First, decanalising urea imports—which would increase the number of importers and allow greater freedom in
import decision--would allow fertilizer supply to respond flexibly and quickly to changes in demand.
 Second, bringing urea under the Nutrient Based Subsidy program currently in place for DAP and MOP would
allow domestic producers to continue receiving fixed subsidies based on the nutritional content of their
fertilizer, while deregulating the market would allow domestic producers to charge market prices.
 Neem-coating makes it more difficult for black marketers to divert urea to industrial consumers. Neem-
coating also benefits farmers by reducing nitrogen losses from the soil by providing greater nutrient to the
crop.
 Fertilizer is a good sector to pursue JAM because of a key similarity with the successful LPG experience: the
centre controls the fertilizer supply chain.

A preferred option would be to set a cap on the number of subsidized bags each household can purchase and require
biometric authentication at the point of sale (POS).

Decanalising imports will ensure timely availability of fertilizers, and universal Direct Benefit Transfer (DBT) to farmers
based on biometric identification with physical off take can reduce diversion of urea

Rationalizing subsidies to domestic firms would release fiscal funds to spend more effectively on schemes that help
poor farmers, such as drip irrigation and connectivity through the Pradhan Mantri Gram Sadak Yojana.

Finally, to secure long term fertilizer supplies from locations where energy prices are cheap, it might be worth
encouraging Indian firms to locate plants in countries such as Iran following the example of the Fertilizer Ministry’s
joint venture in Oman, which allowed India to import fertilizer at prices almost 50 per cent cheaper than the world
price.
Chapter 10: Structural Changes in India’s labour markets

To exploit its demographic dividend, India must create millions of “good”—safe, productive, well-paying—jobs. These
tend to be in the formal sector.

Three trends which are being seen are

 First, the increasing use of contract labour supplied by specialized staffing companies, which allows large
firms to grow, raising aggregate productivity.
 Second, the dynamic of competitive federalism is at work, with states competing to attract employment-
intensive, high-quality companies.
 The third trend involves labour-intensive manufacturing—like apparel—firms relocating to smaller cities.

The slow pace of labour reform has encouraged firms to resort to other strategies to negotiate “regulatory
cholesterol”. One popular strategy is to hire contract workers, which has two key benefits:

 first, the firm essentially subcontracts the work of following regulations and “managing” inspectors to the
contract labour firm.
 Second, because contract workers are the employees of the contractor and are not considered workmen in
the firm, the firm stays small enough to be exempt from some labour law.

The business model of moving factories (formal sector apparel manufacturers) to workers has a number of commercial
and social advantages—it involves spreading economic development to underdeveloped areas, reduces spatial
mismatch in the labour market and can improve competitiveness by raising firms’ access to lower cost labour.

Recent studies have estimated that India’s GDP would grow by an additional 1.4 per cent every year if women were
to participate as much as men in the economy

EPF contributions have an EEE status—Exempt, Exempt, Exempt— meaning that contributions, interest earned and
withdrawals are all exempt from tax. This offers little benefit to workers who are mandated to contribute, because
even the richest such workers—who earn Rs. 15,000 a month—would be below the income tax threshold.

Chapter 11: Powering one India

Since 2014, sweeping changes have characterized the power sector, including: record addition to generation capacity
and the comprehensive initiative ─Ujwal DISCOM Assurance Yojana (UDAY)─to improve the health and performance of
the distribution companies.

The Indian Railways is attempting to shift to open access (OA) for power purchase. This is not only cost efficient, but
also harbingers the possibility of making India one market in power.

In the latest round of auctions under the National Solar Mission, tariffs reached an all-time low of Rs. 4.34/kWh. Grid
parity for solar generation is on its way to becoming a reality.
While discussing the Indian power sector it must be borne in mind that reforms in this sector are more challenging
than in many others due to the clear demarcation in the roles and responsibilities of the states and centre under the
constitution.

Simplification of tariffs with, perhaps no more than 2-3 tariff categories, will improve transparency and may well yield
consumption and collection efficiency, along with governance benefits.

The Open Access policy introduced under Electricity Act, 2003 allows consumers with electricity load above 1MW to
procure electricity directly from electricity markets.

Currently, power plant load factors are at their lowest ebb (about 60%) as generation capacity has increased while
the financial ability of discoms to purchase electricity had diminished.
Volume 2
Chapter 1: State of the Economy: An Overview

The global macroeconomic landscape is currently chartering a rough and uncertain terrain characterized by weak
growth of world output. The situation has been exacerbated by; (i) declining prices of a number of commodities, with
reduction in crude oil prices being the most visible of them, (ii) turbulent financial markets (more so equity
markets), and (iii) volatile exchange rates.

Even in these trying and uncertain circumstances, India’s growth story has largely remained positive on the strength of
domestic absorption

Wholesale price inflation has been in negative territory for more than a year and the all-important consumer prices
inflation has declined to nearly half of what it was a few years ago.

India registered robust growth of 7.2 per cent in 2014-15 and 7.6 per cent in 2015-16, thus becoming the fastest
growing major economy in the world.

GDP at current market prices can be seen as the sum of (a) consumption—both private and public, (b) investment,
also known as Gross Capital Formation (GCF) which comprises fixed capital formation, change in stock and
valuables, and, (c) net exports which represent the difference between exports and imports of goods and non-factor
services.
The substantial erosion of global demand for Indian output, manifest in loss of Indian Exports, acts as a drag on
domestic growth.

Food, Housing, Transport and Miscellaneous are the top 4 categories in share of private consumption.

The difference between GDP and GVA is product taxes net of product subsidies and indicates net indirect taxes (NIT).
GDP-GVA = Product taxes-Product subsidies = Net Indirect Taxes

GVA at basic prices will include production taxes and exclude production subsidies available on the commodity.

On the other hand, GVA at factor cost includes no taxes and excludes no subsidies

GDP at market prices include both production and product taxes and excludes both production and product
subsidies.

GVA at factor cost + (Production taxes - Production subsidies) = GVA at basic prices.

The performance of Scheduled Commercial Banks (SCB) during the current financial year remained subdued. The Year
on-Year (Y-o-Y) growth in bank credit remained below 10 per cent.

The sluggish growth of bank credit can be attributed to several factors:

 incomplete transmission of the monetary policy as banks have not passed on the entire benefit to
borrowers;
 unwillingness of the banks to lend credit on account of rising Non- performing Assets (NPA);
 worsening of corporate balance sheets, forcing them to put their investment decisions on hold;
 interest rates in the bond market being more attractive to borrowers
MUDRA seeks to offer two products, namely refinance products with a loan requirement up to Rs. 10 lakh and
support to micro-finance institutions by way of refinance.

In order to mobilize gold for productive purpose and to reduce the country’s reliance on imports of gold, two main
schemes were launched in 2015: (i) the Sovereign Gold Bond Scheme and (ii) the Gold Monetization Scheme.

The uncertainties in growth in agriculture are explained by the fact that 60 per cent of agriculture in India is rainfall
dependent and there have been two consecutive years of less than normal rainfall in 2014-15 and 2015-16.

The eight core infrastructure-supportive industries--coal, crude oil, natural gas, refinery products, fertilizers, steel,
cement and electricity--that have a total weight of nearly 38 per cent in the IIP

Sector Weight
Electricity 10.32%
Steel 6.68%
Refinery Products 5.94%
Crude Oil 5.22%
Coal 4.38%
Cement 2.41%
Natural Gas 1.71%
Fertilizer 1.25%

Expenditure on Social Infrastructure: Expenditure on education as a proportion of GDP has hovered around 3 per cent
during the period 2008-09 to 2014-15. Similarly, there has not been any significant change in the expenditure on
health as a proportion of GDP, which has remained stagnant at less than 2 per cent during the same period.

The Climate Change Agreement provides binding obligation for developed countries to provide financial resources to
developing countries for both mitigation and adaptation while encouraging other countries to provide support on
voluntary basis. It reaffirms that developed countries will take the lead in mobilizing climate finance from a wide
variety of sources, instruments and channels, noting the significant role of public funds. The decision also sets a new
collective quantified goal from a floor of US$100 billion per year prior to 2025, taking into account the needs and
priorities of developing countries. Pre 2020 actions are also part of the decisions. The Agreement also called upon
developed countries to scale up their level of financial support with a complete road map for achieving the goal of
jointly providing US$100 billion by 2020 for mitigation and adaptation, by significantly increasing adaptation finance
from current levels and to further provide appropriate technology and capacity building support.

With a potential of more than 100 GW, the aim is to achieve a target of 60 GW of wind power as well as 100 GW of
solar power installed capacity by 2022.

The country’s goal is to reduce overall emission intensity and improve energy efficiency of its economy over time, at
the same time protecting the vulnerable sectors and segments of the economy and society.

India has also taken the initiative of setting up an International Solar Alliance (ISA), an alliance of 121 solar-resource-
rich countries, lying fully or partially between the Tropic of Cancer and Tropic of Capricorn.
Chapter 2: Public Finance

Fiscal consolidation entails revenue augmentation and expenditure rationalization.

Fiscal consolidation was paused post the financial crisis that led to tax concessions and higher public expenditure, as
part of the growth revival strategy and this probably continued somewhat longer than required.

Non-tax revenue mainly consists of interest and dividend receipts, external grants and receipts from services provided
by the central government which include fiscal services like currency and mint, general services like the Union Public
Service Commission, police, etc.; social services like education, health, etc. and economic services like irrigation and
transportation.

Non-debt capital receipts mainly consist of recovery of loans and advances, and disinvestment receipts.

The FFC had recommended allocation of greater resources to states through the automatic route by increasing the
states’ share in the divisible pool of taxes from 32 per cent to 42 per cent, and counterbalancing this increase in
devolution by curtailing the resources transferred under central plan assistance to the states and by changing the
expenditure-sharing pattern.

One of the major constraints in the rationalization of non-plan expenditure is committed expenditure. Committed
expenditure occurs on two counts:

 first, interest liability on debt incurred in the past, and

 second, pension payment to superannuated/retiring workforce from government services.

The subsidy bill for BE 2015-16 was placed at Rs. 2.44 lakh crore, which was 1.7 per cent of GDP.

Following the recommendations of the Expert Group on A Viable and Sustainable System of Pricing of Petroleum
Products, the government deregulated the prices of petrol with effect from June 2010.

The government announced the decision to decontrol the prices of diesel in October 2014, ending under-recoveries
in diesel which formed the bulk of the under recoveries.

Improving tax compliance through better tax administration, tapping new sources of revenue, etc. could help raise
more revenue and keep the fiscal deficit at levels projected in the revised fiscal road map.
Chapter 3: Monetary Management and Financial Intermediation

Reserve Money = M0 = Currency in circulation + Bankers’ deposits with RBI

Narrow Money = M1 = Currency with public + Demand Deposits

Broad Money = M3 = Currency with public + Demand Deposits + Time Deposits

The concept of credit impulse was first introduced by Deutsche Bank economist Michael Biggs, in November 2008.
The concept emphasizes that spending is a flow and as such it should be compared with net new lending, a flow,
rather than credit outstanding, which is a stock. Credit impulse is measured as the change in new credit issued as a
percentage of the gross domestic product (GDP). (A stock variable is measured at one specific time, and represents a
quantity existing at that point in time (say, December 31, 2004), which may have accumulated in the past. A flow
variable is measured over an interval of time. Therefore a flow would be measured per unit of time (say a year))
The Forwards Markets Commission (FMC) has been merged with the Securities and Exchange Board of India (SEBI)
with effect from 28 September 2015 to achieve convergence of the regulation of the securities and commodity
derivatives markets and increase the economies of scope and scale for exchanges, financial firms and other
stakeholders.

With a view to strengthening and institutionalizing the mechanism for maintaining financial stability, enhancing
inter-regulatory coordination and promoting financial sector development, the Financial Stability and Development
Council (FSDC) under the chairmanship of union Finance Minister was set up by the government as the apex-level
forum in December 2010. The council maintains macro prudential supervision of the economy, including functioning
of large financial conglomerates, and addresses inter-regulatory coordination and financial sector development issues,
including those relating to financial literacy and financial inclusion.
Chapter 4: External Sector

Reflecting the weak global demand and trends, India’s exports have been declining since December 2014. With
imports falling in level due to lower global commodity prices, merchandise trade deficit continued at moderate levels
in 2015-16 and, net surplus in the invisibles account remaining on an even keel, current account deficit was at 1.4 per
cent of gross domestic product in April-September2015.

The IMF has projected growth in the global economy to go up from 3.1 per cent in 2015 to 3.4 per cent in 2016 and
further to 3.6 per cent in 2017.

A recent feature is that the Chinese economy is gradually slowing down and is transitioning from investment demand
to consumption demand and from manufacturing to services.

Since late 2014-15 (December 2014), India’s merchandise exports have been declining continuously. Both developed
and developing countries are also witnessing a fall in exports as a result of subdued economic conditions and a
downward spiral in crude oil prices.

The top eight export sectors—petroleum products, gems and jewellery, textiles, chemicals and related products,
agriculture and allied sector, transport equipment, base metals and machinery-continue to dominate India’s export
basket, accounting for nearly 86.4 per cent of total exports in 2014-15

Petroleum and crude (20.1%) > Gems and Jewellery (13.2%) > Textiles and allied products (11.8%) > agri and allied
products (10.5%) in share of exports

Petroleum and crude (36.6%) > Gems and Jewellery (13%) > Chemicals (7.9%) > Electronics (7.2%) in share of imports

In terms of major countries, India’s exports to the USA, the UAE and Hong Kong (with shares of 13.7 per cent, 10.6 per
cent and 4.4 per cent in India’s total exports) are the top 3.

Among the top countries for India’s imports, China with a share of 13.5 per cent in total imports, registered a positive
growth rate of 18.4 per cent in 2014-15. However, India’s imports from Saudi Arabia (6.3 per cent share), the UAE (5.8
per cent share) and the USA (4.9 per cent share) declined.
The new FTP aims to increase India’s exports to US$900 billion by 2019-20.

Customs single window initiative: This project envisages that importers and exporters will electronically submit their
customs clearance documents at a single point with customs.

One of the major objectives of the new FTP is to move towards a paperless 24x7 working environment.

The Tenth Ministerial Conference of the WTO was held in Nairobi, Kenya during 15-19 December 2015. The outcomes
of the Conference, referred to as the ‘Nairobi Package’ include Ministerial Decisions on agriculture, cotton and issues
related to least developed countries (LDCs). These cover public stockholding for food security purposes, a Special
Safeguard Mechanism (SSM) for developing countries, a commitment to abolish export subsidies for farm exports
particularly from the developed countries and measures related to cotton. Decisions were also made regarding
preferential treatment to LDCs in the area of services and the criteria for determining whether exports from LDCs may
benefit from trade preferences.

Nairobi Ministerial Declaration reflects divergence amongst the WTO membership on the relevance of reaffirming the
Doha Development Agenda (DDA) as the basis of future negotiations.

As the future of the Doha Round appeared in doubt, India sought and succeeded in obtaining a re-affirmative
Ministerial Decision on Public Stockholding for Food Security Purposes honoring both the Bali Ministerial and General
Council Decisions. The decision commits members to engage constructively in finding a permanent solution to this
issue. Similarly, a large group of developing countries has long been seeking a SSM for agricultural products. In order
to ensure that this issue remains on the agenda of future discussion in the WTO, India negotiated a Ministerial
Decision which recognizes that developing countries will have the right to have recourse to an SSM as envisaged in
the mandate.
WTO Members also agreed to the elimination of agricultural export subsidies subject to the preservation of special
and differential treatment for developing countries such as a longer phase-out period for transportation and
marketing export subsidies for exporting agricultural products. Developed countries have committed to removing
export subsidies immediately, except for a few agricultural products, and developing countries will do so by 2018.

One of the Decisions adopted extends the relevant provision to prevent ‘ever greening’ of patents in the
pharmaceuticals sector. This decision would help in maintaining an affordable and accessible supply of generic
medicines.

Another area under negotiation in Nairobi dealt with the rules on fisheries subsidies. There was no outcome in this
area of the negotiations. On the issue of rules on Anti-dumping, India strongly opposed a proposal that would give
greater power to the WTO’s Anti-Dumping Committee to review Members’ practices. There was no convergence in
this area and, hence, no outcome was achieved.

The possible risks of not joining the TPP are difficult to quantify, but some of the research has highlighted the
possibility of trade diversion and raised concerns about erosion of India’s share in exports to the US and Europe.

Some of the major concerns are as follows:

 Openness of market: TPP economies on average are more open than the Indian economy. The average applied
most favored nation (MFN) tariff rate in TPP economies is 4.5 per cent. India needs to work significantly in
terms of openness of market as its tariff rates are significantly higher than those in the TPP countries
 Import competition: Domestic industries will face severe import competition due to tariff elimination on some
of the products
 SoEs: Membership of the TPP would prevent the government from using SoEs and government procurement
as vehicles for achieving social and economic objectives, including employment generation. India would have
to compromise on the Make in India policy
 IPRs: The TPP agreement on IPRs does not prevent a party from taking measures to protect public health
and, in particular, to promote access to medicines for all. However, the prices of pharmaceutical products can
be expected to rise due to implementation of IPR agreements which will give more protection to patented
medicine and may lead substantially to elimination of generic drugs from the market.
 Government procurement: As the agreement curtails the flexibility available to signatory countries to impose
export restrictions on food, it will jeopardize India’s endeavour to ensure food security
 Labor standards: These bind the members to adopt and maintain laws and practices governing acceptable
conditions of work relating to minimum wages, hours of work, and occupational health and safety determined
by each party. These labour standards may increase the labour cost in the developing countries as they raise
the issue of enforceable commitments
 Environment standards: The TPP members acknowledge that inadequate fisheries management, fisheries
subsidies that contribute to overfishing and overcapacity, and illegal, unreported and unregulated (IUU)
fishing can have significant negative impacts on trade, development and the environment and ‘thus recognize
the need for individual and collective action to address the problems of overfishing and unsustainable
utilization of fisheries resources’. This is in contradiction to India’s current policy of subsidizing the fishery
industry.

South African Customs Union has South Africa, Botswana, Lesotho, Swaziland and Namibia as members

Movement in exchange rate has different impact on different sectors. High-import-intensity sectors like petroleum
products (86.2 per cent imported raw materials consumed), and chemical and chemical products (77.4 per cent) are
more impacted by rupee depreciation as a weaker rupee increases the value of imported inputs. Low import
intensity sectors remain in an advantageous position especially in price-sensitive international markets.
Chapter 5: Prices, Agriculture and Food Management

Weakening of global commodity prices continued in 2015-16. Prices of crude oil, metals and even cereals declined
across the globe not-withstanding a few short spells of rebound.

Headline inflation, based on the consumer price index (combined) series, dipped to 4.9 per cent during April-January
2015-16 as against 5.9 per cent in 2014-15.

Consumer price index-based core inflation (non-food non-fuel) also remained range bound, inching up marginally
from 4.2 per cent in March 2015 to 4.7 per cent in January 2016.

To raise the productivity of agriculture in India there is need to expand the acreage under irrigation along with
adoption of appropriate technologies for efficient utilization of water through suitable pricing. Having ‘more crop per
drop’ through efficient irrigation technologies should be the motto to improve productivity in agriculture which can
ensure food and water security in the future.

The level of farm mechanization in India requires more to be done in terms of introduction of better equipment for
each farming operation in order to reduce drudgery, to improve efficiency by saving on time and labour, improve
productivity, minimize wastage and reduce labour costs for each operation.

The adoption of quality seeds is critical along with other inputs to improve agricultural output in India.

The Pardarshi Kisan Sewa Yojana (PKSY) was launched in September, 2014 and rolled out in April 2015 in Uttar
Pradesh for distribution of hybrid seeds through DBT (Direct Benefit Transfer). The aim of the scheme was to target
the intended beneficiaries and prevent diversion of subsidized seeds, corruption and manipulation.

In the post Green Revolution agriculture scenario, there have been imbalances in the use of fertilizers such as
excessive dependence on urea owing to low/ distorted prices of fertilizers, especially urea, crop and regional
imbalance in the use, neglect/ low use of compost, manure and other forms of natural nutrient providers,
discontinuing practices of inter and rotational cropping.

Indian soils show deficiency of micro nutrients like boron, zinc, copper and iron in most parts of the country, which
limits crop yields and productivity.

Judicious use of chemical fertilizers, bio-fertilizers and locally available organic manures like farmyard manure,
compost, vermi compost and green manure based on soil testing is necessary to maintain soil health and productivity.

According to NSSO, 70th round data, as much as 40 per cent of the funds of farmers still come from informal sources.
Local money lenders account for almost 26 per cent share of total agricultural credit.

Livestock Mission has been launched in 2014-15 with an approved outlay of Rs 2,800 crore during the Twelfth Plan.
This Mission is formulated with the objective of sustainable development of the livestock sector, focusing on
improving availability of quality feed and fodder, risk coverage, effective extension, improved flow of credit, and
organization of livestock farmers/rearers.

Kharif crops: paddy, jowar, bajra, maize, ragi, arhar, moong, urad, cotton, groundnut, sunflower, soyabean, sesamum,
nigerseed

Rabi crops: wheat, barley, gram, masur (lentil), rapeseed/mustard, safflower, toria
Chapter 6: Industrial, Corporate, and Infrastructure Performance

The landmark initiatives like Make in India, Ease of Doing Business, Start Up India, Digital India, and Smart Cities, etc.
will provide further impetus to industries and the industrial sector is expected to be the key driver of economic
growth in the country. These initiatives would also help in transforming infrastructure sector which is sine qua non for
achieving and sustaining higher economic growth.

The contribution of the manufacturing sector to Gross Value Added (GVA) has been hovering around 17 per cent for
the last four years.

The National Investment and Infrastructure Fund (NIIF) has been approved to extend equity support to
infrastructure Non-Bank Financial Companies (NBFC).

In the World Bank’s Ease of Doing Business report 2016, India’s position has improved to 130 in 2016 from 142 in
2015. India produces 86.5 million tonnes (MT) of steel, which is over 5 per cent of world production, making it the
fourth largest producer of crude steel in the world.

The cost of production of domestic steel companies like Jindal Steel and Power Limited, Bhushan Steel and Essar Steel
is more than the import parity price at 10 per cent import duty and hence are not globally competitive.

Due to near-stagnant demand for steel globally, and in particular in China, major global steel producers are pushing
steel products into the Indian market, leading to a surge in steel imports.

MSME Sector

With 3.6 crore units spread across the country, that employ 8.05 crore people, Micro, Small and Medium Enterprises
(MSME) have a contribution of 37.5 per cent to the country’s GDP. MSMEs will play a crucial role in the success of the
Make in India initiative.

Realizing the importance of the MSME sector, the government has undertaken a number of schemes/programmes like
the Prime Minister’s Employment Generation Programme (PMEGP), Credit Guarantee Trust Fund for Micro and Small
Enterprises (CGTMSE), Credit Linked Capital Subsidy Scheme (CLCSS) for Technology Upgradation, Scheme of Fund for
Regeneration of Traditional Industries (SFURTI), and Micro and Small Enterprises Cluster Development Programme
(MSECDP) for the establishment of new enterprises and development of existing ones.

Some of the new initiatives undertaken by the government for the promotion and development of MSMEs, are as
follows:

 Udyog Aadhar Memorandum (UAM): Under the scheme, MSME entrepreneurs just need to file an online
entrepreneurs’ memorandum to instantly get a unique Udyog Aadhaar Number (UAN). The information
sought is on self-certification basis and no supporting documents are required.
 Employment Exchange for Industries: To facilitate match making between prospective job seekers and
employers an employment exchange for industries was launched on June 15, 2015 in line with Digital India.
 Framework for Revival and Rehabilitation of MSMEs: Under this framework, which was notified in May 2015,
banks have to constitute a Committee for Distressed MSME enterprises at zonal or district level to prepare a
Corrective Action Plan (CAP) for these units.
 A scheme for Promoting Innovation and Rural Entrepreneurs (ASPIRE): ASPIRE was launched on March 16,
2015 with the objective of setting up a network of technology centres and incubation centres to accelerate
entrepreneurship and promote start-ups for innovation and entrepreneurship in rural and agriculture based
industry.
Top 5 FDI countries into India are Singapore, Mauritius, Netherlands, USA and Japan.

Delhi, MH, KA, TN, GJ and AP are the top FDI earners

With the objective of making India a global hub of manufacturing, design and innovation, the Make in India initiative,
which is based on four pillars --new processes, new infrastructure, new sectors and new mindset—has been taken by
the government.

The Government of India has set up Invest India as the national investment promotion and facilitation agency. With
the objective of promoting investment in the country, a full-fledged Investment Facilitation Cell has been set-up under
the Make in India initiative

As envisaged by the National Manufacturing Policy 2011, Make in India seeks to create 100 million additional jobs in
manufacturing by 2022.

An innovation promotion platform called Atal Innovation Mission (AIM) and a techno-financial, incubation and
facilitation programme called Self-Employment and Talent Utilization (SETU) are being implemented to encourage
innovation and start-ups in India.

The India Aspiration Fund has also been set up under the Small Industries Development Bank of India (SIDBI) for
venture capital financing of newly set-up or expanding units in the MSME sector.

The Prime Minister, on 5th January 2015, launched the 100 cities National LED Programmes with the aim of
promoting use of the most efficient lighting technology at affordable rates. This programme has two components: (i)
the Domestic Efficient Lighting Programme (DELP) aiming to replace 77 crore incandescent bulbs with LED bulbs by
providing LED bulbs to domestic consumers and (ii) the Street Lighting National Programme (SLNP) to replace 3.5
crore conventional streetlights with smart and energy-efficient LED streetlights by March 2019.

The MMDR Act also has provision for the establishment of District Mineral Foundation, a non-profit organization, in
any district affected by mining-related operations, with the objective of working for the interest and benefit of
persons as well as affected areas where mining activity is taking place.

Under Pradhan Mantri Khanij Kshetra Kalyan Yojana, an amount of Rs. 6000 crore per annum is to be spent on
welfare schemes related to people and districts adversely affected by mining activities.

Swachh Bharat Mission (SBM): The SBM aims at making India free from open defecation and at achieving 100 per cent
scientific management of municipal solid waste in 4041 statutory towns/ cities in the country

Smart cities

The purpose of the Smart Cities Mission is to drive economic growth and improve the quality of life of people by
enabling local area development and harnessing technology, especially technology that leads to smart outcomes. The
Smart Cities Mission targets promoting cities that provide core infrastructure and give a decent quality of life to its
citizens, a clean and sustainable environment and application of ‘smart’ solutions.

The core infrastructure development in a smart city includes adequate water supply; assured electricity supply;
sanitation, including solid waste management; efficient urban mobility and public transport; affordable housing,
especially for the poor; robust IT connectivity and digitalization; good governance, especially e-Governance and citizen
participation; sustainable environment; safety and security of citizens, particularly women, children and the elderly;
and health and education.
The strategic components of area-based development in the Smart Cities Mission are city improvement (retrofitting),
city renewal (redevelopment) and city extension (Greenfield development) plus a pan-city initiative in which smart
solutions are applied covering larger parts of the city. Retrofitting will introduce planning in an existing built-up area to
achieve smart city objectives, along with other objectives, to make the existing area more efficient and livable.

 In retrofitting, an area consisting of more than 500 acres will be identified by the city in consultation with
citizens.
 Redevelopment will effect a replacement of the existing built-up environment and enable co-creation of a
new layout with enhanced infrastructure using mixed land use and increased density. Redevelopment
envisages an area of more than 50 acres, identified by ULBs in consultation with citizens.
 Greenfield development will introduce most of the smart solutions in a previously vacant area (more than
250 acres) using innovative planning, plan financing and plan implementation tools (e.g. land pooling/ land
reconstitution) with provision for affordable housing, especially for the poor. Greenfield development is
required around cities in order to address the needs of the expanding population.

The distribution of smart cities will be reviewed after two years of the implementation of the mission.

Based on an assessment of the performance of states/ULBs in the challenge, some reallocation of the remaining
potential smart cities among states may need to be done by the Ministry of Urban Development (MoUD).

The Smart City Mission will be operated as a Centrally Sponsored Scheme and the central government proposes to
give it financial support to the extent of Rs. 48,000 crore over five years, i.e. on an average Rs. 100 crore per city per
year. An equal amount, on a matching basis, will have to be contributed by the state/ULB; therefore, nearly one lakh
crore of government/ULB funds will be available for smart cities development.
Chapter 7: Services Sector

India ranked ninth in terms of overall GDP and tenth in terms of services GVA in 2014, climbing one rung in both
rankings.

India has joined the Regional Comprehensive Economic Partnership (RCEP) plurilateral negotiations. The RCEP is a
proposed FTA which includes the 10 ASEAN countries and its six FTA partners, viz. Australia, China, India, Japan, South
Korea and New Zealand. The RCEP is the only mega-regional FTA of which India is a part.

India’s share in International Tourist Arrivals (ITAs) is a paltry 0.7 per cent compared to 7.4 per cent of France, 6.6 per
cent of the US, 5.7 per cent of Spain and 4.9 per cent of China.

To promote medical tourism, the Government of India has launched India’s Healthcare Portal and Advantage Health
Care India. India’s Healthcare Portal is a comprehensive one-point information source and covers hospital-related
and travel-related information on India.

An international summit on medical value travel, Advantage Health Care India (AHCI) 2015, was held from 5 to 7
October 2015 at Pragati Maidan, New Delhi, to showcase India and its immense pool of medical capabilities as well as
create opportunities for health-care collaboration between participating countries.

Recognizing the need to encourage the growth of Indian tonnage and for higher participation of Indian ships in Indian
EXIM trade, the government has implemented several measures which include making fuel tax free for all Indian flag
coastal vessels engaged in container trade; giving income tax benefit to Indian seafarers working on Indian ships,
thereby making the cost of personnel more competitive for the Indian shipping industry; removing obstacles in the
smooth implementation of the India Controlled Tonnage (ICT) scheme which allows Indian companies to directly
own ships in foreign flags; and easing many procedural compliance issues like ship registration, procuring chartering
permission and payment of chartering fees online.

Various actions are being taken to develop IWT infrastructure, particularly the implementation of the Jal Marg Vikas
Project. 'Jal Marg Vikas' (National Waterway-1) project, which envisages developing a fairway between 1,620 km
Allahabad and Haldia stretch, has taken off with a $3.5 million funding from the World Bank.

India’s broadcasting distribution network comprises 6000 multi system operators (MSO) and 7 direct to home (DTH)
operators. The Government of India has embarked on an ambitious exercise to digitize its cable network in four
phases, leading to a complete switch off of analog TV services by 31 December 2016.

HITS (headend in the sky) technology will play a key role in achieving the goal of 100 per cent digital distribution in
India.
Chapter 8: Climate Change and Sustainable Development

The year 2015 witnessed two landmark international events: the historic climate change agreement under the
UNFCCC in Paris in December 2015 and the adoption of the Sustainable Development Goals in September 2015.

A new set of 17 SDGs and 169 targets were adopted by the world governments in 2015.

India announced its intended nationally determined contribution (INDC) which set ambitious targets for domestic
efforts against climate change. Including other efforts, the country has set itself an ambitious target of reducing its
emissions intensity of its gross domestic product (GDP) by 33-35 per cent by 2030, compared to 2005 levels, and of
achieving 40 percent cumulative electric power installed capacity from non-fossil fuel-based energy resources by
2030.

In 2014, in terms of absolute emissions, China was at the top, while in terms of per capita emissions, the USA was at
the top. India’s per capita emissions are among the lowest in the world.

China>USA>EU>India (Overall emissions)

This universal agreement will succeed the Kyoto Protocol. Unlike the Kyoto Protocol, it provides a framework for all
countries to take action against climate change. One of the main focus of the agreement is to hold the increase in the
global average temperature to well below 2°C above pre- industrial level and on driving efforts to limit it even
further to 1.5°C.

The Paris Agreement also clearly states in its decision that it is under the aegis of the UNFCCC and will come into force
only when at least 55 Parties to the Convention, accounting for at least an estimated 55 percent of total global
greenhouse gas emissions, have deposited their instruments of ratification, acceptance, approval or accession.
The term green finance has gained a lot of attention in the past few years with the increased focus on green
development. The Rio+20 document clearly states what green economy policies should result in and what they should
not. While there is no universal definition of green finance, it mostly refers to financial investments flowing towards
sustainable development projects and initiatives that encourage the development of a more sustainable economy

India’s INDCs

 To reduce the emissions intensity of its GDP by 33 to 35 per cent of the 2005 level by 2030
 To achieve about 40 per cent cumulative electric power installed capacity from non-fossil fuel- based energy
resources by 2030 with the help of transfer of technology and low cost international finance including from
the Green Climate Fund (GCF).
 To create an additional carbon sink of 2.5 to 3 billion tonnes of CO2 equivalent through additional forest and
tree cover by 2030
 To mobilize domestic and new and additional funds from developed countries for implementing these
mitigation and adaptation actions in view of the resources required and the resource gap.
 To build capacities, create a domestic framework and an international architecture for quick diffusion of
cutting-edge climate technology in India and for joint collaborative R&D for such future technologies.

The Green Climate Fund (GCF) was established as an operating entity of the financial mechanism of the UNFCCC in
2011 and is expected to be a major channel for climate finance from developed to developing countries. The GCF has
so far been pledged US$10.2 billion by 38 governments.

The Global Environment Facility (GEF) was established as a pilot programme for environmental protection. The GEF
was adopted as a financial mechanism for helping developing countries meet their financing needs for achieving
their climate change goals.

Chapter 9: Social Infrastructure, Employment and Human Development

The Labour Force Participation Rate (LFPR) is 52.5 for all persons. The LFPR for rural areas at 54.7 is greater than that
for urban areas at 47.2.

 National Career Services Portal: The Government is mandated to maintain a free employment service for its
citizens.
 Shram Suvidha Portal: The features of the Shram Suvidha Portal launched by the Government are: Unique
Labour Identification Number (LIN) to units/ establishments registered on it; transparent labour inspection
scheme; unified annual returns
 Universal Account Number: As part of the Pandit Deen Dayal Upadhyay Shramev Jayate Karyakram,
portability feature has been launched through the Universal Account Number (UAN) by EPFO

The Sector Skills Councils as autonomous industry led bodies through the NSDC create National Occupational
Standards (NOSs) and Qualification Packs (QP) for each job role in the sector, develop competency frameworks,
conduct training of trainers, conduct skill gap studies and assess through independent agencies and certify trainees
on the curriculum aligned to NOSs developed by them.

The Pradhan Mantri Kaushal Vikas Yojana (PMKVY) targets offering 24 lakh Indian youth meaningful, industry-
relevant, skill-based training and a government certification on successful completion of training along with
assessment to help them secure a job for a better future

In addition, the Deen Dayal Upadhyaya Grameen Kaushalya Yojana (DDU-GKY), a placement-linked skill
development scheme for rural youth who are poor, as a skilling component of the NRLM has also been launched.
The National Policy on Skill Development and Entrepreneurship 2015 aims to ensure ‘Skilling on a large Scale at a
Speed with high Standards and promote a culture of innovation based entrepreneurship to ensure sustainable
livelihoods’.

Besides continuing support to existing interventions, initiatives such as 'RBSK' and `Rashtriya Kishor Swasthya
Karyakram’ (RKSK) have been launched in 2013 and 2014 respectively under the NHM to provide comprehensive
health care. Since drugs constitute the bulk of OOPE, the Government of India has intensified efforts for provision of
free essential drugs in public health facilities under the NHM Free Drugs Initiative. ‘Jan Aushadhi Scheme’ for
providing quality generic medicines at affordable prices in collaboration with the State Governments has also been
launched.
14th Finance Commission Report
Introduction

The Fourteenth Finance Commission (FC-XIV) was constituted by the President under Article 280 of the Constitution
on 2 January 2013 to make recommendations for the period 2015-20. Dr. Y. V. Reddy was appointed the Chairman of
the Commission.

Issues and Approach

The core mandate of the Finance Commission, as laid out in Article 280 of the Constitution, is to make
recommendations on

 the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be,
divided between them
 the allocation between the States of the respective shares of such proceeds
 the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated
Fund of India
 the measures needed to augment the Consolidated Fund of a State to supplement the resources of the
Panchayat and Municipalities in the State on the basis of the recommendations made by the Finance
Commission of the State

Broader issues relating to the need for rebalancing the roles of Union and State are

States’ arguments

 there is greater focus by the States on their own development models

 States have acquired capabilities of designing their strategies for development and have matured in terms of
economic management, though there is considerable diversity among them
 there is considerable variation in the expectations of the people of different States about the level and
nature of public services
 some States argued for the need to give State Governments greater policy space
 States highlighted the emerging fiscal implications for them arising from the Union Government’s policies
relating to natural resources, as for example forests and allocation of spectrum
 in terms of the functioning of the Finance Commission, the States have argued that, apart from the merits and
demerits of the Centrally sponsored schemes (CSS), the increase in their number as well as of Plan grants to
States reveals the excess fiscal space available to the Union Government.

Union’s arguments

 increasing economic integration with the global economy requires the Union Government to be empowered
to manage global shocks, assure financial markets and to adopt counter-cyclical policies
 global opinion makers and credit rating agencies give over-riding importance to the Union Government’s
fiscal position in their assessment of the national economy
 Union Government should have adequate fiscal space to transfer resources to the States in regard to
overlapping functions and for political economy considerations

Short-term risks include worsening of geo-political tensions and continuing volatility in financial markets. Medium-
term risks include a low potential growth in advanced economies and a decline in potential growth of the emerging
economies.
While the Finance Commission transfers through tax devolution have remained the primary source of resource
transfers to States, the share of these transfers in aggregate transfers has declined, particularly in the last decade. The
share of Plan grants has increased, with an increase in the share of transfers for CSS primarily through the
implementing agencies, bypassing the State budgets till 2013-14.

Aggregate transfers accounted for around 50 per cent of the gross revenue receipts of the Union. There is no scope
for increasing the transfers beyond the current level. However, there is a need to alter the existing composition of
transfers by increasing the share of untied transfers. This should provide enhanced fiscal flexibility to the States to
meet their expenditure needs and make expenditure decisions in line with their own priorities.

Review of Union Finances

The Union Government introduced the concept of effective revenue deficit through an amendment to the FRBM Act in
2012. Effective revenue deficit makes a distinction between the grants given to the States and implementing
agencies for the creation of capital assets and grants for meeting revenue expenditures.

The concept of effective revenue deficit is not recognized in the standard government accounting process.

The non-debt capital receipts fluctuated due to slippages in achieving the projected disinvestment targets

The ratio of revenue deficit to fiscal deficit has shown a steady increase.

Total Liabilities for 2014-15 (BE) are expected to be 48% of GDP and public debt is expected to be 38.5%

Corporation Income Total Customs Union Service Total Total

Tax Tax Direct Tax Duties Excise Tax Indirect Union
Duties Tax Tax Rev
2014-15 3.5% 2.16% 5.67% 1.57% 1.60% 1.68% 4.93 10.6%
(BE) %
GDP
2014-15 33.05% 20.39% 53.52% 14.79% 15.12% 15.83% 46.48% 100%
(BE) %
Gross Tax

The share of revenue from indirect taxes has been higher than that of direct taxes for the most part of the post-
Independence period. However, this trend reversed from 2007-08

The various tax concessions and exemptions given by the Union Government reduce the revenue collections and
adversely affect the resources accruing to both Union and State Governments and is called Revenue Foregone.

Around 5% of GDP or 49.4% of Gross Tax revenue is revenue foregone in 2013-14

According to the 2014-15 Budget, the proportion of revenue foregone is the highest for exemptions on customs
duties (45.5 per cent) followed by countervailing excise duties (34.2 per cent).

The total cess and surcharges constituted over 12.4 per cent of gross tax revenues in 2012-13 (actuals). These are
excluded from the divisible pool. Cesses are meant to be fully utilized for the purposes for which they are levied.

Similarly, surcharges are meant to be levied only for short periods.

Dividend receipts constitute the largest source of non-tax revenues of the Union Government. Their share in non-tax
revenue is estimated at 42.5 per cent in 2014-15 (BE).
 Revenue Interest Pay and Pension Defence Subsidies Capital Total
Exp Payments Allowances Exp Exp
2014-15 12.18 3.32% - 0.64% 1.78% 2.02% 1.76% 13.94%
(BE)% GDP

The major explicit subsidies of the Union Government are on food, fertilizers and petroleum and they have
significant implications on expenditure management and fiscal consolidation.

Food Fertilizer Petroleum Others

Subsidies Subsidies Subsidies
2014-15 9.67% 6.13% 5.33% 0.78%
(BE)%
Revenue
Receipts

Interest payments form the largest component of Union Government expenditure.

The outstanding Union debt has remained within the limits set by the FC-XIII. However, this is primarily due to a high
nominal growth in GDP.

The reduction in non-tax revenues is primarily due to declining interest receipts on loans outstanding from State
Governments. This source is likely to dry up further in future, since no fresh loans are being extended to the States.

Review of State Finances

The FC-XII had also recommended the creation of a Debt Consolidation and Relief Facility (DCRF), which involved the
rescheduling and consolidation of certain loans from the Union Government to the States.

Sharing of Union Tax Revenues

The States have pointed out that apart from requiring them to provide matching contribution conditions are also
imposed for them to access Central funds for CSS. This makes it difficult for the States to provide the required level
of budgetary support from their own expenditure programmes.

Further, the CSS impinges upon the fiscal autonomy of the States, as they do not have any say in design of these
schemes and face many restrictions in their implementation.

Introduction of CSS midway during the year and changes in the sharing pattern of existing CSS imposes an
unpredictable fiscal burden on the States and distorts their expenditure priorities. It also creates a mismatch
between the budget provisions of the CSS, the quantum approved and the actual amount released by the Union
Ministries.

Under Article 270, taxes referred to in Article 268 and 269 - surcharges on taxes and duties and cesses levied for
specific purposes - should not form part of the divisible pool.

Total transfers are comprised of tax devolution, non-Plan grants, Plan grants and grants for various CSS including
those which were transferred directly to the implementing agencies bypassing the State budget until 2013-14.

Tax devolution should be the primary route of transfer of resources to States since it is formula based and thus
conducive to sound fiscal federalism. However, to the extent that formula-based transfers do not meet the needs of
specific States, they need to be supplemented by grants-in-aid on an assured basis and in a fair manner.
Amounts equivalent to more than 60 per cent of the divisible pool goes to the States in various forms of transfers and
keeping in view the Union Government's expenditure responsibilities, there is little scope to increase the share of
aggregate transfers.

However, a compositional shift in transfers from grants to tax devolution is desirable. We have factored in four
important considerations: (i) States not being entitled to the growing share of cess and surcharges in the revenues of
the Union Government; (ii) the importance of increasing the share of tax devolution in total transfers; (iii) an
aggregate view of the revenue expenditure needs of States without Plan and non-Plan distinction; and (iv) the space
available with the Union Government.

Considering all factors, in our view, increasing the share of tax devolution to 42 per cent of the divisible pool would
serve the twin objectives of increasing the flow of unconditional transfers to the States and yet leave appropriate
fiscal space for the Union to carry out specific-purpose transfers to the States.

Use of the latest population data would penalize those States that have taken effective population control
measures. A few States have also suggested that growing urbanization imposes challenges for States in terms of
providing services to its population.

Though we are of the view that the use of dated population data is unfair, we are bound by our ToR and have assigned
a 17.5 per cent weight to the 1971 population. On the basis of the exercises conducted, we concluded that a weight
to the 2011 population would capture the demographic changes since 1971, both in terms of migration and age
structure. We, therefore, assigned a 10 per cent weight to the 2011 population

We put the floor limit at 2 per cent for smaller States and assigned 15 per cent weight

A large forest cover provides huge ecological benefits, but there is also an opportunity cost in terms of area not
available for other economic activities and this also serves as an important indicator of fiscal disability. We have
assigned 7.5 per cent weight to the forest cover

We have decided to revert to the method of representing fiscal capacity in terms of income distance and assigned it 50
per cent weight

Income distance has been computed by taking the distance from the State having highest per capita GSDP. In this
case, Goa has the highest per capita GSDP, followed by Sikkim. Since these two are very small States, adjustments
are needed to avoid distortions and hence income distance has been computed from the State with the third highest
per capita GSDP - Haryana.

As service tax is not levied in the State of Jammu & Kashmir, proceeds cannot be assigned to this State.
Local Governments

Finance Commissions since the FC-XI have sought data from States on finances of local bodies but were hampered by
the lack of reliable data.

We were, therefore, handicapped, like the previous Finance Commissions, in using the supplied data to determine
the resource gap at the level of rural and urban local bodies.

In our view, a common issue that emerges from SFC reports is the need to have reliable data on the finances of local
bodies in order to enable all stakeholders to make informed decisions. For this, the compilation of accounts and their
audit assumes importance. Another common issue is that the local bodies need to be encouraged to generate own
revenues and to improve the quality of basic services they deliver.

There was a strong consensus amongst the participants in favour of providing more funds for drinking water,
sanitation, drainage, local roads, school buildings, solid waste management, street lighting, maintenance of burial and
cremation grounds and parks.

Local bodies should be required to spend the grants only on the basic services within the functions assigned to them
under relevant legislations.

Books of accounts prepared by the local bodies should distinctly capture income on account of own taxes and non-
taxes, assigned taxes, devolution and grants from the State, grants from the Finance Commission and grants for any
agency functions assigned by the Union and State Governments. In addition to the above, we also recommend that
the technical guidance and support arrangements by the C&AG should be continued and the States should take action
to facilitate local bodies to compile accounts and have them audited in time.

The delivery of basic civic services is related to the current population to be served within the administrative
jurisdiction of the local body. Area is also relevant from the viewpoint of the costs of delivering such services.
Therefore, we recommend distribution of grants to the States using 2011 population data with weight of 90 per
cent and area with weight of 10 per cent. The grant to each State will be divided into two - a grant to duly
constituted gram panchayats and a grant to duly constituted municipalities, on the basis of urban and rural
population of that State using the data of Census 2011.

We have recommended grants in two parts - a basic grant and a performance grant for duly constituted gram
panchayats and municipalities. In the case of gram panchayats, 90 per cent of the grant will be the basic grant and
10 per cent will be the performance grant. In the case of municipalities, the division between basic and
performance grant will be on a 80:20 basis.

We are providing performance grants to address the following issues: (i) making available reliable data on local bodies'
receipt and expenditure through audited accounts; and (ii) improvement in own revenues. In addition, the urban local
bodies will have to measure and publish service level benchmarks for basic services. These performance grants will
be disbursed from the second year of our award period, that is, 2016-17 onwards, so as to enable sufficient time to
State Governments and the local bodies to put in place a scheme and mechanism for implementation.

The grants recommended by us shall be released in two installments each year in June and October. This will enable
timely flows to local bodies during the year, enabling them to plan and execute the works better. We recommend
that 50 per cent of the basic grant for the year be released to the State as the first installment of the year. The
remaining basic grant and the full performance grant for the year may be released as the second installment for the
year. The States should release the grants to the gram panchayats and municipalities within fifteen days of it being
credited to their account by the Union Government. In case of delay, the State Government must release the
installment with interest paid from its own funds.
State Governments should strengthen SFCs. This would involve timely constitution, proper administrative support
and adequate resources for smooth functioning and timely placement of the SFC report before State legislatures, with
action taken notes.

We notice that there is considerable scope for the local bodies to improve revenues from own sources by taking steps
as recommended by the SFCs and the Finance Commissions.

In our view, States need to ensure property tax reforms including objective determination of the base and its regular
revision to adjust for inflation, strengthening of mechanisms for assessment, levy and collection and improving billing
and collection efficiency.

In the case of urban local bodies, the tax had two components - tax on hoardings and the tax on advertisements on
buses, cars, lamp posts and compound walls. In this context, we suggest that States may like to consider steps to
empower local bodies to impose this tax and improve own revenues from this source.

States should exploit entertainment tax effectively through improved methods of levy and collection. Newer forms
of entertainment such as boat rides, cable television and internet cafes should be brought into the entertainment
tax net and no exemptions should be given without compensating local bodies for the loss.

We recommend raising the ceiling from Rs. 2,500 to Rs. 12,000 per annum. We further recommend that Article 276(2)
of the Constitution may be amended to increase the limits on the imposition of professions tax by States. The
amendment may also vest the power to impose limits on Parliament with the caveat that the limits should adhere to
the Finance Commission's recommendations and the Union Government should prescribe a uniform limit for all
States.

We recommend that State Governments take action to assign productive local assets to the panchayats, put in place
enabling rules for collection and institute systems so that they can obtain the best returns while leasing or renting
common resources.

Mining puts a burden on the local environment and infrastructure, and, therefore, it is appropriate that some of the
income from royalties be shared with the local body in whose jurisdiction the mining is done. This would help the
local body ameliorate the effects of mining on the local population.

In India, the market for municipal bonds is insignificant and the municipal bonds have played a limited role as a source
of finance for funding urban infrastructure projects. We recommend that local bodies and States explore the
issuance of municipal bonds as a source of finance with suitable support from the Union Government. The States
may allow the larger municipal corporations to directly approach the markets while an intermediary could be set up to
assist medium and small municipalities who may not have the capacity to access the markets directly.

Areas under Schedule VI in Meghalaya, Mizoram, Tripura and Assam, the areas in the hill districts of Manipur, rural
areas of Nagaland and Mizoram will remain outside the ambit of the measures we have recommended for panchayats
and municipalities.

Disaster Management

A major concern for the States has been the fiscal burden of financing disaster management, including relief and
reconstruction, without a commensurate flow of resources from the Union Government. As a consequence, State
Governments said, they were compelled to spend funds in excess of the SDRF from their own resources, particularly
on post-disaster restoration and reconstruction.

Many States argued that special weightage should be given to vulnerability of States rather than to actual expenditure
incurred in the past.
A common concern was the cumbersome processes and delays in the assessment of relief assistance from the NDRF.

The financing of the NDRF has so far been almost wholly through the levy of cess on selected items, but if the cesses
are discontinued or when they are subsumed under the goods and services tax (GST) in future, we recommend that
the Union Government consider ensuring an assured source of funding for the NDRF.

Contributions could be another source of financing the NDRF and we recommend that a decision on granting of tax
exemption to private contributions to the NDRF be expedited.

Scientifically validated risk vulnerability indicators would be useful measures of the type, frequency and intensity of
disasters confronting States.

We recommend that in view of the very wide responsibility cast on governments at different levels by the statute, the
Union Government expedite the development and scientific validation of the Hazard Vulnerability Risk Profiles of
States.

We adopted the practice of previous Commissions and used past expenditure on disaster relief for the period 2006-07
to 2012-13 to determine the SDRF corpus for each State.

We recommend that all States contribute 10 per cent to the SDRF during our award period, with the remaining 90
per cent coming from the Union Government.

The decision of constituting DDRFs is best left to the wisdom of the State Governments, and hence, we do not
recommend separate grants for the financing of DDRFs.

Considering the need for flexibility in regard to state-specific disasters, we recommend that up to 10 per cent of the
funds available under the SDRF can be used by a State for occurrences which it considers to be 'disasters' within its
local context and which are not in the notified list of disasters of the Ministry of Home Affairs.

Grants in Aid

Almost all States raised concern over the growing trend of attaching conditions to the grants, which adversely affected
the overall utilization of these grants.

According to States, the stringent conditions attached to the release of grants were responsible for the utilization of
grants remaining low. A few States held that the condition-linked, discretionary transfers also violate the principle of
State autonomy in fiscal matters.

We have adopted the following four principles in our approach to grants-in-aid:

 The devolution of taxes from the divisible pool should be based on a formula which should, to a large extent,
offset revenue and cost disabilities.
 The assessment of expenditures should build in additional expenditures in the case of those States with per
capita expenditure significantly below the all-State average.
 If the assessed expenditure need of a State, after taking into account the enabling resources for
augmentation, exceeds the sum of revenue capacity and devolved taxes, then the State concerned will be
eligible to receive a general purpose grant in-aid to fill the gap.
 Grants-in-aid for state-specific projects or schemes will not be considered, as these are best identified,
prioritized and financed by the respective States.
The objective of inter-governmental transfers is to offset the fiscal disabilities arising from low revenue raising
capacity and higher unit cost of providing public services. The ultimate objective is to enable every State to provide
comparable levels of public services that it is mandated to provide by the Constitution at comparable tax rates.

We consider health, education, drinking water and sanitation as public services of national importance, having
significant inter-state externalities. However, in our view, the grants to these sectors should be carefully designed and
implemented and an effective monitoring mechanism put in place with the involvement of the Union Government,
State Governments and domain expertise. Therefore, we have desisted from recommending specific-purpose grants
and have suggested that a separate institutional arrangement be introduced for the purpose.

Cooperative Federalism

The recommendations of previous Finance Commissions have covered both vertical and horizontal devolution, as well
as grants-in-aid, including non-Plan revenue deficit grants, grants to local bodies, grants for disaster relief, as well as
sector-specific and state-specific grants. The 'other transfers' flow mainly as Plan grants and the rest as non-Plan
grants.

The Plan grants comprise the following: (a) normal Central assistance, comprising untied assistance for the annual
plans of States, based on the Gadgil-Mukherjee formula; (b) additional Central assistance for specific-purpose
schemes and transfers; (c) special Central assistance, comprising untied assistance for the North-eastern and certain
hilly States; and (d) special Plan assistance.

In addition, there are Central Plan schemes and Centrally sponsored schemes, which are conditional upon the
implementation of specified schemes and programmes. Up to 2013-14, funds for the Centrally sponsored schemes
were routed through two channels - the Consolidated Funds of the States and directly to State implementing
agencies. From 2014-15 onwards, direct transfers to State implementing agencies have been done away with, and
all transfers to States for Centrally sponsored schemes are now being routed through the Consolidated Fund of the
State. The non-Plan grants constitute a very small part of the 'other transfers'. Plan grants are utilised both for capital
and revenue expenditures, though the share of the latter has been increasing in recent years.

In recent years, the aggregate transfers from the Union to the States (including direct transfers), as a percentage of
the gross revenue receipts of the Union, have ranged between 44.7 per cent and 53.7 per cent

A bulk of the 'discretionary' transfers from the Union to the States is for the centrally sponsored schemes,
accounting for nearly 62 per cent of the 'other' transfers in 2012-13 (including direct transfers to implementing
agencies)
The States, in general, have been critical of the rise in the share of non-statutory transfers, in particular non-
formula-based transfers, at the expense of statutory transfers.

In the context of Central transfers, the First Administrative Reforms Commission (1966) had observed that the role of
the Union Government in areas which are covered by the State List of subjects in the Constitution should be largely
that of a 'pioneer, guide, disseminator of information, overall planning and evaluator'.

The Commission on Centre-State Relations, headed by Justice R.S. Sarkaria (henceforth, 'Sarkaria Commission'), in its
report submitted in 1988, had recommended that the number of Centrally sponsored schemes should be kept to the
minimum. It added that these should be formulated in prior consultation with the States

Accordingly, the Commission recommended reduction in the number of these schemes and their funding in a phased
manner, as well as flexibility in the guidelines governing their implementation to suit state-specific situations.

The Chaturvedi Committee on “Restructuring of CSS” recommended that apart from providing greater operational
flexibility to States to address development gaps, the committee recommended reduction in the number of Centrally
sponsored schemes.

The Inter State Council should be strengthened by establishing clear norms for consultation between the Union and
the States, inducting domain expertise either within the structure of the Council or through consultative
mechanisms, providing adequate regional representation in the formulation of policies and strategy and, perhaps, in
staffing the secretariat.

We recommend for consideration the evolution of a new institutional arrangement, consistent with the overarching
objective of strengthening cooperative federalism, for: (i) identifying the sectors in the States that should be eligible
for grants from the Union, (ii) indicating criteria for inter-state distribution, (iii) helping design schemes with
appropriate flexibility being given to the States regarding implementation and (iv) identifying and providing area-
specific grants.

Goods and Services Tax

The main concern about compensation highlighted by the States are (a) proper estimation of revenue loss and
corresponding compensation package, (b) a credible compensation mechanism and (c) the period of compensation.

It is suggested that 100 percent compensation be paid to the States in the first, second and third years, 75 per cent
compensation in the fourth year and 50 per cent compensation in the fifth and final year.

The Commission recommends that a GST Compensation Fund be set up by the Union to compensate the States for
their revenue losses. We, therefore, recommend the creation of an autonomous and independent GST Compensation
Fund through legislative actions in a manner that it gives reasonable comfort to States, while limiting the period of
operation appropriately.

In particular, exclusion of any goods from the ambit of GST through Constitutional guarantee is not desirable. This
could lead to leakages of revenues due to disruption of tax credit chain and audit trails and would continue to have
the problem of cascading.

Fiscal Environment and Fiscal Consolidation Roadmap

We consider the existing ceiling on the fiscal deficit of the Union Government at 3 per cent of GDP appropriate, but it
may be able to achieve this by the end of 2016-17. The debt-GDP ratio of 45 per cent desired by the FC-XIII at the end
of 2014-15 is also treated as an appropriate ceiling to start with.
The National Small Savings Fund (NSSF) operations combine several functions. These are: (a) sovereign debt
management, involving financing through involuntary borrowings by States, (b) banking, outside the prudential norms
applicable to commercial banking, (c) financial intermediation by the sovereign outside the fiscal accounts, (d) inter-
governmental transfers, preventing full exposure of States to the market and (e) savings promotion.

Consolidated Sinking Fund (CSF) is an integral part of prudent fiscal management. The CSF creates a cushion to meet
repayment obligations in times of fiscal/market stress, as it boosts investor confidence and thereby facilitates
borrowing in the primary market at a reasonable cost even in normal times.

The Union Government amended the FRBM Act in 2012 by including the definition of an effective revenue deficit. The
effective revenue deficit, as defined in the Act, is the difference between the revenue deficit and grants for the
creation of capital assets. There is a further definition of grants for creation of capital assets to mean the grants-in-
aid given by the Union Government to State Governments, Constitutional authorities or bodies, autonomous bodies,
local bodies and other agencies implementing schemes for the creation of capital assets which are owned by the said
entities.

We recommend that the Union Government should consider making an amendment to the FRBM Act to omit the
definition of effective revenue deficit from 1 April 2015. We also recommend that the objective of balancing
revenues and expenditure on the revenue account enunciated (express in clear terms) in the FRBM Acts should be
pursued.

A number of countries have constituted fiscal councils to monitor fiscal policy calibration, particularly since 2005. A
common objective of these fiscal councils is to assist the national legislatures to monitor and evaluate the fiscal
adjustment process and impart greater transparency to this process by objectively estimating the costs of various
policies and programmes. The fiscal councils also enhance accountability to Parliament/Legislatures and the public at
large in calibrating fiscal policies. In addition, these institutions are also mandated to undertake objective and
independent evaluation of budget forecasts in order to impart greater realism to budget formulation. Experience
shows that such independent institutions may undertake ex-ante (before an event takes place) analysis and ex-post
evaluation.

In an amendment to FRBM Act in 2012, a new Section 7A was inserted which requires the C&AG to conduct a periodic
review of the compliance of the provisions of the FRBM Act by the Union Government.

We recommend an amendment to the FRBM Act inserting a new section mandating the establishment of an
independent fiscal council on the lines indicated above to undertake ex-ante assessment of the fiscal policy
implications of budget proposals and their consistency with fiscal policy and Rules. In addition, we urge that the
Union Government take expeditious action to bring into effect Section 7A of the FRBM Act for the purposes of ex-post
assessment.

Pricing of Public Utilities

Our approach on Pricing rests on four pillars: measurement, pricing, subsidies and regulation

The Electricity Act, 2003, currently does not have any provision of penalties for delays in the payment of subsidies by
State Governments. We, therefore, recommend that the Act be suitably amended to facilitate levy of such penalties.

We endorse the initiative to set up a Rail Tariff Authority (RTA) and urge expeditious replacement of the advisory
body with a statutory body, through necessary amendments to the Railways Act, 1989.
The tariff structure in the Railways is characterized by very low passenger fares and high freight charges. To remedy
this, a regulatory framework for tariff setting is urgently required. Union Government has recognized this need and
recently approved the setting up of a RTA. This requires an amendment of the Railways Act, 1989.

The primary function of the RTA would be to develop an integrated, transparent and dynamic pricing mechanism
for the determination of tariffs for the Indian Railways.

We endorse the initiative to set up a RTA and urge expeditious replacement of the advisory body with a statutory
body, through necessary amendments to the Railways Act, 1989.

We recommend the setting up of independent regulators for the passenger road sector, whose key functions should
include tariff setting, regulation of service quality, assessment of concessionaire claims, collection and dissemination
of sector information, service-level benchmarks and monitoring compliance of concession agreements.

We recommend that all States, irrespective of whether WRAs are in place or not, consider full volumetric
measurement of the use of irrigation water. Any investment that may be required to meet this goal should be borne
by the States, as the future cumulative benefits, both in environmental and economic terms, will far exceed the initial
costs.

We recommend that States (and urban and rural bodies) should progressively move towards 100 per cent metering
of individual drinking water connections to households, commercial establishments as well as institutions. All existing
individual connections in urban and rural areas should be metered by March 2017 and the cost of this should be borne
by the consumers.

Public Sector Enterprises

In our view, the evaluation of the fiscal implications of the current level of investments in, and operations of, the
existing public enterprises, in terms of opportunity costs, is an essential ingredient of credible fiscal consolidation.
Hence, we recommend that the fiscal implications in terms of opportunity costs be factored in while evaluating the
desirable level of government ownership for each public enterprise in the entire portfolio of Central public sector
enterprises

We recommend that the route of transparent auctions be adopted for the relinquishment of unlisted sick
enterprises in the category of non-priority public sector enterprises.

The NIF, at present, serves no purpose except for routing the disinvestment receipts through the public account for
limited accounting needs. We, therefore, reiterate the recommendations made by the FC-XIII to maintain all
disinvestment receipts in the Consolidated Fund for utilization on capital expenditure. The National Investment Fund
in the Public Account should, therefore, be wound up in consultation with Controller General of Accounts (CGA) and
C&AG.

We recommend that, in view of the significant fiscal implications, a clear-cut and effective policy on investments of
Central public sector enterprises in their subsidiaries be adopted.

We recommend that a Financial Sector Public Enterprises Committee be appointed to examine and recommend
parameters for appropriate future fiscal support to financial sector public enterprises, recognizing the regulatory
needs, the multiplicity of units in each activity and the performance and functioning of the DFIs.

Public Expenditure Management

We endorse the view that the transition to accrual- based accounting by both the Union and State Governments is
desirable. We also recognize that this transition can only be made in stages, as it requires considerable preparatory
work and capacity building of accounting personnel. We, therefore, reiterate the recommendation of the FC-XII that
the building blocks for making a transition to the accrual-based accounting system in terms of various statements,
including those listed by the Commission, should be appended in the finance accounts by the Union and State
Governments. We also reiterate its recommendation that action should be taken to build capacity among accounting
professionals in accrual-based accounting systems.

We recommend the linking of pay with productivity, with a simultaneous focus on technology, skills and incentives.
Further, we recommend that Pay Commissions be designated as 'Pay and Productivity Commissions', with a clear
mandate to recommend measures to improve 'productivity of an employee', in conjunction with pay revisions. We
urge that, in future, additional remuneration be linked to increase in productivity.

Dissent by Prof. Abhijit Sen

The Centre’s acceptance of the FC recommendation to raise the states’ share of divisible Central taxes from 32 to 42
per cent has increased the projected receipts of the states by Rs 1.41 lakh crore — that is, by 37 per cent. But this has
been matched by a reduction of Rs 1.34 lakh crore in the budgeted Central assistance to state plans (CASP). Even
taking into account the grants-in-aid recommended by the FC, the total transfers from the Centre to the states go up
from Rs 7.62 lakh crore in 2014-15 (budget estimate) to Rs 7.93 lakh crore in 2015-16, a nominal increase of only 4 per
cent. Any increase in the share of the states was bound to be met by cut-backs on centrally funded schemes.

My main concern was that 42 per cent tax devolution would shrink the Centre’s net tax resources by nearly 1 per
cent of the GDP and this could be disruptive if cuts were made unilaterally by the Centre across the various Plan
schemes and block grants, giving the states very short notice.

The RKVY is among the schemes to be “run with changed sharing pattern”, with a 2015-16 allocation that is slightly
less than half of the 2014-15 budget estimates. But no allocation has been made for the NCA and BRGF in 2015-16.

the end of the BRGF district component may make the ministry of Panchayati raj almost redundant since its Plan
budget has been reduced from Rs 7,000 crore in 2014-15 to Rs 94 crore in 2015-16. Moreover, this means that,
despite a sizeable FC award, panchayats across the country will collectively receive less from the Centre in 2015-16
than in 2014-15, with the burden falling on the poorest districts.
Budget 2016-17
Rail Budget 2016-17

The theme of the budget is overcoming challenges-reorganize, restructure, and rejuvenate Indian Railways:”Chalo,
Milkar Kuch Naya Karein”

The three pillars of strategy are New Revenues (Nav Arjan), New norms (Nav Manak) and New structures (Nav
Sanrachna)

Motto of the budget is Yatri ki Garima, Rail ki gati, Desh ki pragati

Key provisions

 Passenger fares have been left untouched

 Wifi at 100 stations this year and meals optional on some trains
 Passengers can ask staff to clean the coaches of the train
 3 new fast train servies Humsafar (focus on India's middle-class travelers, will be an exclusively three-tiered
AC train with optional meals), Uday (overnight double-decker train) and Tejas (high-tech entertainment
units, Wi-Fi facilities, and integrated braille displays) will be launched
 Superfast unreserved train named Antyodaya Express
 Aastha circuit to connect all main pilgrimage centres via train
 All stations will be brought under CCTV surveillance
 Additional berths and water vending machines
 Mahamana express with modern refurbished coaches
 Optional travel insurance
 Quota for senior citizens and women has been increased
 Freight rates will also be cut soon
 Passengers will have the choice to have local cuisine
 North East India mainly Mizoram and Manipur would be connected through broad gauge
 Lumbing-Silchar section in Assam has been opened providing connectivity of Barak valley to the rest of the
country
 Rail Mitra Sewa has been launched to expand Sarathi Seva in Konkan railway that helps old and disabled
passengers
 Children’s menu to be provided
 All operational halts will be converted into commercial halts
 1000 unmanned level crossings to be eliminated
 All India 24x7 helpline number for safety specially women
 Automatic ticket vending machines
 All stations will be developed to make them accessible for divyang
 All train coaches will become Braille enabled
 25 tonne will make infrastructure suitable to carry 25 tonne axle load
 Mission hundred will deal with freight terminals and sidings with greater private participation
 Under Raftaar, speed of freight trains would be doubled
 Under beyond book keeping, there will be a move from single entry to double entry
 Revenue projections are set at Rs. 184000 crores
 How to achieve investment target of Rs. 100002 crore is not clear
General Budget 2016-17

The budget clearly focuses on agriculture and rural economy. It has also laid stress on infrastructure and public
investment in the same. GDP growth is pegged at 7.6%.

9 pillars of the budget are

 Agriculture and farmers welfare with a focus on doubling farmers’ income in 5 years
 Rural sector with focus on employment
 Social sector
 Education, skills and job creation to make India a productive society
 Infrastructure and Investment to enhance efficiency and quality of life
 Financial sector reforms
 Governance and ease of doing business
 Fiscal discipline
 Tax reforms
Corporation Tax>Income Tax>Union Excise Duties>Service Tax>Customs

Foreign exchange reserves touched highest ever level of about $355.55 billion.

Plan and Non-plan classification to be done away from 2017-18

Committee to review implementation of FRBM Act

Rashtriya Gram Swaraj Abhiyan proposed with allocation of Rs. 655 crores. The scheme will help Panchayat Raj
Institutions deliver Sustainable Development Goals

Deen Dayal Antyodaya Mission to bring every block under drought and rural distress as an intensive block

100% electrification of rural villages by 2018

Digital literacy scheme to cover 6 crore more rural houses

Rs. 850 crore to be spent on livestock and cattle development

Rs. 2000 crore for initial cost for providing LPG to BPL homes
10 public and private institutions to emerge as world class teaching and research institutions

1% excise imposed on articles of jewellery excluding silver

0.5% Krishi Kalyan cess to be levied on all services

Pollution cess of 1% on small petrol, LPG and CNG cars; 2.5% on diesel cars and 4% on high end models

Deduction for rent paid will be raised from Rs. 20000 to Rs. 60000 to benefit those living in rented houses

Service tax exempted for housing construction of houses less than 60 square metres

15% surcharge on income above 1 crore

2.87 lakh crore grants to gram panchayats and municipalities- a quantum jump of 228%

Allocation to social sector at Rs. 1.5 lakh crores

Health protection scheme for health cover up to Rs. 1 lakh per family

Total Rs. 97000 crores for road construction including PMGSY (27000 crore)

New Greenfield ports to be developed on east and west coasts

100% FDI in marketing of food products produced and marketed in India

Those with undisclosed income can come clean by paying a tax of 45%

Ek Bharat Shrestha Bharat programme will be launched to link states and districts in an annual programme that
connects people through exchanges in areas of language, trade, culture, travel and tourism

Education Sector

 Allocation of Rs. 72394 crores compared to Rs. 68963 crores last year which is 4.9% increase
 If you consider inflation and GDP growth rate, education budget comes to lower than last year’s allocation
and remains far from the desired 6% of GDP
 10 public and private institutions to emerge as world class teaching and research institutions
 Allocation of Rs. 1700 crore for 1500 multi skill development centres, targeting skilling 1 crore youth in the
next 3 years under PM Kaushal Vikas Yojana and allocation of Rs. 500 crore for promoting entrepreneurship
among SC/STs
 Digital literacy scheme to cover 6 crore more rural houses
 Opening 62 new Navodaya vidyalayas to provide quality education
 (Its significance lies in the selection of talented rural children as the target group and the attempt to provide
them with quality education comparable to the best in a residential school system. These talented children
otherwise would have been deprived of quality modern education traditionally available only in the urban
areas. Such education would enable students from rural areas to compete with their urban counterparts on an
equal footing.)
 Creation of Higher Education Funding Agency with Rs. 1000 crore

Agriculture and Farmers’ welfare

 Allocation to farm sector at Rs. 35984 crore

 28.5 lakh hectares to be brought under irrigation as per PM Krishi Sinchayee Yojana
  5 lakh acres to be brought under organic farming
 Long term irrigation fund in NABARD with initial corpus of Rs. 20000 crore
 Double farmers’ income in 5 years
 100% FDI in marketing of food products will benefit farmers as fruits and vegetables will fetch right prices and
also reduce their wastage
 Krishi Kalyan cess of 0.5% on all taxable services to improve agriculture and welfare of farmers
 Dairy development for advanced breeding and animal wellness
 PM Fasl Bima Yojana with nominal premium and highest ever compensation in case of crop loss

Social Sector

 LPG connection to all BPL families

 New Health protection Scheme (one third of Indian population) with health cover up to Rs. 1 lakh
 Under Jan Aushadi Yojana 3000 stores to be opened for providing quality medicines at affordable prices
 National Dialysis Services Programme in PPP mode to provide services in all district hospitals
 Stand Up India Scheme -2 projects per bank branch to benefit 2.5 lakh entrepreneurs
 National SC and ST hub in partnership with industry associations

Rural sector

 Total allocation of Rs. 87000 crore

 2.87 lakh crore grant in aid to Gram Panchayats and municipalities
 SP Mukherjee Rurban Mission to develop 300 clusters. These clusters will incubate growth centres in rural
areas by providing amenities and market access for the farmers
 Digital literacy mission to cover 6 crore additional households
 Rashtriya Gram Swaraj Abhiyaan with Rs. 655 crore
 Rs. 27000 crore for PM Gram Sadak Yojana

Infrastructure and investment

 10000 kms of National Highways to be approved

 Total investment in roads including PMGSY at Rs. 97000 crores
 Total infrastructure investment outlay at Rs. 221246 crore
 Opening up road transport by removing permits in passenger transport segment
 Calibrated marketing freedom to incentivize gas production from deep water areas
 100% FDI through FIPB route in marketing of food products
 Revive 160 unserved and underserved airports in partnership with state governments
 Reforms in FDI policy in insurance and pension, asset reconstruction companies and stock exchanges
 Steps to revitalize PPPs
o Public utility (dispute resolution) Bill
o Guidelines for renegotiation of PPP concession agreements
o New credit rating system for infrastructure projects

Skills and Job Creation

 1500 multi skill training institutes to be set up under PM Kaushal Vikas Yojana
 National Board for skill development certification to skill 1 crore youth in 3 years
 100 model career centres to help job seekers connect with potential employers and skill providers
  Model shops and establishments bill to be circulated to states (allow cinema halls, restaurants, shops, banks
and other such workplaces to be open 24/7. The law would also enable women to work during the night in
such offices with mandatory cab services and other workplace facilities for them.)
 GOI to pay 8.33% of EPF for all new employees enrolling to EPFO for the 1st 3 years
 Entrepreneurship training and education-2200 colleges, 300 schools, 500 Government it is and 50 vocational
training centres through Massive Open Online Courses
 Deduction under Section 80JJAA of IT Act available to all assesses

Reforming the financial sector

 Comprehensive code on resolution of financial firms to be introduced

 Statutory basis for a monetary policy framework and a monetary policy committee
 Deepening of corporate bond market
 Financial Data Management Centre to be set up for data aggregation and analysis
 Amendments in SARFAESI Act, 2002 to enable sponsor of an ARC to hold up to 100% stake in ARC
 Comprehensive central legislation for dealing with menace of illicit deposit taking schemes
 Roadmap for consolidation of public sector banks
 Allocation of Rs. 25000 crore for recapitalization of PSBs
 General insurance companies owned by government to be listed on stock exchanges

Governance and ease of doing business

 Creating social security platform- bill for targeted delivery of subsidies, benefits and services using Aadhaar
framework
 Introduce DBT on pilot basis for fertilizers
 Automation facilities in 3 lakh fair price shops by March 2017
 Companies Act amendment to improve enabling environment for start ups
 Price stabilization fund to help maintain stable prices of pulses
 Nationwide rollout of ATMs and micro ATMs through postal network

Fiscal Discipline

 Fiscal deficit in 2016-17 targeted at 3.5%

 Setting up a committee to review implementation of FRBM Act
 Every new scheme sanctioned to have sunset data and outcome review
 Plan and Non-plan classification to be done away with from 2017-18

Tax reforms

 Roadmap to reduce corporate tax while phasing out tax exemptions

 Deduction for additional interest of Rs. 50000 per annum for loans up to Rs. 35 lakhs for first time home
buyers
 13 cesses levied by various ministries to be abolished
 Decreased tax burden on individuals –ceiling tax rebate under section 87A raised from Rs. 2000 to Rs. 5000
(Currently, under this section a resident individual with income up to or equal to Rs 5 lakh can get a rebate in
tax equal to 100 per cent of the income tax payable or Rs 2000 whichever is less. This low cap of Rs 2000 has
now been increased to Rs 5000.)
 Rent deduction limit under 80GG increased from Rs. 24000 to Rs. 60000
  Tax relief for MSME sector-turnover limit under presumptive taxation scheme in section 44AD of IT Act
increased to Rs. 2 crore (A person adopting the presumptive taxation scheme can declare income at a
prescribed rate and, in turn, is relieved from tedious job of maintenance of books of account.)

Cheer for first home buyers

 Additional interest deduction of Rs. 50000 a year for loans up to Rs. 35 lakh sanctioned during 2016-17 for
first time homebuyers. However cost of house should be less than 50 lakhs.
 Service tax will not be imposed on developers of affordable housing with unit sizes less than 30 square metres
in the larger cities and 60 square metres in the smaller cities.
 Excise duty exemption for ready mix concrete for use in construction work

Chance for tax evaders to come clean

The government has decided to open a one-time, four-month compliance window called “Income Disclosure
Scheme” for domestic black money-holders. This gesture is intended to help them come clean by paying tax and
penalty of 45 per cent.

The compliance window will enable one to declare undisclosed income or income represented in the form of any
asset, and clear up past tax transgressions by paying tax at 30 per cent, a surcharge of 7.5 per cent and a penalty of
7.5 per cent. This will add up to 45 per cent of the undisclosed income. The surcharge at 7.5 per cent will be called
Krishi Kalyan surcharge, and the money thus raised will be used for agriculture and rural economy.

(surcharge goes to consolidated fund of India and can be used for any purpose, a cess is earmarked for a particular
purpose only)

One-time Direct Tax Dispute Resolution Scheme

The one-time Direct Tax Dispute Resolution Scheme is aimed at resolving cases pending in any Court or Tribunal,
Arbitration or mediation under the Bilateral Investment Protection Agreement (BIPA). It will provide a stable and
predictable taxation regime. As per the existing law, these companies are liable to pay everything, including principal
tax, interest and penalty… now they can simply pay off principal amount and entire interest and penalty can be
waived off. The government expects that the scheme will help to hasten the resolution of the outstanding issues
between the tax department and companies such as Vodafone and Cairn following notices for multibillion dollar tax
liabilities.

Others

 Union Finance Minister introduced a Rs. 2,000-crore scheme for providing cooking gas cylinder connections to
poor households
 a scheme to protect the poor from high healthcare costs with a cover of Rs. 1 lakh and an additional cover of
Rs. 30,000 for senior citizens
 a plan to list public sector general insurance companies and a new policy for strategic sales as well as making
public sector enterprises take up fresh investments
 Arun Jaitley announced an increase in the quantum of securities transaction tax (STT) on options contracts
from the current 0.017 per cent to 0.05 per cent.

Agriculture and Farmers

Cess of 0.5% on all taxable services that would expressly be used to finance improvements in agriculture and schemes
to benefit farmers
Dedicated long term irrigation fund with a corpus of Rs. 20000 crore

Salaried class

Accumulated savings under the National Pension Scheme (NPS) that were fully taxable at the time of retirement would
now be taxable only for 60 per cent of the retirement corpus. The same logic has been extended to the EPF making 60
per cent of savings taxable at the time of withdrawal. EPF contributions, income as well as the final corpus at
retirement were tax-free till now.

The Finance Ministry, with this move, has sought to bring parity between the Labour Ministry-run EPF, the NPS and
the superannuation pension funds in terms of their tax treatment. EPFO manages around Rs. 10 lakh crore of
retirement savings from 8.5 crore members, while NPS accounts number 1.15 crore with savings totaling Rs. 1.1 lakh
crore.

Along with this, the Finance Minister proposed a one-time exemption from any tax liability on those looking to switch
their retirement savings from a recognized provident fund or superannuation fund to the National Pension System.

He also proposed tax incentives for the Sovereign Gold Bond Scheme and the Gold Monetization Scheme.

“Earlier, contributions to PF up to 12 per cent of the base salary were exempt from tax. Now, contributions above Rs.
1.5 lakh will be taxed. Along with this, on withdrawal, 60 per cent of the amount will be taxed except in case of
excluded employees [those earning a monthly salary not exceeding a yet to be specified amount]

Gold Bonds

“It is proposed to provide that redemption by an individual of Sovereign Gold Bond issued by RBI under Sovereign
Gold Bond Scheme, 2015 shall not be charged to capital gains tax. It is also proposed to provide that long term capital
gains arising to any person on transfer of Sovereign Gold Bond shall be eligible for indexation benefits,” Mr. Jaitley
said. Along with this, he proposed that the interest and capital gains earned on the deposits under the Gold
Monetization Scheme also be made exempt from tax.

Mr. Jaitley has also proposed to raise the surcharge levied on individuals earning above Rs. 1 crore a year from 12 per
cent to 15 per cent. He also proposed a 10 per cent tax to be levied on individuals or companies earning dividends
more than Rs. 10 lakh.

Those earning less than Rs. 5 lakh a year will now receive a tax rebate of Rs. 5,000 under section 87A, up from a rebate
of Rs. 2,000 earlier.

Cars

According to the budget speech, there will be a levy of one per cent infrastructure cess on petrol/LPG/CNG-driven
motor vehicles of length not exceeding 4 metres and engine capacity not exceeding 1200cc; 2.5 per cent cess on
diesel-driven motor vehicles of length not exceeding 4 metres and engine capacity not exceeding 1500cc; and four per
cent for other big sedans and SUVs.

Also, there will be an additional one per cent ‘luxury tax’ on all the cars priced above Rs. 10 lakh and increase in
service tax by addition of 0.5 per cent Krishi Kalyan cess.

Air travel

Airfares are likely to go up as the government announced a sharp increase in the excise duty levied on aviation
turbine fuel (ATF).
Now, 14 per cent excise duty will be charged on aviation fuel, up from eight per cent at present. However, the excise
duty hike will not apply to the supply of fuel from regional routes, under the proposed Regional Connectivity Scheme.

Aadhaar to get legal backing

In a bid to ensure that the benefits of various government subsidies reach the people “who deserve it,” the
government plans to give statutory backing to the Aadhar platform. It will soon introduce a Bill in Parliament linking
various financial inclusion schemes with Aadhaar numbers.

The move will help streamline delivery of government subsidies to the poor and the government plans to bring all the
benefits and subsidies funded from the Consolidated Fund of India on the Aadhaar platform.

“First, we will introduce a Bill for Targeted Delivery of Financial and Other Subsidies, Benefits and Services by using the
Aadhaar framework. The Bill will be introduced in the current Budget Session of Parliament,” Mr. Jaitley said. He,
however, added that the Aadhaar number will not confer any right of citizenship or domicile.

Infrastructure

Finance Minister Arun Jaitley on Monday announced a record budgetary allocation of Rs. 2.21 lakh crore for
infrastructure sector, in a crucial move to revive investments in the sector with the participation of the private
players.

The roads sector alone has been allocated Rs. 97,000 crore as the government plans to award 10,000 kilometres of
new road projects in FY17, including Rs. 19,000 crore earmarked for rural roads under the Pradhanmantri Gram Sadak
Yojna. The aim is to connect 65000 villages unconnected by roads by 2019.

The finance minister announced a series of measures for modernizing existing ports and building new ports along
India’s east and west coasts. He said that initiatives are being introduced to reinvigorate infrastructure sector through
Public-Private Partnership (PPP).

There are about 160 airports and air strips under state governments that can be revived at an indicative cost of Rs.50
crore to Rs. 100 crore each. The central government will develop 10 out of the 25 non operational air strips that are
with the AAI

In 2015, India’s major ports handled the highest ever quantity of cargo. New Greenfield ports to be developed in
Eastern and Western Coast. The work on the National waterways is also being expedited. Rs. 800 crore has been
provided for these initiatives
Important Terms

Basis Point: 1 Basis point = 1% of 1% = 0.01%

Bill of Exchange: A written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain
sum, either immediately (a sight bill) or on a fixed date (a term bill), for payment of goods and/or services received.

Central Excise Duty: Indirect tax levied on those goods which are manufactured in India and are meant for home
consumption. It is a tax on manufacturing, which is paid by a manufacturer, who passes its incidence on to the
customers.

Current Account Deficit: Exports - Imports + Net income from abroad + Net current transfers

Customs Duty: Indirect tax levied on the import and export of goods in international trade (border taxes)

Deflation: Drop in prices

Direct Tax: It is collected directly by the government from the person on whom it is imposed. Eg: Income tax,
corporate tax

Disinflation: Drop in the rate of growth of prices

Indirect Tax: It is a tax collected by an intermediary (such as retail store) from the consumer (who bears the ultimate
burden) and later forwards it to the government. Eg: Sales tax, GST, VAT, Customs Duty, Excise Duty etc.

Sovereign Wealth Funds: State owned investment funds investing in real and financial assets such as stocks, bonds,
real estate etc. Most SWFs are funded by revenue from commodity exports or from forex reserves held by central
bank